Bespoke budgeting: A plan for you
My previous posts argued that money is not the end game, but rather it is a tool that can help enable your life strategy. Now it’s time to think about how to structure a financial plan that will facilitate the life you want to live.
Hot take: You need a budget
Corporations use the terms “plan” and “budget” synonymously for good reason. A budget is an intentional plan made in advance that outlines anticipated revenues, how much can be spent and on what, and how much profit will be generated.
Every legitimate company in the world has a budget - and you should too.
This is not just a tool for people trying to make ends meet. Your budget is your plan for how you are going to balance competing needs and wants – both in the present and the future. It’s insane not to have a plan for something this important.
Back to square one
Every personal finance book, blog, and sweatshirt will agree on this simple truth: if you want financial freedom, you need to “live below your means”. AKA, spend less than you make. A la, save some of your earnings.
JL Collins, author of the bestselling book “The Simple Path to Wealth”, says it bluntly in his manifesto:
“If your lifestyle matches or, god forbid exceeds, your income you are no more than a gilded slave.”
Without savings, you’ll have to work your entire life and/or convince someone else to fund your existence. And you’ll be one unexpected event away from being plunged into debt and possibly bankruptcy.
At the beginning of your financial journey, I agree with Dave Ramsey when he says, “Your most powerful wealth-building tool is your income. And when you spend your whole life sending loan payments to banks and credit card companies, you’re making everyone else wealthy, and you end up with less money to save and invest for your own future.”
I suspect everyone reading this post will accept this point as elementary and obvious – so let’s move on.
Income vs Balance Sheet Goals
For me, everything starts with clearly articulating your financial goals. Sounds obvious, but many people skip this step.
I think of financial goals in two buckets based on how they will be funded.
Income Goals: These are recurring cash outflows that must be funded by wage earnings each year (prior to retirement). This includes charitable giving and the ongoing lifestyle you want to enjoy (both baseline needs and discretionary wants). These outflows need to be (sufficiently) below wage earnings to yield savings.
Balance Sheet Goals: These are the big-ticket items that you save toward. When it comes time to buy them, the funds are (conceptually) withdrawn from the accumulated nest egg. A sound financial plan ensures that annual savings, coupled with a robust investment strategy, will yield enough funds to cover these balance sheet goals at the desired timing.
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My wife and I have 4 core balance sheet goals:
Own reliable and safe cars
Own a home in a safe/fun location that is comfortable for our family
Fully fund college for all 3 of our kids
Retire at our target age with the ability to live our desired lifestyle and leave a legacy for our children and charities.
A 5th – but conceptually different – balance sheet goal is to be able to absorb an unexpected negative financial shock (e.g. temporary loss of income, large surprise expense, etc.) This is consistent with the standard guidance of building an emergency fund.
All other expenses are charged to the annual P&L (i.e. funded by wage earnings).
I know other families will save multiple years for larger expenditures such as a special vacation, house projects, etc. These are short-term balance sheet goals if you want to go beyond what would make sense based on a single year’s income. And it’s smart to ‘accrue’ in advance for these items versus taking on debt to play catch-up after the fact.
If you save for it in advance, college tuition is a major “balance sheet” goal.
How much do you need to save?
When I was in college my dad told me, “Saving should be an intentional part of your personal budget, not just something that happens should there be money left over at the end of a month.”
Well said. But how much should you save?
Don’t blindly follow dumb rules of thumb you find on the internet.
For example, search Google for, “How much of my income should I save?” The first result I see is for the 50/30/20 rule: Spend 50% on necessities, 30% on discretionary items, and save 20%. It’s simple and easy to remember, but it might not get you to the life you want to live.
Your savings targets should be linked to your financial goals, which should be rooted in your life strategy. Don’t worry about what your neighbor, sibling, or co-worker is doing.
Know your numbers
This is where it gets fun – math! Most of the elements of your ongoing lifestyle today should be relatively easy to quantify (income goals). You know how much it costs to live in your desired geographic area. You can easily estimate your groceries and entertainment expenses. And so on.
A harder task, but just as important, is to calculate the annual savings required to fund your big-ticket future balance sheet goals. Let’s do a few for fun…
House
The math here is easy. For example, you’ll need $150,000 to put 20% down on a $750,000 house. If you want to buy in 4 years, you’ll need to keep the assets in safe, liquid investments.
To accomplish your goal, you’ll need to save ~$34,000 in year 1, increase this with inflation in years 2-4, and invest the funds in a vehicle that slightly bests inflation.
College
Let’s say you want to give your kids the opportunity to attend the best college in the world (Duke, of course!) and you don’t want to bank on a basketball scholarship.
Not-so-fun fact: You should open a 529 account and save ~$17,000 the year your diaper dandy is born and increase this amount annually by inflation every year until they graduate college. And that’s just for 1 kid!
Retirement
Retirement is a big one that gets much (rightful) attention by the personal finance community. Much more on this in future posts, but yes, maxing out your 401(k) is a great idea even in your early 20s. Let’s do some basic math for our fictitious friend JJ.
JJ is 22 and just graduated from college. He maxes out his 401(k) in 2024 by contributing $24,000 and commits to increasing this each year by inflation.
The fed keeps inflation in check at 2% and JJ earns an 8% return on his portfolio. Recognizing that a pre-tax retirement account is really a joint venture with the IRS, he mentally haircuts 20% to pay to the government someday.
By age 60 JJ will have $2.8m in today’s dollars. Using a 3.5% safe withdrawal rate, he could retire with an annual budget of ~$100,000 for the rest of his life, and likely leave a substantial inheritance for his kids. This is the power of starting early, staying committed, and capitalizing on the financial miracle of compounding.
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It’s okay to get help on the calculations if you need to, but you need to know what it will take to achieve your goals. Otherwise, you risk overspending today and shortchanging your future self.
Iterate until the slipper fits
Here’s a mathematical fact: Inflows – Outflows = Savings.
Maybe you’ll be lucky and on your first pass your desired spending levels today yield a savings amount that exceeds the threshold required to hit your future balance sheet goals. If so, congrats – your budget is ready to go!
However, you’ll likely need to iterate (and make tradeoffs) until you are happy with the balance of present vs future wants and needs.
When the equation isn’t balancing, you’ve got 4 major levers to pull: earn more, cut your current spending, revise your balance sheet goals, or push out your timeline.
Where do you stand?
In recent years, I’ve started calculating and tracking our “funded ratio”. This is our total savings (i.e. net worth) divided by the total amount required to accomplish all our balance sheet goals. Conceptually, when this equals 100% you can hang up your Nike’s and retire.
I also think the funded ratio can be a helpful tool to keep you grounded on your goals and mitigate the temptation to chase the ever tempting ‘more’. It is well-documented that people at all income levels say that they would need more money to ‘really be happy’. The trap is obvious – you think getting to the next income rung will make you happy, but the people already there usually aren’t!
In our sinful nature, the human heart is always tempted to covet more. We must constantly seek God’s help to keep desire in check.
Conclusion
I believe you should have a financial plan that is bespoke to your specific goals and rooted in your life strategy. You have to know what you are solving for.
The median net worth for US families is ~$103,000. The average savings rate is just 4.1%, and the average American has ~$102,000 in debt. A 2023 survey indicated that 63% of employees would be unable to cover a $500 emergency expense. Most people haven’t cracked the code on personal finance.
Stay focused, be intentional, and don’t be distracted by what other people are doing. After all, if you want a different outcome, you need to be different.