Monday, May 27, 2013

Spring Clean your finances: Budgeting for recurring expenses

Once you have your monthly budget set up and working, the next step is to plan for your periodic expenses, things like your insurance premiums, taxes, or any other budget item that comes up less often than every month.

There's a reason why I think this is the most important next step in getting your finances in order, before you even think about emergency cash reserves or debt reduction: You've ALREADY spent this money.  You don't have it anymore.

Let me say that again, in case it wasn't clear.

You don't have this money anymore.  It's already spent.  You may see it in your checking account and think, Hey, look at all this money I have to buy pretty things for my house, save for my kids' college, or pay off my student loans.  You're wrong.  It's an illusion.  It's not there anymore.  It's already spent.

Do you need to re-read that a few times in order to internalize it?  It's okay.  I'll wait.  Let me know when you're ready.

So.  Now that we have that clear, let's talk about what to do about it.

If you're making a new, specific budget every month (which you should be) and you have a ton of discretionary cash (which you probably don't if you're reading this), then you can just adjust the specific month's budget by decreasing other spending to make up for the big payment you have that month.

If you don't have the cash, no matter how much you cut down on movies out, then you need to think about those expenses before the month when they're due.  This should not be money that comes out of your emergency fund or causes you to go into credit card debt because it isn't an emergency.  It isn't a surprise.  You know exactly when it's coming.

So, what to do.

I recommend setting up a separate savings account, with instant cash transfer privileges, just for your recurring expenses.  I call mine my "Freedom account" - I'm pretty sure I stole that from Suze Orman - and it's separate from my emergency fund.  (If you're extremely disciplined, you can do this as an entirely paper and pencil exercise and just keep the money in your main checking account, but you have to remember when you see the money that it ISN'T REALLY THERE.)

Then, make a list of all the expenses you have that come up a few times a year. I include Christmas on this list now, but I didn't when I was first starting out (we just had some arts and crafts Christmases for a few years).  Figure out how much you need, how often for each one.  Then, you have to fund this account.  There are two main ways to do this.

Monthly Deposits

I divide my recurring expenses by 12 (or by 6, for the ones that come up twice a year) and figure out how much they are actually costing me per month.  Then, I have my savings account set up to automatically transfer that much money out of my main checking account every month.  For each of my recurring expenses.   Then when I get a bill in the mail, I just log on and transfer the money back to my checking account.  No worries, no stress.  I know the money is there, I know that's what it's there for.

This puts a huge dent in my monthly cash flow because all of these items are line items on my budget every month.  When I think about how much money I have available to spend, I always take this out first.  This is annoying, but in the long run it's really a good thing.

Lump sum deposits

If, right now, you don't have enough money in your monthly budget to add line items for each of your recurring expenses, you need to be a little more creative about how you fund them.  Here's how I recommend doing this with lump sum deposits:

Make a list of all your recurring expenses.   List them in order of when they come due, and if you have more than one due in the same month, list them in order of importance (as in, if you run out of money and can't pay one, which one will hurt you and your family less).  Then, every time you get an extra influx of cash - some extra income, a tax return, a gift, a three pay check month - fund those expenses in the order they are on your list.  So, if you get $400 from doing an odd job for your neighbor, the first $300 might go to your life insurance premium, and the next $100 would go to your real estate taxes.  Transfer that money to your freedom account, and check off on your list what you have funded.  Continue to do this until all your expenses for the year are covered.

Again, I really recommend you do this BEFORE you do anything else with your money.  Before your emergency fund, before your debt reduction.  It will give you peace of mind because a bill will never take you by surprise and ruin you again.

(I think, ideally, your goal will be to adjust your cash flow so that you can eventually do monthly deposits.  This gives you even more peace of mind than the lump sum method, which still relies a little bit on "magic money.")

I keep my freedom fund in an ING Direct account (which isn't called that anymore.  I think it's Capital One 360 now).  When I started doing this, it was one of the highest interest accounts you could find.  It really isn't anymore, but because it's so easy to use I have kept my money there.  If you are interested, I can send you a referral link which will give you an extra $25 when you open your account (and give me a little money too).  You can also search BankRate to find which banks have the highest interest and find an account that way.  I do recommend you put this money in an account that makes you at least a little interest.  If it's just going to sit there, it might as well work for you.


Susan said...

We call ours a catastrophe fund. =)