#002 | Ballin' on a Budget
Budgeting is the foundation of the wealth-building process. Learn how you can transform your life by using a "Pay Yourself First" budget
If you want to be great at anything, you need to master the fundamentals. By sticking to the basics and being consistent, you can win big over the long term.
Managing your money is no exception to this.
By learning how to budget, it will no longer be a matter of if you will achieve your financial goals… it becomes a matter of when you will achieve them.
Creating a budget can be daunting though. There are many reasons that people decide to forgo budgeting completely.
When done right, budgeting doesn’t need to be painful or stressful. It should actually bring you peace of mind and allow you to sleep better at night.
For the last few years, I have been using my personal variation of a “Pay Yourself First” budget.
It is a straightforward budgeting system that takes a minimalist approach to personal finance. It doesn’t require spreadsheets, takes less than 10 minutes of maintenance a month, and can be automated entirely when your accounts provide the necessary features.
Despite its simplicity, it can be incredibly effective. It is the exact budget that I used to save my first $100k in cash and investments, which I later used to pay off ~$61k of student debt in full.
Today’s edition will break down everything you need to know about budgeting. By the end of this week’s article, you will have an understanding of:
What budgeting is and why it is important
Why a high income does not solve your financial problems
How to divide your money between spending, saving, and investing
Budgeting is a routine that promotes the achievement of financial goals
Just as exercising improves your physical health, budgeting improves your financial health.
Budgets provide numerous benefits. They give you a clear picture of your income and expenses, encourage mindful spending, and help you make better decisions.
Your budget is your personal blueprint for financial freedom. Creating a mindset, habits, and environment that are conducive to achieving your goals will increase your probability of success.
“You do not rise to the level of your goals. You fall to the level of your systems.”
- James Clear
It’s not about how much you make; it’s about how much you keep
Many people believe that a higher income would make their money problems go away.
Unfortunately, it’s not that simple - CNBC reported last year that 36% of those earning over 250k a year are still living paycheck to paycheck.
There are also numerous cases of multimillion-dollar earners going completely broke. Celebrities such as Allen Iverson, Mike Tyson, and Francis Ford Coppola all declared bankruptcy despite having lucrative careers in entertainment.
The wealthy understand that it’s not about how much you make; it’s about how much you keep.
If you don’t save and invest a portion of your money, you risk losing it all.
To achieve true financial freedom, you need to become an investor and find ways to make your money work for you.
There is a reason that companies like Apple, Microsoft, and Google still use budgets despite generating tens of billions of dollars every year.
Don’t fall into the misconception that you are too good to budget.
Another common reason that people struggle financially is lifestyle creep. This term describes the behavior of increasing your spending as your income increases. It can impact individuals at any income level.
Let’s compare the financial habits that describe this phenomenon:
Most People: As their income increases, they consume more. Receiving a raise at work is a queue to start looking at larger, nicer apartments (or homes) in trendy neighborhoods. They trade in their practical cars for brand-new luxury vehicles. They start dining out at more expensive restaurants and indulging in designer clothes. Their overconsumption may result in credit card debt that they pay a ~20% interest rate on. Even though their income increases, their financial future does not end up in a better place.
The Wealthy: As their income increases, they maintain their current lifestyle and invest more. They stay in the same apartment (or house) and continue driving their reliable 2012 Toyota. They never run up a credit card balance they can’t afford to pay in full. They think long-term and understand that investing can multiply their future earnings. They may still enjoy luxury items and experiences, but they spend mindfully and live within their means. Their increased income allows them to accelerate their journey to financial freedom.
Wealth isn’t about the extravagance of an opulent lifestyle - it’s about having security, freedom, and independence.
“We buy things we don’t need with money we don’t have to impress people we don’t like”
- Dave Ramsey
The Pay Yourself First budget explained
Most budgets recommend you find ways to cut your expenses, and then save or invest what’s left. This is problematic though, as most of us will not have money left to save or invest if spending is our first order of operation.
The concept of "paying yourself first" is a powerful strategy that shifts the traditional budgeting approach.
When you prioritize saving and investing a portion of your income before paying bills and other expenses, it forces you to live within your means and makes it easier to avoid overspending.
“Do not save what is left after spending… spend what is left after saving”
-Warren Buffett
Now, let’s address the 3 steps required to actually implement this budget.
Step 1: Identify your income
Your budget will be based on your monthly take-home pay (or “net pay”), which is the amount that you actually see in your bank account after taxes and other deductions have been taken out.
If you are on a salary, this will be a fixed amount that is typically paid out biweekly or semimonthly.
Business owners, freelancers, and salespeople may have a hard time budgeting, as their income during any given month can be unpredictable. If this applies to you, a conservative practice is to budget based on the lowest monthly income you’ve received over the last 2 years.
If you have a variable income, this approach implies you will have a budget surplus most months. Consider using this money to further secure your financial future, rather than viewing it as extra spending money.
Creating cash flow is the purpose of budgeting
Rich people could become wealthy if they understood cash flow.
Take-home pay - expenses = cash flow
The equation is simple - spending less than you earn creates cash flow.
Ideally, you want to grow the gap between your monthly income and expenses as much as possible. This is accomplished by increasing your income, decreasing your expenses, or some mix of both. The larger the gap is, the more money you will have available to save, invest, or use towards debt repayments.
Cash flow is also important because it is directly responsible for increasing your net worth. For example:
If your take-home pay was $3,000 last month and you had $2,800 of expenses, you generated a positive cash flow of $200. As a result, your net worth is now $200 higher.
Assume the same income, but change the expenses to $3,500. This means you generated a negative cash flow of $500. Your net worth is now $500 lower, and you have potentially put yourself in $500 of debt.
Step 2: Identify how you will allocate your income
You can only do three things with your money - spend it, save it, or invest it.
Your budget will determine how your take-home pay gets allocated between these three categories.
Here is exactly how I divide my income every payday, ranked in order of priority:
33% for saving and investing (or debt repayments)
33% for housing costs
34% for all other spending
Save and invest 33% of your income
Many budgets recommend that you save and invest 10-20% of your income. I like increasing this aggregate saving and investing rate to 33%, which can lower the time required to achieve your financial goals. (Note: It’s okay if your budget does not currently allow for a 33% saving and investing rate. This point will be addressed later in the article.)
The way you divide this 33% between saving, investing, and debt repayment doesn’t need to be set in stone. This budget is made to be flexible depending on your preferences. For example:
You can take a balanced approach to saving and investing, applying an equal 16.5% to each
If you are looking to aggressively pay down debt, you can apply 20% toward debt repayments and 13% toward saving
If stocks are looking cheap, you can invest 23% and save 10%
No matter how you mix it up, this budget is powerful because 33% of your income is responsible for improving your financial future.
33% rule for housing costs
The 33% rule is a rule of thumb that helps determine the maximum housing costs you can afford. These costs should include your rent or mortgage payments, utilities, wifi, insurance, maintenance, HOA, property taxes, and all other related costs.
You don’t want to be “house broke” though, as this can lead to limited flexibility in other areas of your budget.
Keeping housing costs around 20-25% of your monthly take-home pay is a great goal to strive for.
34% for all other spending
Once I have met my financial obligation of paying myself first, I believe in guilt-free spending.
This 34% allocation includes everything that is not related to housing costs. Expenses in this bucket include car payments, food, gas, tolls, travel, gym memberships, and more.
This budget doesn’t require you to micromanage and categorize your various expenses.
What if you can’t save and invest 33% of your income?
Understand that these are aspirational numbers you can work towards over time. It’s completely fine if your budget doesn’t permit a 33% saving and investing rate right now.
Start small if you need to. Taking a small step towards improvement is better than doing nothing at all. In the long term, minor improvements can lead to significant differences.
If you are doing nothing else to secure your financial future, try to save at least 10% of your take-home pay. Saving a modest 10% of your income for 10 years can allow you to save up one year’s worth of income!
“Most people don’t think they can afford to save. But frankly, we can’t afford not to save”
- Tony Robbins, Money Master the Game
If you can’t afford to save more than 10% of your income, be radically honest with yourself and diagnose the reason why, as different problems will have different solutions.
Is it an income problem? Earn a raise at work. Job hop for a pay raise. Take your current skills to the open market and build a book of business. Invest time into learning a new skill and start a side hustle. Start doing Uber, Instacart, or food delivery.
Are you house-broke? Consider downsizing. Look at other neighborhoods, or even other states, where you can earn a similar income and have a lower cost of living. Don’t cut costs by eliminating necessities though, such as insurance.
Do you have a spending problem? Before making a purchase, reflect on whether that item is a need or a want. Practice the 24-hour rule, which recommends that you wait 24 hours before making any discretionary purchases, potentially helping you avoid impulse buys. As mentioned earlier, spending what is left after saving can force you to live within your means.
Save yourself frustration by not comparing your financial situation to others. Remember that you are running your own race and your only competition is yourself. Your financial journey should be based on your personal benchmarks, not what other people are doing.
Step 3: Stick with your budget
The best budget is one that you are able to stick with.
The biggest key to my personal success has been automation, which makes the entire budgeting process frictionless.
In 2023, you don’t need to be a coding or computer wizard to start automating your finances. All you need is a bank, brokerage, and credit cards with the following features:
Auto bill pay
Autopay for your credit card statement balance
Scheduled transfers to savings
Recurring investments
Dividend Reinvestment Plans (DRIPs)
If you are anywhere near as lazy as myself, automation will work wonders for you. It takes a few minutes of upfront work to get started, but once you’re done, you’re done. Your wealth-building will be put on autopilot and all you need to do is monitor your balances to ensure you aren’t overspending.
“I choose a lazy person to do a hard job. Because a lazy person will find an easy way to do it”
- Bill Gates
I hope this budget works as well for you as it does for me. Now get out there, automate your budget, and get busy living your life.
That’s all for today - thank you for taking the time to read!
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