In my writing and in my personal finance classes, probably the least loved topic is budgets. A budget is kind of like a diet, or a new year’s resolution. It’s something we tell ourselves we should do but we don’t want to.
And then like the diet and the resolution, we don’t.
Making Budgets Fun!!
OK, that’s not really true. You’ll rarely hear someone say “Let’s skip the trip to Disney. We’re all going to work on our budget. Yay”
However, let’s try to think a little differently about a budget.
The Great Capital Allocator
Warren Buffet is known as the great capital allocator.
What does that mean?
Buffet’s company – Berkshire Hathaway – owns or controls many businesses including Fruit of the Loom, Sees Candy, GEICO, and Brooks Running Shoes. Bet you didn’t know that.
Buffet’s philosophy over the past 60 years or so has been to acquire great companies and let their management teams run them under the Berkshire umbrella. Buffet tends not to poke his nose into day to day operations.
What Buffet does do is manage the cash. Let’s say underwear is hot. Fruit of the Loom makes a huge profit, but, as a well-established company, it does not have a lot of opportunity to re-invest that money effectively.
GEICO, on the other hand, is expanding in insurance. By opening local offices, advertising and adding support staff, it has a huge opportunity to take business from competitors. Buffet will take some of the Fruit of the Loom profit and give it to GEICO.
Simply put, Buffet’s role is to find the best use for the capital (profits) his conglomerate generates. Sometimes it’s supplementing another business under his umbrella, sometimes it’s buying a company like Burlington Northern Santa Fe, and sometimes it’s buying more shares of a company like Coca Cola that he does not own outright but invests in regularly.
So What!
The reason I bring this up is that a budget helps each of us work like Buffet and effectively allocate our own capital.
Let’s take a look.
I get a monthly paycheck. OK, I’m retired so I don’t now, but I did.
I decide how to allocate that capital. Some goes to pay my electric bill, some to my cell bill…you get the drill.
A budget is simply a list of who I’m going to pay and in what order.
When I do a budget, I pay myself first. The first line-item is money for investment. Then I get to all the non-discretionary stuff.
Non Discretionary
I don’t like this term. Everything is discretionary. Mortgage too high? Downsize or move to an apartment. 2 car payments killing me? Sell one and learn to share.
Sound tough? It is. I’m not telling anyone to make these decisions, I’m just presenting them as decisions we could make.
Budget
The process of setting up a budget and managing to it is not an exercise to deprive ourselves, it is an exercise to ensure that we are getting the best value out of our capital.
Dave Ramsay says that a budget is telling your money where to go instead of wondering where it went. I love this.
It shouldn’t matter to me or to anyone else what any one person chooses to spend money on, but we work hard for our money. We should make a choice.
Capital Allocation at Home
I have a Netflix subscription and an iTunes music subscription. Are these the best possible uses for my money? For me, yes. Netflix is paid for (mostly) by T-Mobile and it is really the only streaming we watch. I listen to a lot of music – probably 3-4 hours each day. To me, these expenses make the cut. Many others have not.
And my favorite cuts are the ones that don’t deprive me. I love to cut dollars from the budget by reducing what I pay for something rather than depriving myself.
- Every year I shop for cheaper insurance – most years I save a few hundred
- I’m about to change cell providers. I love my current provider, but MVNOs are offering the same service on the same network for $15 per line per month with unlimited data.
- Buy your next vehicle certified pre-owned instead of new
- Cut out home repair costs by doing it yourself. Youtube will show you how to do almost anything.
Wrap Up
Whether we’re Buffet or an average Joe, we’re making capital allocation decisions all the time. If we’re doing this without a list, we’re doing it blind.
The iTunes subscription may seem worthwhile at $10.99 per month, but if we’re using a credit card to pay and we’re paying 25% on the balance, it’s not really $10.99. It’s a lot more.
And get the family involved. Many of our expenses are family expenses. Here’s a great way to get the kids involved and to teach them about managing their own money.
I heard a story about a guy who would go to the mall with his kids. The kids would want stuff so he’d give them $5 and tell them they could buy it or they could keep the $5 for themselves. Most often, they’d keep it.
Getting the whole family involved in these decisions makes everyone committed.
How we choose to manage our budget is a personal decision up to each of us. But unless we end each month with more money than we know what to do with, we should have one. Read more here.