Unit Budgeting - A New Way To Save Money

The data that is available from the Federal Reserve Board is staggering. In 1989, credit card debt in America had reached $238 billion. By 2005, this number had almost tripled topping out at around $800 billion. The average Middle Class American family owes approximately $9,000 in credit card debt. When interest rates fell to “all time lows” and homeowners rushed to the banks to cash out all of their available equity on interest-only adjustable rate mortgages, they learned a harsh lesson when interest rates began to rise.
With the end of their interest only payment options coming due, we are seeing the results of the lack of a good budgeting system. The practice of excessively living beyond our means by treating credit as a source of wealth and not looking to the future is at last being exposed for what it really is: a harsh road to foreclosure and bankruptcy.
What about the folks who are not $9,000 or even $1,000 in debt, and yet never seem to have much money, and even if or when they do, they never seem to be able to make it last or put it to it’s best use? What the about those who do have a lot of extra money? What about those who make several thousand dollars more per month than what their bills amount to? Are they in serious trouble as well? Sadly, I’m afraid so. What is amazing is that the cause is the same for the well off as it is for the poor: the lack of a good budgeting system.
The Traditional Approach
There are numerous “traditional” methods of budgeting, which include simply balancing your checkbook and making sure you keep track of all of the checks you write. There are software programs like MS Money and Quicken that allow you to see where your money is being spent. There are a few pencil and paper methods where you are told to write down everything you spend your money on and make sure that that never exceeds your monthly income.
The common trait among all of these methods; however, is that they take a pragmatic approach to budgeting. Rather than relying on principle, they treat each expense or “budget problem” as unique. As such, there can be many different methods to budget your money, and the success or failure of a particular system depends on whether “it works” (at least in the short-term) regardless of the long-term consequences of the method. It is not surprising, then, that we see several different popular methods all claiming to be “the right one” or “the best”.
These methods are also 100% reactionary. Which means you are passively reacting to your money, your bills, and your financial life in general. The system depends on you reconciling your checkbook, or your spreadsheet, or whatever you’re using after you’ve already made purchases. These methods can only record and track your spending history, not help you control your current and future financial situation. The result is a static report of your past.
If you find yourself in a position where you never seem to have any money or enough money at the end of the month, this is the reason why. You cannot simply react to the world around you and try to control it at the same time. This passive, reactionary approach to budgeting often leaves an individual wondering “what am I doing wrong? I know what my expenses are, I know how much money I make every week/month, why can’t I seem to get ahead?”
If you find yourself with a lot of “extra” money, it is entirely possible, and in fact probable that you are losing money in the form of opportunity cost. Often times, those who are well off don’t see the need for a budget. They perceive it as something only the poor or the less well off folks need. However, budgeting in principle is good, therefore it is good no matter who you are - rich, middle class, or poor. To illustrate this point consider the situation of the famous pop singer Elton John who, earning $25 million a year, was spending so much money that he had to take out a $40 million loan just to pay off his debts. Even if you are thrifty, budgeting can be the difference between controlling where and what your savings is doing (in terms of return on investment) or simply passively reacting to it.
Then, there are what I call the "inspirational" methods. These are budgeting "tips" which set unrealistic expectations on you such as "just cut back on going out to the movies" or "always buy the generic brand" when grocery shopping. These methods attempt to control your lifestyle and dictate your wants and desires. It is no surprise that, usually, these systems fail for most people because they present you with a dichotomy (a split) between "needs" and "wants" that makes life generally unpleasant. I'm not saying that there aren't things that you should cut back on or that you don't need to change your lifestyle in order to become financially successful. But, whatever changes you make to your life should be your choice, not your advisor's.
The “Unit Method”
The Unit Method of budgeting takes a fundamentally different approach to managing your money. Instead of taking the pragmatic, reactionary approach, we are going to take a pro-active approach. Instead of simply reacting to each individual expense, we are going to plan for them and budget them before they ever happen. Instead of passively monitoring our savings, we are going to control it. Instead of telling you what to cut back on, to start buying the generic brands, or how you should live your life, we are going to let you make that choice.
To begin with, you need to gather together everything you spend your money on. It may be helpful to grab a cheap notebook and write down everything you spend your money on for an entire week, or an entire month, just to get an idea of where all of your money is going. Write down the specifics as well as how much money you spend on each item. Don’t forget the date that you made the purchase.
The next step is to collect all of your regular expenses. Total up everything that you spend your money on in a year (including when you spend it). You want to look ahead 12 months because you don’t want to forget expenses that may only come once or twice a year - like taxes, or car insurance, etc. Some examples of regular expenses (just to get you thinking) are:
Taxes (if using gross income or you are self employed)
Mortgage Payment
Second Mortgage payment
Household (yard)
Gas
Elect/Water/ Gar
Gas (for your automobile)
Auto Insurance
Maintenance (car maintenance like oil changes, tune ups, etc.)
Automobile Registration
TV
Life Insurance
Loans (car loans, personal loans, educational loans)
Credit Cards
Babysitting/Daycare
Clothing
Grocery
Eating Out
Nonfood grocery items (cleaning supplies, toilet paper, soap, laundry detergent, etc.)
Medical Bills
Hair cut/personal care items
Charitable Donations
Emergency Fund
College Fund
Dry Cleaning
Birthday gifts
Christmas gifts
Holidays and other gifts (i.e. Valentine’s Day)
Maintenance (home repairs, etc.)
Retirement Savings
Magazine Subscriptions
Membership dues (elks club, moose, club, or other social organization)
Dates (going out to “dinner and a movie” with your sweetheart)
Video rentals
Entertainment/”Play Money” (i.e. any hobbies)
After you’ve gathered all of your expenses together, it’s time to do some thinking. The method that we will be using to develop your “bulletproof” budget actually involves two processes: differentiation and integration. What you need to do is try to identify similarities among two or more concrete or specific expenditures and differentiate them from the rest of your expenditures. This should be done as simplistically as possible. Then, we need to integrate these similar expenditures while omitting their specifics and thus forming a new “unit”. This new “unit” becomes the basis for our budget and will allow you to easily track and control everything in your financial life.
The list I gave you above already accomplished part of the job for you. I merely asked you to do this process in reverse to come up with the concretes. For example, if you look at your expenditures and you find that you have a Discover card, 3 Chase cards, a Capital One card, and a Visa - we would group these together by their similarities, omit their specifics and form a new "unit" around them. From now on all credit cards can be filed under this “unit”.
But, what do we call this "unit"? Do we simply refer to the unit as "credit cards"? Is this the common denominator? Perhaps. We could group all credit cards together and form a unit called "Credit Cards". However, perhaps we could do better than that. What is a credit card? What is its essence? What is its purpose? What does it allow us to do? Aren't we borrowing money when we charge up a credit card? Isn't the major distinction between this expense and all of the other ones really the fact that these are all some type of loan? I think that this would be a more accurate association than just "credit cards". "Credit cards" denote what they are but not their purpose. Their purpose is to provide us with credit - with a loan, and unsecured loan, but a loan just the same. This is the key to making the "Unit Method" really work for you. You must find the most accurate associations between your expenses.