How to Budget for Different Purposes

Making a budget is often touted as one of the first things to do when taking control of your finances. There is a good reason for that. A budget is for tracking and planning cash flow. Where your money comes from and where it goes. That said, there are many ways to make and use a budget. In fact, how you make a budget should depend on what you plan to use it for. Learn more about different ways to use a budget and I’ll also provide some links to spreadsheets or apps that may help you.

The Survival Budget

This was the first type of budget that I became acquainted with. When you have a fixed amount of income coming in and it is dangerously close to your living requirements, then a budget is part of financial survival. One of the clues that you may be financially ill and need some budget therapy is carrying credit card debt.

Medical students get access to massive lines of credit (LOC). So, they might avoid carrying credit card debt. However, in that case, ballooning debt on that LOC may be a warning sign. A budget to predict how that LOC will grow during training is vital.

I see medical students who don’t know what to do because their LOC is maxed out and they still have training left to fund. Or residents who can barely keep up with the interest payments on their LOC while paying for their basic costs of living on a resident salary. Some basic budgeting and understanding of debt may have prevented that crisis.

It is important that you (and your family or others who influence how you spend or feel entitled to your money) understand that access to debt is not money that you have earned yet.

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Detail is the key to a survival budget.

The key to a survival budget is detail. This serves a dual purpose. First, it prevents you from being caught off guard by predictable expenses. Detailing where your money goes also makes you aware of what you are spending on. You might be able to identify opportunities to cut costs with minimal compromise. Forcing yourself to document your spending also makes it harder to ignore problem areas. It may even make you hesitate in anticipation of documenting your sins in the budget confessional.

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Income & Debt

When making a survival budget, start with regular sources of income. Account for payroll tax deductions at source to get your net income. The after-tax money is the income that matters and you can estimate that with a simple tax calculator. You may have some uncertain or variable sources of income. Personally, I would not count uncertain income and would be conservative with variable sources of income. That forces a harder look at keeping core expenses below regular income. Extra income is a bonus, and you can decide how to treat it after it is actually in hand.

If your expenses exceed your income, then you will accrue debt. That may be unavoidable, like during medical school. However, debt is really just spent future-income. Future-You will have to earn money and repay debt using your after-tax income. Your future self will likely thank you for eating, living in a secure situation, and improving your income or career. On the other hand, consider carefully how you will feel working when you are older to repay your debt for money spent on more elective expenses that have long since turned to rust or been consigned to the rubbish bin. Have a chat with Future-You before major purchases. Try to spend deliberately in ways more likely to yield lasting results.

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Planned Expenses

Start with the big mandatory rocks. Then, add the sand of smaller mandatory expenses. Do the same for discretionary spending. The rocks can crush you if you are not careful, but the sand is also important for getting traction.

Some costs are completely predictable, like rent, insurance premiums, or car payments. Other expenses are not perfectly predictable, but you can make a pretty good estimate on a monthly basis. For example, food made at home, utility bills, toiletries, cleaning supplies, haircuts, and clothing replacement. Then, add in intermittent predictable costs, like tuition, tax installments, or a vacation.

You can classify expenses by categories like housing, utilities, transport, food and personal care, and entertainment. That is not my preferred method for a survival budget, but it is useful when you evolve to a GPS budget.

For a survival budget, I prefer to categorize my expenses into mandatory and discretionary costs. For example, rent is mandatory. Netflix is discretionary. Eating food that is prepared at home is mandatory. Eating in a restaurant or buying food at work rather than packing meals is usually discretionary.

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Emergency Expenses

There are also unpredictable emergency costs. They will predictably happen; it is just uncertain about when or how exactly. Common examples would be vet bills or car maintenance and repair. If you are on a survival budget, you probably don’t have an emergency fund built up. However, you should put building one into your budget. We did this by including common unexpected expenses in our budget. While the timing may not be precise, it would help ensure that our income and expenses over the year are balanced out.

For example, if we could expect a $2.4K vet bill or car repair to be possible over the course of a year, we would put at least $200/month in the budget towards our emergency fund. Some people may choose to keep that emergency money in a separate account to help them resist the urge to spend it.

If using a line of credit to fund your life, it is still important to consider unpredictable costs. They will happen. You need to account for them when ensuring that your LOC will see you through to the point where you can pay it back. If not, then an earlier course correction is easier and less risky than an emergency evasive maneuver later.

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Tracking Actual Income & Spending

A survival budget is not a theoretical exercise. It is to track real money with real implications. That said, it is hard to perfectly set and keep a budget. Do not let the pursuit of a perfect detailed budget stop you from getting started. Make a budget and get started.

If what you have at the end of the month doesn’t match what your budget says you should have, figure out why and adjust. You may discover expenses that you did not account for. You may also find that what you thought you were spending on a certain area is different from reality. One way to do this is to have a column or row for your budgeted items and another one for actual. Then, you can make a head-to-head comparison.

Here is an example of a free template that has lots of detail for the types of income and expenses. Plus, the ability to project and compare to actual income/expenses.

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The closer to real-time tracking, the better.

Updating your budget closer to real-time also has some benefits. It may serve as a deterrent to you spending outside the budget because you are going to have to enter that or see it entered right away. You can also detect trouble and potentially make adjustments sooner. On the side of the ledger, you may see that you are controlling your spending better and it is helping you to make financial progress. That is a good feeling.

When I started out, I had a paper budget that I updated each day after returning home from hunting wooly mammoths. Now, there are apps that can do that based on your bank account and credit card transactions. Most come with a fee that I would want to save if I were in survival mode. However, the cost and ease of use may be worth it for some compared to digging a deeper hole.

The Fun Budget

While the survival budget approach may be mandatory when you are skimming the financial surface, it is generally not fun. We did it early in our financial lives. It helped us to build our financial foundation, but it was not a source of pleasure for me. Further, the survival budget is generally built around a scarcity mindset. Money is a scarce resource to be guarded and preserved. That is adaptive while in a precarious financial state, but it is restrictive when you do develop more financial power.

Some people do find the challenge of penny-pinching fun, but for those who don’t, The Fun Budget may be a better approach. Take care of business and then loosen up.

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The Fixed Stuff

The premise behind The Fun Budget is that tracking every little expense is a killjoy and you need some freedom. Yes, a basic level of directed spending is required to provide current and future security. However, once that is established, it is a tool to make your life better. Having fun is part of a better life. The 4-step budget is a great example of how to do this and there is a template embedded on the page I just linked to.

Basically, you make a good estimate of your monthly after-tax income. Next, make a good estimate of your monthly mandatory expenses. I would include some planned debt repayment and building an emergency buffer as mandatory.

Finally, add in your monthly discretionary spending that you are not willing to compromise on. Like Netflix or your gym membership. If your debt is at a comfortable level, then starting investing also falls into the category. Which account to start with may vary, but regular contributions and investing will help you to build this vital habit and skillset. Plus, you will benefit more from compound growth the sooner you start.

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The Fun Stuff

What is left becomes your “fun money”. Or name it something more fun and outrageous. This approach allows you to focus on what you can do with the “fun money” rather than restricting yourself. A more abundance mindset approach.

The GPS Budget

As you move from survival to loosening the purse strings a bit, the next step in your financial evolution is to actively choose your destination and the waypoints to get there. This is vital when you have significant financial power at your fingertips. The first part is to learn more about what features of a good and satisfying life resonate with you. Be aware of traps to avoid. To get there, you must also set value-based goals to act as waypoints in your journey and keep you motivated. The GPS budget is a powerful tool to give you feedback and help you to navigate.

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Making a GPS Budget

The nuts and bolts of a GPS budget are the same as making a survival budget or a fun budget. You can choose the level of detail that suits you. That is not the focus of the GPS budget. The main difference is to highlight how different spending feeds into your major financial goals.

For example, our budget has a section for debt repayment. Not only what our payments are, but also the balance. So, we can see our debts shrinking. Similarly, there is an investing section where we track contributions and withdrawals for our various investment accounts. Physical activity is important to our family – sports and hobbies gets its own category in our budget. The same goes for charitable donations.

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Budget Feedback

Having categories or lines in the budget for spending in support of our goals and highlighting what we value not only helps us to think about them. It also helps to give us feedback. We track our budget at a high level each year and can see where our money is going. Then, we can compare it across years to hopefully see spending on areas that we value become a larger proportion of our spending pie.

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Permission to Spend

For some of us, it can be a real struggle for us to spend money. Even when we should spend to make the most of opportunities or when it is aligned with our goals. Many of us were raised in an environment where money was scarce, or perceived that way because of financial precariousness or calamity experienced by the generation who raised us. That fear of running out of money can be powerfully ingrained.

Having a budget, particularly over the course of years, to show that your basic needs are being met, and that you are saving and investing and progressing towards goals is helpful. What helped us even further was putting the amount we were going to spend on something like a nice vacation, fancy bike, or donation to charity into the budget. The act of doing that was like spending the money. We could acclimatize to the idea that we were going to spend the money on it. Then, when the time arrived, there was a subtle pressure to spend the money – it was already budgeted and part of our spending goal.

Concretely planning for important spending that aligns with your values gives you permission to spend on what you’ve decided is important and may even make you feel guilty when you don’t!

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Comfort to Make Decision Rules

When you have a solid financial position, seeing that clearly from your budget can also help you to offload some of your financial decision-making by making decision rules. For example, I now have a decision rule that if a task requires me to work on a ladder over my head I will pay someone else to do it. The risk is not worth the savings to me anymore. Another decision rule for us is that we will get a hotel close to the venue when going to an out-of-town event. The traffic and stress are not worth the cost to us. Even at Taylor-Swift hotel rates.

Previously, we would have agonized over decisions like that and felt guilty spending the money when we could go a thriftier route. Knowing that it fits into our budget and it is a rule to be obeyed relieves us from that psychological and cognitive load. We can then avoid injuries, focus more on enjoying the moment, and conserve our energy for bigger financial decisions that are more impactful.

The Tax Planning Budget

How to make and use a budget changes depending on your financial situation and the purpose of your budget. After my financial awakening, I started to pay more attention to the tax planning component of my budget. This may not be very necessary for most people. So, you probably haven’t heard much about this before. I recently shared the impact that tax planning had on us.

For most people, income tax is deducted directly from their paycheck with a minor adjustment (often a refund) at tax filing. However, as a high-income or wealthy investor, taxes are more complex and impactful. Budgets are about cash flow. When you take cash flow and from where can make a big difference in how much tax you pay.

If you are incorporated or if you are drawing from different investment account types, you can plan and control that. This requires a budget that links personal and corporate cash flow. Preferably with some embedded tools to help estimate taxes. I will describe how to do that with a budget tool that I made in a future post, but here are highlights of how a tax planning budget may be helpful.

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Planning for Income Smoothing

For example, if you have a large spend coming up that requires you to sell holdings in a personal taxable account, you might consider doing that over two calendar years to stay below the new $250K/yr capital gains tax threshold. If you are incorporated, you may want to consider different methods to get big money out of the corporation. For example, using a shareholder loan and then repaying it over a couple of calendar tax years may be an option. But, only if you plan ahead and discuss your plans with your accountant to leverage their tax planning expertise. We recently did this to plan for a big splurge.

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Planning for Tax Installments

When you pay yourself from a corporation, the income tax is not always remitted right away. So, you must plan for that. You may also need to plan for quarterly tax installments. If not, you may find yourself with a cash flow crunch.

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Optimal Compensation from Your Corporation

Tax-deferred by investing using a corporation can be very powerful. However, that requires you to leave money within it and personal spending needs are what drive that. So, a budget for personal spending is where it all starts. For a corporate investment income to be a tax-efficient as possible requires attention to how you pay yourself using salary & dividends. When you pay dividends relative to the corporate fiscal year-end may also help to release refundable taxes efficiently.

Many incorporated professionals have a fiscal year-end different from the calendar year. This allows for tax planning opportunities, but you need to plan your cash flow to execute them. A budget helps to visualize that.

Budget Evolution

A budget tracks income and spending. However, it can be used for much more. While most budget-talk in personal finance centers around cost control, a budget can also enable you to have more fun because you can spend free of worry and guilt. While you may need a survival budget to start, hopefully that builds the foundation for you to graduate to a fun budget. As your financial freedom grows, shifting to a GPS budget functions as a tool for working towards your goals and enabling decision-making. That is a step beyond what most people do. Now that you know, you cannot unsee this post. Use it.

For those of us with higher incomes, taxes also become a major expense. Tax is often the largest single line- item in our budget. Having a corporation to regulate cash flow and making efforts to tax plan can help. That may be the next step in your evolution.

Even if you use a financial advisor and/or accountant, tax planning starts with your planned consumption and cash flow to match that. From the people whom I have helped mentor and speaking with my advisor colleagues, understanding cashflow with some type of budget is a critical starting point. It is often missed by those focused on selling products, and you must be an active participant. Helping you to tax-efficiently plan your budget and align it with your goals is one of the areas where an advisor may add value. It is hard (even for them) to find good tools to help. As an enthusiast, I have made a spreadsheet that has evolved alongside my budgeting and tax planning process. Once I have it cleaned up, I’ll describe and share it in a future post.