DECEMBER 2006 :: CONSUMER ED

The Trouble With Budgets
They're Hard to Stick to. Try a 'Spending Plan' Instead.

'Budget" is the four-letter word of personal finance.

People despise budgets, and they despise the word because it immediately conjures feelings of confinement, as though it's because of their budget that they can't live the life they think they deserve. So even though everyone generally recognizes that they need a budget, budgets are, like New Year's resolutions, usually abandoned fairly quickly.

›Adapted from "The Wall Street Journal Complete Personal Finance Guidebook," by Jeff D. Opdyke. Copyright 2006 by Dow Jones & Co. Published by Three Rivers Press, an imprint of the Crown Publishing Group, a division of Random House.

Yet budgets don't have to feel constricting. Budgets can be liberating. They show you exactly what you're spending on things that aren't really important to you. And working with a budget can help you realize that you can afford the more-important things if you let up a little on the less important things.

Let's start this lesson on budgets by rethinking the word itself. Instead of "budget," think in terms of a "spending plan."

A budget and a spending plan share the same goal: to help you manage your income better. However, how your brain relates to money psychologically determines how successful you are in sticking to your budget. If your brain tells you that you feel frustrated with a plan that doesn't let you spend what you think you can afford to spend, then your budget isn't going to work. If, on the other hand, your brain tells you that you're feeling satisfied, that you're using your money the way you think it should be used, then you're far more likely to stick to the path you've established for yourself.

What's the Difference?

So what exactly is a spending plan, and how does it differ from a budget?

In essence, a spending plan matches your known income each month with your fixed costs (rent, utilities, etc.) and then allows you to determine how you want to spend or save the leftover money- your discretionary income-every month.

By comparison, most people use their budget just to get a rough idea of how their fixed costs-those big, monthly items such as a mortgage, rent, car loans, and utilities-match up against their income. Then they try to cram the remaining dollars into categories based on historical patterns. The thinking goes something like this: "If I spent $100 a month on average last year on magazines and newspapers, I had better budget for that this year."

Never mind that you rarely read the daily paper during the week. Maybe instead of budgeting that $100 by default, you should find a more productive use for the money. That's where the spending plan comes in.

A spending plan shows you exactly how much money you can spend each month on variable costs for dinners out, spur-of-the-moment purchases, a wardrobe makeover, and newspapers and magazines, or how much you can funnel into savings or toward paying off credit-card and other debt. Knowing exactly what you have to spend-and, more important, where you spend it-gives you power over your money by providing the analysis necessary to stop spending wastefully and start spending smartly. That's the spending plan's biggest advantage: You're in control of your money instead of feeling as though your money controls you.

Many guides to successful budgeting like to pump you up by describing how easy it is to cut excess expenses from your budget by, say, simply resisting the urge to buy a $5 cappuccino every day.

And that's great-if you can stifle that yearning to caffeinate. But that's precisely the problem. Budgets don't drink coffee; you do. Once a budget starts making you feel guilty for spending on small pleasures, you'll quickly abandon it; this, in turn, will probably leave you feeling as though you failed again at corralling your finances. Fear of failure can make you just forgo budgeting altogether, an attitude that makes you financially vulnerable, because you'll have trouble saving for what you really want and preparing for emergencies, possibly causing you to become dependent on credit to fund your life.

Spending plans are more user-friendly. They can be complex, or they can be simple. Whatever the case, the secret to sticking to your budget is spending your discretionary dollars on what is most important to you and eliminating what you know you can live without. When that happens, your budget becomes integrated into your thinking about money, and you inherently know how unexpected purchases will jibe with your spending plan. That's where spending plans really stand apart from budgets.

Flexibility to Change

S ince you draw up a spending plan at the beginning of every month, you have the flexibility to switch your plan on the fly without throwing off your spending. For instance, friends invite you to join them on a weekend ski trip. The trip, you figure, will cost about $200. You take a quick peek at your spending plan and see that you had penciled in $250 for new clothes to update your wardrobe. So now you have a choice: clothes that you can put off buying until next month or later in the year, or a ski trip with friends?

Without the ability to see such choices in black and white on their budget, most people simply do both, either taking on debt by whipping out their credit card or dipping into their savings. They do so because the human brain has an immense ability to compartmentalize. We spend on the clothes we need and immediately put that expense behind us, forgetting about it because it's in the past. The trip is in the future, so that comes out of future money that will come in our next paycheck. We book the trip; we can afford it. The problem is that both the clothes and the trip come out of the same pot of income for the month.

That's the wrong path to financial success.

To give you a better sense of what you've already spent in the month and what you still expect to spend, you need a visual indication of where you are at any point during the month.

See the nearby chart, which is a small slice of a larger spending plan. With such a plan, one glance and you know instantly where you are financially during the month. This approach helps you keep your spending on track; it helps you to remember during the month how much you have already spent on various discretionary items and what expenses are still to come. Knowing what you've already spent and what you haven't yet spent allows you to adjust your spending on the fly when those weekend trips and other offers pop up.

For the first few months, putting together a spending plan will seem tedious as you get used to the process. By the third month, however, you'll know the process; by then, many of the variables won't change and you'll be able to track your plan in very little time.