This is the second installment in our series about how to create and use a budget to monitor and improve real-world spending habits. In part 1, we introduced some key concepts you need to understand to get the most out of this installment. If you haven’t already, please go read Part 1 before diving in here.

Let’s Start Tracking

Fig. 4 - Monthly Budget

Fig. 4 – Monthly Budget

Looking at your spending each month is the conventional wisdom, and if you have never tried to follow a budget before, this would seem like a sensible start. (Or would it? Let’s see.)

This example shows that we have recorded January’s numbers, and the red number at the bottom shows that we have already overspent. (Yikes!)

Predictabiy, our overspending is in those Discretionary categories (the rows highlighted in yellow).

The obvious problem with monthly spending reviews is that we spend throughout the month, not just once a month. It follows, therefore, that if we want to stay true to our spending goals, we need to review this stuff more often than monthly.

It is NOT sufficient to look at our spending just monthly.

Weekly Spending Reviews

Spending is a behavior. Like any behavior we want to optimize, we need to monitor our spending behavior often enough that we can shape that behavior to match our goals. We could fastidiously review every transaction at the point of sale (or better yet: know whether we are still within budget before we do each transaction), but most people simply will not do that.

A good compromise between monthly surprises and daily obsession is taking a look weekly. Doing that implies a different spreadsheet than above–along these lines:

Fig. 5 - Weekly Budget

Fig. 5 – Weekly Budget

We have split up the month into 4 weeks, and we have added “Beginning Balance” and “Ending Balance” rows to show the cash available at the beginning and end of each week.

We now show the week-to-week timing of both income and spending; this provides a much closer model of our real world.

All the red in the “Total” column makes it very clear that our spending issues are in our Discretionary categories.

Looking at those numbers by week suggests that we should have spent much less in Week 4 than we did.

As useful as that might be, it’s not exactly stunning insight.

We are still missing a couple of key ingredients–despite how complicated it seems our spreadsheet is becoming.

Let’s fix both sets of problems.

Smaller and Getting Better

This is a good time to act on the “Under-30 Simplicity Rule” discussed in Part 1. Recall that we don’t need to spend time tracking the things over which we have no control, so we can eliminate most of the rows in our spreadsheet.

Fig. 6 - Only Discretionary Categories

Fig. 6 – Only Discretionary Categories

Quite a difference, eh?

“Beginning Balance” for Week 1 is now simply the budgeted total of what we are tracking–the $600 in Discretionary Spending, in this case.

Note that this is true because we are at the beginning of our budgeting experience. Our “beginning balance” for Week 1 of February will be January’s (negative) Ending Balance + that $600 monthly budgeted amount: (212) + 600 = $388.

We’re getting closer to some real insight. Now that we are focusing on just these Discretionary Spending rows, it is easier to see that we actually ran out of money Week 3. If we had been looking at this each week, we could have stopped spending in Week 4 to prevent most of ($181) of our end-of-month deficit. (This actually isn’t even the answer, but it’s a start.)

So far, we have been talking about how our spending compares to our goals, but spending too much can also affect our cash flow–resulting in nasty surprises and embarrassment. Let’s explore that a bit to wrap up this installment.

Cash Flow vs. Spending Goals

Recall from the “Savings First” topic in Part 1 that we allocated all of our take-home pay to either savings or spending. Assuming we set up direct-deposit of our savings goals to our savings account, this means that if we over-spend what’s left, we will run out of available money (“cash”), which could make us be overdrawn at the bank. If we are avoiding the use of credit cards (definitely the thing to do), this could mean overdraft charges (ouch!) and/or denied transactions at the cash register (double-ouch!).

There are ways (besides sticking to our spending goals) to avoid overdrafts, but they involve either dipping into our savings or incurring debt (like with an overdraft “protection” account that draws from savings or the flavor that racks up debt via credit line “draws.”) Either option digs us a financial hole–not exactly the desired outcome when we are trying to be improve how we use our money.

Some budgeting experts recommend using real (physical) cash for discretionary spending. The idea here is that when we are handing over physical cash, the tactile/visual experience makes our brains pay closer attention to our behavior. One obvious benefit of this approach is that when the physical cash is gone, there is (literally) no more money to spend, so we are not risking overdraft charges or going into debt. This can be an effective approach, but it would (in this example) mean carrying around $300 in cash each pay period. That just doesn’t work for me; I really don’t like carrying physical cash, because it tends to jump out of my wallet when I’m not looking.

The “cash mindset,” however, is key. If we treat all of our discretionary transactions like we are depleting our pile of discretionary cash, we get better at monitoring and adjusting our discretionary spending behavior.

Use the cash mindset. Treat your discretionary spending as if you are pulling physical money from a shrinking pile of available cash.

Part 2 Review

We have covered these key concepts in this installment:

  • Weekly Reviews – We spend throughout the month, so reviewing spending just monthly doesn’t cut it. Weekly reviews are an effective way to keep on top of our spending behavior without becoming obsessive.
  • Cash Mindset – Treat your discretionary spending as if you are consuming a disappearing pile of physical cash. If you need more tangible reinforcement, actually use physical cash. This mindset is key to avoiding overdrafts and transaction denial embarrassments, and it can do wonders for developing better spending habits.

In Part 3, we build out the weekly review process by adding the ability to (automatically) compare what we intended to spend against our actual spending behavior. This is the key to being able to adjust and learn from our spending habits.