Do I Really Need a Budget?
I’ve read a number of blogs lately about how people claim they don’t need a budget. They don’t like budgeting and just track their spending after the fact. I understand, people don’t want to spend their time going over boring numbers. Worse yet the numbers might suggest you should actually change your behavior!
Read on to learn: 1) Why your budget is a key part of your financial independence (FI) foundation, 2) How to calculate your FI number, 3) Why it’s important to start investing now.
You Need a budget
If your goal is to be financially independent you need a budget. Without a budget you cannot responsibly manage your money. You need to properly manage your money so you can maximize your investing. Trust me even multi-millionaires have a budget. In the book The Millionaire Next Door most, if not all of the millionaires interviewed said they have and stick to a budget! You need a budget to calculate your FI number.
Your Financial Independence Number
Sure, FI is about freedom and spending time doing things you enjoy with people you care about. To earn that freedom, you need passive income to cover your expenses. To do that you need to know your FI number. Old school retirement was defined as working for a single company for 30 years. After that they gave you a gold watch, a pension and you moved to Florida in the winter. Not anymore! Today you need to look out for yourself. The good news is now you can work where you choose when you choose but only if you plan accordingly.
The traditional rule for a 30-year retirement is you need 25 times your annual expenses to avoid out living your money. See my post on the 4% rule https://www.1engineeronfire.com/?p=57 . Don’t forget taxes, we need to pay Uncle Sam and the Governor. We’ll use 20% for our tax calculation. Now we have all the variables to calculate our FI number.
This FI number is an estimate and doesn’t take in account social security or any other income. It should be a target to help get you started. As you refine your budget you will also be able to refine your FI number. Example: Monthly budget = $2,666 x 12 = $32,000 / 0.8 (20% tax) = $40,005 x 25 = $1,000,125. Your FI number would be $1 million.
It’s All About Time
Unless you are planning to sell your upstart tech dot-com for many millions you need to start investing today. As you can see from the above calculation you need ~$1 million for every $40,000 of pretax income. For the average American saving $1 million seems like a daunting task. This is where the power of compound interest comes in. This will be the most powerful tool in the investment toolbox.
With your FI number and a solid budget in hand you can calculate the time to FI. Start by subtracting your monthly expenses from your monthly income. Anything left over can be invested. Better yet include investing as a top budget priority and eliminate all frivolous expenses to increase your investing.
Time matters! The path to $1,000,000 can be reached in many ways. With an average return of 9% here are four examples:
$214/month in 40 years, $547/month in 30 years,
$1,498/month in 20 years, $5,178/month in 10 years
As you can see starting sooner makes a HUGE difference in the calculation. The FIRE community has aggressive examples where individuals maximize their income, minimize their expenses allowing them to maximize their investing. This is how a blogger can claim to be retired at 37 after a 13-year career. Most of us will find a balance investing what we can in our younger years and ramping up as we earn more. The key is to squeeze every dollar out of your budget and assign it to investing as soon as you can!
Get Started
Establishing a budget does take a little work. Suck it up and just do it. Just list your expenses largest to smallest. Start with the easy ones that come every month like mortgage / rent, food, utilities, transportation, phone, etc. Next consider irregular expenses like insurance, property tax, medical, etc. Then consider the oddball items that always pop up like birthday presents, technology, clothing, hair care, tax prep, etc.
Your list will not be perfect. You will need to modify it over time but that is ok. Now fill in the dollar amount. If you have last years history great, use it to come up with monthly averages. If not, don’t stress over it and take your best guess. When next month rolls around make changes as necessary. Congratulations! you now have a budget.
What does 1 Engineer On FIRE do?
I still use MS Excel to create my monthly budget with every detailed expense. I track around 40 individual expenses. It’s what engineers do😊. I update the budget at least annually using inputs from last year’s expenses. It sounds like a lot but I just spend about an hour annually and a few minutes as needed throughout the year.
I automate all regular payments and use an app for irregular expenses like restaurants, car repair, travel, etc. I use a simple phone app called Accounts II. Every month on the 1st I pay myself by adding the monthly budgeted amount to the app. At any time, I can look at my app and see if I have money left to spend. A little trick to help develop your budget is to plan a slush fund to fill in the gaps as you are developing your budget. As your budget becomes more refined you can lower the slush amount and put that toward investing.
Conclusion
You really do need a budget. At first it takes a bit of effort but it becomes less over time. You can’t calculate an accurate FI number without an accurate budget. Without an accurate FI number, you are likely to fall short on savings and significantly delay your retirement date. Good luck budgeting!
1 Engineer On FIRE