Today, let’s talk about tracking a budget. In other words, let’s talk about how to monitor our income, expenses, and investable funds.
Tracking Income and Expenses
After you have created a budget, the first thing you have to do is closely track your income and expenses.
Tracking your income is fairly straightforward for most people. If you have a job that pays you every week or two, then you can simply look at the gross amount on your paystub and write down that number. And if you have income from other sources, then you can also jot down those numbers.
Expenses are a little trickier and more time-consuming to track. This requires noting every time money goes out the door. Whether that’s for food or housing or transportation, or any other expense you might have.
Even though it takes some effort to accurately track your expenses after you’ve generated a budget, it is very important to do so. For a budget to be useful, it needs to be reasonable. And the only way that it will be reasonable, is if the numbers inside the budget are reasonable.
Once you’ve accurately written down all of your expenses (including the infrequent ones) and you know how much money is going out the door, it’s time to determine whether or not these expenses are necessary (i.e., needs versus wants). After you figure it out what expenses are necessary, you can compare those expenses to your income and determine if you have funds left over to invest. Ideally, your expenses would be way below your income, so that you’re able to invest as much as possible into income-producing assets that will work for you.
With all that work done, you now have a baseline of how much money you can invest over a specific time period.
Let me take a little detour for a minute. I highly recommend that you have a short-term cash reserve in place for unexpected expenses. Things seem to creep up in real life, and you can never perfectly know what your future expenses are. So it’s best to have some money squirreled away for a rainy day.
It would be tragic if you had saved up some money and made an investment, and then shortly thereafter, were forced to sell that investment at a loss because an unexpected bill showed up at your door. To avoid this double-whammy (unexpected expense + forced selling of investments at the wrong time), it’s best to have perhaps a six-month cash reserve in case you run into something unexpected or you fall on hard times. This cash reserve will help you avoid selling investments at the wrong time.
Focus on Investable Funds
Okay, so now you have a budget in place, and that budget should be realistic because you have been tracking your actual income and expenses.
With a realistic budget in place, what I like to do is to start focusing on the investable funds that I get. In other words, while I still pay attention to my income and expenses generally, I don’t track them in detail.
What I like to do when I receive a paycheck, is take out the investable funds portion (that should be left over after all expenses) and put those funds into an investment account. Essentially, I like to take out the investable funds first (some people call this paying yourself first) and then simply live off the remaining funds from that paycheck. By taking out the investable funds first, and using the remainder of the paycheck for expenses, I have forced myself to live on the budget that I originally set, and ensured that I have the investable funds specified in my budget. This is critically important so that expenses don’t creep up over time, completely overwhelm your budget, and then shrink the amount of your investable funds to zero. This practice of withdrawing investable funds first introduces some discipline into your spending right off the top.
Additionally, by budgeting in this manner, you save yourself some effort. It takes a fair amount of time to consistently and accurately track your income and expenses; with this method of simply taking out the investable funds first, it helps you live on what’s left over.
Now, you obviously can’t completely ignore your income or expenses when you take out the investable funds first. But as long as you have the same income coming in, and your expenses are approximately in line with your budget, you should be able to make things work. And you should have the amount of investable funds that you budgeted for. This will help you know how much money you have available to invest over time.
Additional Thoughts & Conclusion
One thing that you also might want to consider is adding a little bit of cushion to the expense side of your budget. This will help you weather any small additional expenses that may come your way.
Also, you should probably revisit your budget once a year or so — because income and expenses do change over time. It shouldn’t take long to revise some of the numbers. Usually, it’s fairly obvious what changes need to be made. But with this revised budget you can now have a revised number for your investable funds. Hopefully, the investable funds number has gone up. The goal should always be to increase your investable funds number.
By following the suggestions mentioned above, you should be able to track your budget, make sure that it is realistic, and accurately determine the amount of investable funds you will have over time. This knowledge can help you formulate a more solid investment plan, and hopefully aid you in your goal of compounding at high rates.