The Wealth-Building Power of Personal Budgeting (Part 2)
Image sourced by brandon rae @brandonrae
Welcome Back!
Today, we’re going to expand on our blog post on personal budgeting, Part 1 and discuss the three primary types of costs and expenses we incur regularly.
In case you missed Personal Budgeting Part 1, click here.
Once more, we’ll follow the “TV Q&A Interview Method” that we featured in Part 1.
Let’s get to it!
Arthur, you break down everyday spending into three types. Please explain.
The three categories are: Fixed Costs, Periodic Costs and Variable Costs.
Clearly, you must be an accountant. HA!
What can I tell you. . .
Old habits die hard. But my accounting and finance skills do come in handy now and again.
Let’s start with fixed costs.
Fixed costs are expenses or money you pay, money you spend every month.
Fixed costs stay constant – stay the same – from month to month.
Examples include rent; debt service payments that are fixed payments; car loan payments, car payments or lease payments; utilities; and property taxes.
Although, your mortgage lender may add your property taxes to your monthly mortgage payment.
Instead, if you pay your property taxes directly to your town or municipality, your town may require monthly payments or quarterly payments. In order to meet your obligations, you could budget 1/12th of the annual total taxes and set that amount aside so you have money on hand to pay the tax bill when it becomes due and payable. In other words, reduce your spending to accumulate money equal to the property tax bill.
With rent payments, the rent would stay the same for the term of your lease. The lease term could be one or two years for example.
In the event there are up-charges, you can estimate them. Assume an estimate for the costs or handle them as the costs and expenses arise.
Another way to tackle unexpected costs and unexpected expenses is to create a general amount oromnibus amount, for example an emergency fund. Where you would set aside funds for expenses that may pop up during the year.
Debt service payments, for example your monthly mortgage payments, might vary from month to month if you have a variable rate mortgage.
Utilities payments are generally fixed although you may see seasonal changes in the winter or summer. Depending on how detailed your personal budget is, you may want to use the actual estimates based on last year’s actual expenses plus an increase for inflation. Or you could calculate an average monthly amount and enter that in your budget.
Haircuts – I get a haircut every 3 to 4 weeks. A haircut costs $30 each time. I treat this as a monthly expense.
The key to financial success is to reasonably estimate your expenses so you get a solid handle on your expenses and cash flow.
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What about Periodic Costs?
Periodic costs are costs and expenses don’t occur monthly but do occur throughout the year at different times throughout the year.
One example is property taxes, which we discussed above.
The exact timing of these expenses may vary and the amount may vary as well from year to year, Periodic costs may arise at different times of the year.
Some of the expenses may be seasonal.
In other words, seasonal costs and seasonal expenses occur when an event arises.
Examples include holiday gifts, back-to-school expenses, vacation, automobile servicing, automobile repairs and home repair costs.
The marital residence had a septic tank (instead of town water and sewer). Every two years, we had to hire a septic tank cleaning service to empty the tank. Depending on the cost of the cleaning and how detailed a budget you keep, you could set aside 1/24th the cost every month. This way, you’ll accumulate the total cost when it’s time to empty the tank.
And Variable Costs?
Variable costs change with the wind.
Variable costs are often called ‘Discretionary Costs’ or ‘Discretionary Spending’.
Perhaps variable costs themselves don’t change with the wind, but whether you incur variable costs do.
Discretionary spending is costs and expenses that you can change on a moment’s notice.
With variable costs or discretionary spending, you can decide whether to spend the money or not. Whether to spend your money or Keep your money in your pocket.
One could say that a variable-rate mortgage is a variable cost. But to me, a variable rate mortgage has a fixed rate until the lender resets – changes – the interest rate. I treat a variable-rate mortgage as a fixed cost that stays constant until the bank resets the mortgage rate, which changes the monthly payment.
Examples include:
Coffee at Starbucks® or another pricey coffee bar
Dining out at restaurants, and which restaurants – fancy or basic
Buying lunch at work or bringing your lunch from home
Taking a vacation and deciding what kind of vacation you take. For example, a nice vacation to Tuscany or perhaps a ‘staycation’ where a change of pace, a few naps or some local trips could be just what the doctor ordered.
Treats and other nice-to-have special items at the grocery store.
The point is you Can Control variable costs. This is the primary way to create free cash.
Which you can use to pay off debt or invest for retirement or a down payment on a house or a down payment on a new car, etc.
Next week, we’ll discuss pitfalls associated with personal budgeting and how to overcome them. We’ll also reveal how to use your personal budget to make your money work for you and help you achieve your financial plan.
In the meantime, to build more wealth right now, click here.
Until next week,
Arthur VanDam, CPA MBA
Budget and Grow Rich® – ISSN: 2992-9296 – USA International Standard Serial Number (ISSN)
Disclaimer: OH and Please Remember, we are Not financial advisors, financial planners, attorneys or accountants and are Not providing any specific financial, tax, accounting or legal advice here. Be sure to conduct your own due diligence and consult your own professional advisors to get sound professional advice that’s specific to your financial and personal circumstances, risk tolerance, time horizon and investment goals and objectives among other key factors!
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