Last week, I was really looking forward to my Saturday afternoon. Why? Because I was about to make my life 100x easier and less stressful by automating my finances.
I read about it in a book by one of my favorite personal finance bloggers, Ramit Sethi called I Will Teach You to be Rich.
He had a suggestion in there that you should automate your finances, and this got me super excited. It really changed the way I thought about my income and expenses. They goal is to get to an amount that you can spend GUILT-FREE. Money you can freely spend because you have taken care of all your monthly expenses as well as your long-term and short-term savings goals.
Here’s my promise. If you spend one hour making a budget, you will have a much more commanding grasp of your money. You will have a sense of what you are spending on monthly expenses, how much you’re saving, and what you’re left with to spend on fun things.
This isn’t some budget where you have to revisit it constantly and categorize your purchases. I hate those. This is pretty much a one-time deal. You might adjust it here and there if you come across new expenses or get a raise. Otherwise, you can do this pretty much just one time and got a ton out of it. Minimal effort, huge gains.
Let’s jump in. I’m going to use a hypothetical person to illustrate the steps. Let’s use my cartoon character, Andy, as an example.
Andy is 22 years old and makes $50,000. He gets paid once a month and often counts down the days to his next paycheck so he can continue to live his comfortable life of spending whatever, whenever and dealing with it later.
Today is the day he gets his life together. He’s not looking for precision, he just wants to get a clue about how much he makes and what he can afford.
He opens up Excel and starts a small spreadsheet.
At the top, he puts his annual salary ($50,000). He knows how to work Excel formulas so he breaks it down into his monthly salary ($50,000 / 12). But wait, that’s not what he actually takes home. Don’t forget taxes and social security! Andy is going to take a guess that he takes home about only about 75% of his salary after taxes and whatnot.
So, Andy brings home $3,125 after taxes. If you have a more exact number from previous paychecks then you can save yourself from doing this estimate.
Now, he creates 3 columns. One for his monthly expenses. These are the things he needs to live. The second column is long-term savings. The third column is short-term savings.
He tackles the monthly expenses column. These are all the bare necessities. This may vary between individuals. Some may have cable, others may not. Some need car, others rely on public transportation.
Andy lives in a city and relies on public transportation. Instead of car insurance and car maintenance costs, he factors in public transportation into his costs.
Off the top of his head, he thinks about his daily routine. In order for Andy to live, he identifies the following as his bare necessities monthly expenses as well as about how much they cost.
Andy didn’t stress out too much about making exact cost measurements. If he wasn’t sure, he erred on the side of estimating more. In fact, after he’s added up all his monthly expenses he tacks on an extra 15%. This is to capture anything he may have missed or anything he miscalculated.
They key insight here is that you need at least this much money just to live. If you spend more here, you have less left over for the end result (Guilt-free spending). If you want more money to go out, you need to cut down on some of the bigger expenses like rent.
Now that that’s out of the way, the next important thing after the bare essentials is long-term savings. Yes, this is more important than short-term savings. If you are young and start putting money away for the long term (even a little), you will be way better off later on in life thanks to compounding. You should be putting away a decent chunk of money away here, but it’s really up to you. Just put some amount here Take advantage of tax-advantaged accounts such as a 401k and/or a Roth IRA. Always get as much company match as you can (if your employer offers it) because that is free money.
Andy unfortunately is not eligible for company match yet so he opts for the Roth IRA.
The last column details short-term savings goals. This includes things like holiday gifts for others, vacations, wedding, and house down payment. Did you know that the average wedding costs $28,000? Yikes! If you have any inkling of getting married at some point in your life, doesn’t hurt to start saving for it so you don’t plunge into debt after your big day. House down payments are quite costly as well. If you’re looking to purchase a home for $300,000, you’ll need to put up 20% for a down payment. Best to get an early start.
Weigh your categories accordingly, but don’t worry about not meeting certain goals. Andy thinks at the earliest he might get a house within the next 7 years. Well the down payment of $60,000 divided by 7 means he needs to save over $8,500 a year (or over $700 a month) just for a house down payment. Don’t forget, your financial situation may improve over the years so the important part is setting goals and just getting yourself started. It’s more gratifying saving for certain goals such as a vacation fund. In fact, Andy likes playing with the latest gadgets so he is putting aside $50 every month for him to buy tech related objects. He also threw in a category called Unexpected. This is for any surprise costs that life may throw Andy’s way.
The Magic Number
OKAY. So Andy has his bare essentials, his long-term savings goals, and a short list of short-term savings goals.
Here’s it all put together.
Andy checks what he’s left with. And he’s very happy. He has $546 left over to spend on WHATEVER he wants every month. That’s plenty for him at this point in his life. And he can spend it without even thinking twice because he’s already put away money for his expenses and savings.
Here’s the key to his plan. Andy will automatically pull these amounts from his paycheck every month. His paycheck will go into his checking account, and then money will be moved to his Roth IRA as well as his many savings accounts.
After he’s setup the automatic transfers, he’s saving for the short-term and long-term without even lifting a finger. Now he has a good sense of how much he has left over to spend.
This post is getting a bit long so I’ll save the actual setting up of automatic transfers and such for a later post, but if you’re anxious to get started right away it’s very easy to set up these recurring transfers. Your money goes into your checking, and from there things get moved around a few days after your payday.
- Now Andy knows he can freely spend up to $550 every month on whatever he wants. He can go eat out, party, etc. knowing he is saving a bunch of his money.
- As long as Andy spends less than $550, he is golden. If he wants to live a more expensive lifestyle, he needs to find a way to adjust for that so that he does not go into debt.
- Along those lines, the best place to find more guilt-free money is reducing your cost of living. Don’t sacrifice your savings. Get rid of unnecessary monthly expenses or move to a cheaper place.
- Use a budget to tackle debt. Set aside a large chunk of money to pay off any debt you may have.
I think this one-time budget is beautiful. You are setting yourself up for success. If you don’t do something like this, you’ll never know where your money is going or how you can start saving.
Figure out a budget you can live with. If you need $800 of guilt-free spending to enjoy life, then adjust things to make it happen. Then setup your bank accounts to move this money for you every month. Live your life freely and enjoy those moments even more knowing both your present self is happy and your future self will be happy with all that money you’re currently saving!
Ever since I’ve automated my finances, I’ve been bragging to my roommates about how much of a financial wizard I am (I’m serious). Once you’ve figured out your financial situation, you’ll want to brag too.
Give it a shot. Tell me what you think. Oh, and sign up via email up at the top right of the page. I’m thinking about making a sweet and simple Excel file with all the formulas built in and sending it to subscribers.