How to stop rationalizing purchases and move to a proactive budgeting model?

[red_pill]

I want out of the rat race, and am trying to figure out what the barriers are preventing me from achieving that.  I have spent weeks churning through our finances and thinking about stuff, and I just figured out a big blind spot we have.  I'm hoping someone might have an idea how to fix it. 

My wife and I have a rationalization/justification problem.  For example, a few years ago we said "Let's not go on a big vacation this year. Instead, let's put in a new backyard deck that costs the same amount as the vacation would have."  But then, when it's time to plan the next vacation we say "well, we didn't go on a vacation last year, so we can afford to splurge a bit more this year."  You see the problem, right?   We spent the money twice but convinced ourselves we only spent half of it!

Generally, we make tons of "frugal" choices, but then undo the progress we made with an un-frugal choice.  But the real problem is we define our identity off of the "frugal" choices, and have convinced ourselves that we are not spendy.  The cold, hard truth of numbers suggests otherwise.  Thankfully, we aren't super flashy people, we have lived within our means, and our means are a bit above average, so we aren't on an in-correctable trajectory and our finances aren't a dumpster fire.  But, I'm sure we are no where near where we could be, and that reaching that potential wouldn't even hurt at all - it's just a matter of making better decisions.  So why not just make those changes and reap the rewards?

To that end, I want to start budgeting better and I'm looking for help in setting up "categories" so we can't lie to ourselves about what we are spending on certain things.  Does that make sense?  This will be particularly important when we are mortgage free in a few months and more cashflow opens up.

EDIT:  Our current strategy is I know what pay is coming in on payday, and I know what fixed bills are coming out between then and the next payday, as well as what our usual spending is on slightly variable bills such as groceries, gas, etc.  I see what is left over and will put it on the mortgage or allocate it to larger necessary expenses or discretionary spending (house maintenance, vacation, etc).  Inevitably, this results in a lack of proactive allocation of spending based on conscious, long term planning, and instead is prone to the whim of the day.

My idea is to set up a few partitioned savings accounts for a few different categories, that will then be used for those expenses that aren't constants.  The ones I had in mind were:

Annual expenses (car insurance and house insurance are paid once per year, I could save 1/26th of each bill each payday)
Vacations
Home Improvement
What else?

How does the more experienced MMM folks deal with stuff like clothing, where in one month you may have $0 expenses, but the next month it might be a few hundred bucks if you have to buy a new jacket, for example? 

Also, I like dealing with cash for our spending money, since I find we spend less when we have to physically hand over the cash than just tap a card.  But, what types of purchases would qualify as "spending money" versus another budget category?

I don't want to have 100 budget categories, the fewer the better.  But I also don't want to give myself an excuse to lie to myself.

Thanks!

[AccidentialMustache]

What matters are your long term trends, not a month to month variation. Start getting good data and look at it over time. How do you get data? I hear you can YNAB. I don't, I DIY in a google sheets + google forms (loaded on my phone). Form is super simple -- pick a category from a defined list of ~12, amount, note (usually: where and/or what). It isn't perfect, but it is good enough for us.

Our use of google sheets tracks in retrospective, rather than proactive mode. It works for us.

[red_pill]

What matters are your long term trends, not a month to month variation. Start getting good data and look at it over time. How do you get data? I hear you can YNAB. I don't, I DIY in a google sheets + google forms (loaded on my phone). Form is super simple -- pick a category from a defined list of ~12, amount, note (usually: where and/or what). It isn't perfect, but it is good enough for us.

Our use of google sheets tracks in retrospective, rather than proactive mode. It works for us.

I've been using Mint, which has shown the long term trends.....and we sometimes spend like drunken sailors on shore leave.  I think for our personalities, we need to move from a retrospective appreciation of where we spent our money to a proactive model where we decide where money is going to go before it goes there.  Since we are cash flow positive and relatively debt free, I have the breathing room to set this up properly at this point, but I'm just not sure of the structure I should use.

[englishteacheralex]

Try YNAB or EveryDollar. You are absolutely right: you need to set realistic limits on all budgeted items and then stick to them. We use Mint because it's free. But I've heard YNAB has a whole program that helps you set up a budget.

For things like clothes/car or home repairs/travel/grooming (things that don't come up on a monthly basis), my husband and I do a thing called sinking funds. We figure out about how much would be appropriate to spend on those categories per year, and then pro-rate it by 12 months. That's the monthly budget for those categories. THEN (and this is too much hassle for a lot of people) we actually have separate accounts in Capital One 360 for each sinking fund and we make transfers to them every month. That way, if I need clothes, I check how much is in the "Clothes" account and that's how much I can spend.

We also have a spreadsheet of larger, long term money priorities (we try to run our finances like a business). We have a meeting about the spreadsheet about twice a year. We talk about bigger things we might like to do (vacations, home renovations, car purchases, charitable contributions, etc.) and the projected amount these things might cost, the level of priority they should take, and when we can realistically expect to make them happen. We look over old money "dreams" and decide if they still seem important to us.

The spreadsheet keeps us in line with making sure we're being intentional about our money and not impulsively spending it. It also makes it very easy for us to have a great time blowing money on something fun--for the most part, our fun but expensive stuff is planned out ahead of time and we are confident that it's something we truly wanted to do and that we are not robbing from some other priority unknowingly.

[gooki]

Pay your future self first. Each pay day transfer as much as is reasonable into investment accounts that are hard to withdraw from.

The learn to live off what’s left.

[Laura33]

First, try YNAB.  It forces you to budget proactively, which seems to be your issue:  you have to create categories for all of your future expenses, and then budget for them each month.  And if you have some other great idea pop up, you have to take the money from somewhere else in your budget to pay for it, so you literally cannot spend the same dollar twice.  I have heard that the transition can be hard (because you budget in advance, your first months you are in the red because you haven't saved up for your expenses yet), but that it can be very very effective for managing this mindset.

Second, if you don't like YNAB, use the "sinking fund" approach like englishteacheralex says.  DH and I have done that since we got married -- we looked at all of the periodic expenses (both known things like car insurance, and "will happen but we don't know when" things like vacations, car maintenance, car replacement, etc.), added it all up, divided by 12, and then put that amount in a money market fund every month.  You don't actually need physically separate accounts for all of these expenses, but if you need the extra discipline that provides, I think your three proposed categories are fine.  That would keep you from raiding the "necessary" expenses to cover "fun" expenses.

Finally, like gooki says, you need to pay yourself first.  If you always deposit what's leftover, you will never have much left over -- for a lot of people, if it's available, it gets spent.  If you start off with automatic deposits into savings and the sinking fund, you will very likely naturally adjust to spending what is left.

[formerlydivorcedmom]

At the bank, we have a savings account that serves as escrow for real estate taxes and insurance, and another savings account that includes both vacation savings and home improvement savings.  I am thinking about opening a third to save for the next car. The money is transferred automatically to these accounts on the 1st day of the month.

I love Mint.  You can set up your Budgets in Mint so that last month's leftover flows into this month's spending -- and last month's overages means there is less to spend in that category this month.  That is how we handle things like clothes, medical expenses, and even utilities.

When I started, I only had a few categories.  For me, this masked the problem.  I spent 6 months trying to reduce the eating out budget item, but it never made a difference.  So I broke that up into a lot of other categories - Work lunches - H, work lunches - me, one parent/kid, family, social occasions, desserts.  Turns out that although we had successfully brought down the family meal portion, the work lunches part had skyrocketed.  We now have monthly budgets for each of those individual categories, and that's helped us be more aware of the spending.

We're also trying to be more mindful about ALL of our spending.  Your Money or Your Life really woke me up, and we've seriously cut down the amount of random spending we do, just by asking more questions of ourselves before we stick it in the cart or we only shop from a list.  It's a lot easier than I thought it would be.

We are also big planners. For vacations, we alternate - a large expensive vacation one year, a cheap driving vacation the next year.   I booked the March 2019 vacation in March 2017, so I know exactly how much I have to save before it has to be paid in full at the end of this year.  I am already starting to plan the 2021 vacation so we can start putting money aside in April 2019.  Our vacation this year will be going to a state park in the next state over - lots of cheap outdoor fun.

We aren't perfect at this yet.  We still spend a lot more money than I think we should, but it's a lot better than it was.

[Lady SA]

Here's how we create our spending plan. Caveat, there is no "right" way to do this, this is just what works for us and our brains. It isn't a perfect solution, but it gets us to the point where we have a plan for every dollar that comes our way and then real-time tracking how we are doing against that plan.

1. track spending. I keep track of yearly spending in a spreadsheet tab, one column per year. I can see macro-level trends and averages over multiple years. I have about 3-4 years of pretty accurate spending data right now. You can look back with Mint Trends to see spending in the various categories for previous years.
I break out all the categories in a way that makes sense for us. Each of these categories that we spent money on then gets mapped to a corresponding budget line item in the next step.


2. Allocate your income to the buckets of spending. This is the complicated step.
Take your the income you have coming in (paychecks) and allocate it based on your historical spending track record and savings goals, with an eye on how much money you have left. Each spending category takes away money for everything else. I use google sheets for this. I have sections for pre-tax expenses/savings (health ins, etc), post-tax savings, and regular expenses.
I put in all of the more rigid/inflexible spending categories in first. This would be rent, loan payments, maxing our 401k and IRA contributions, transfers to our emergency fund, groceries, sinking funds for car maintenance, etc. The expenses are based on our pretty stable historical averages (in the case of groceries and car maintanence, for example) or knowns (like how much our rent is).

Then I fill in all the "wants" with our historical averages too. But because these are wants, they can be a bit more flexible. As an example, we spent $2748 on restaurants in 2016 and $2702 in 2017. That is pretty darn stable, and we are pretty happy with this level but it could be tightened up a tiiiinnyy bit, so I'm going to set the restaurant budget for 2018 at $2700 (this is yearly, so it breaks out to $225 per month). This is mostly based on gut feeling, I guess? (So far this year, we are well under our average spending, so I don't even think we will hit $2400 total in this category. So this new data point would be entered at the end of the year and then I would do a rolling average to determine our next spending plan for this category)
This "wants" section includes things we have control over like gifts, travel, restaurants, entertainment, sports, clothing, alcohol, and a misc category that is historically down to ~$3 per year, but even though it is small, I still account for it!
All this time I'm keeping an eye on my little count-down section of my spending plan sheet, seeing how much I have left over each month after all this. We follow the Investment Order that floats around on the forum, so after maxing our IRAs, HSA, 401ks, and then our holistic expenses, I know how much is left over each month to put toward a taxable brokerage account. That "taxable brokerage" line item is the one I fill out last, with whatever is left over.

My spending plan is pretty comprehensive, it includes 35 line items on it. Any little thing that has been spent on in the last 3 years is accounted for in this spending plan, because if we spent on it once, we likely will again. As time goes on, more data points will make this more and more accurate.

However, if you don't have quite as big of a gap as we do, you might be getting close to being into the red. Do you need to make any adjustments? This is where you can use your best judgement on what tradeoffs are reasonable given your baseline comfort level. Can you reasonably cut $20, $50, $150 from a category? You know yourself best, would your family actually be disciplined enough to adhere to the slight change? As a LAST resort, you might consider scaling back brokerage or 401k/IRA contributions (based on the investment order) to give yourselves a bit of breathing room.

On this step, I usually spend at least a week each year filling in the details and running numbers and making small tweaks to make both my expenses and my goals work without going over. At the end, this plan is essentially an ideal budget, but because all the numbers are based on your own spending history and you made reasonable, attainable tradeoffs, it is really more of a solid spending plan than a pie-in-the-sky, unrealistic budget.
If anything changes during the year (raises, changes in rent, etc), I also go back and review all the numbers again, and make any adjustments needed.



3. Recreate this spending plan in Mint using their budgeting feature. Then you can see how you are doing each month and make real-time adjustments to your spending if you are seeing things creeping up. I have most line items set to rollover for each month so then we naturally spend less on those categories the next.
My DH and I have a monthly review to see how we did on our spending plan that month and commit to any changes we want in order to help us meet our goals. I also check Mint weekly, if not daily, so I'm pretty on top of our real-time spending. DH is less so, but then all I have to do is mention "hey, we're running a bit over on our restaurant plan this month" and then we just naturally scale back a bit.