The base of the financial planning pyramid is budgeting and cash flow management. The rest of the pyramid cannot be built if one’s cash flow is out of line. For such an important part of the planning process, most people are thinking about their budget completely wrong.

How We Think Of Budgets

The way we think of budgets traditionally is we first have money coming in via our paycheck. We then pay our recurring bills such as our rent/mortgage, utilities, loan payments and then try to not spend what is leftover. If there is anything left over, we will then save that in a savings or retirement account. The problem is there isn’t usually anything left over to save!

How We Should Think About Budgets

We need to flip the way we think about budgets upside down. The top of the funnel will always be our income. But instead of the next stage being our bills, we need to move savings and make that the next stage of the funnel. Instead of paying someone else first, we now pay ourselves.

You first need to figure out what your savings goals are and what time frame you would like to accomplish them in. Are you wanting to go on a $5,000 vacation a year from now? You need to save $416.66 per month. Are you looking to establish a 3 months salary emergency fund over 3 years when you’re making $50,000 per year? You’ll need to save $347.22 per month. And if your savings goal is more complicated, like saving for retirement - you’ll need to make some more in-depth calculations to determine that amount each month.

Once you determine your savings numbers, you can then craft your recurring expenses around what is remaining. Using this mindset prevents you from having a house or car you can’t afford. These are the rent/mortgage, utilities, loan payments, etc. from before - things you know you are going to be paying every month.

And after you determine what your recurring expenses are, you then craft what I call your “lifestyle” or “discretionary” expenses. This is where things like groceries, dining, bar tabs, movies, clothing, household items, etc. come in.

What If There Isn’t Enough Money For Everything?

More than likely, you will find out that there isn’t enough money for you to take care of everything you want to take care of. So what do you do in this situation?

The first step is to figure out if you can make more money. It may be time for you to ask for a raise or look for a position in another company that puts you at a higher level than you’re at now? Or maybe there is a side-hustle or small business you can start to generate some extra income.

If making more money isn’t an option - you’ll have to make some cuts. I would recommend you start cutting in the recurring expenses first as that will have the biggest impact followed by the lifestyle expenses. Once you’ve cut all you can realistically cut, then you may need to adjust your savings goal expectations. Instead of taking a big vacation every year, make it every 2 years. The very last item I would try to change is contributing to your retirement accounts. Once that is cut, it is much harder to adjust the amount back down the line.

How To Put This Strategy In Place

This all may seem very overwhelming, but it’s actually not as complicated as it may seem. The key to making this easy is to have three banking accounts at a single bank. One of these accounts will be a savings/money market account. The other two will be checking accounts, and only one of these checking accounts will have a debit card associated with them. Your Main Checking account will be the account that does not have a debit card tied to it - the Main Checking account will be your financial hub.

Side-note:

The reason having them at a single bank is to make transferring in and out of accounts as streamlined as possible. A big objection I hear to this is a client may be able to get a higher interest rate with an online savings account. To that, I say the purpose of this is not to generate interest income. The purpose of this is to build habits that will stick. In the long-run, having this built-in habit is going to generate much more in your savings account than having a higher interest account.

Money from your paycheck flows into your Main Checking account. You then set up automatic transfers to your savings account to make sure you are paying yourself first. These transfers should be as close to payday as possible.

Once those are set up, you then make sure to stagger your recurring bills to avoid any shortfalls in cash flow. Chances are you can’t pay all your bills on the 1st of the month, so figure out what can be paid at the beginning, middle, and end of the month without getting behind on your bills. All recurring bills are paid out of your Main Checking account.

The last step is making transfers to your Debit Account. Like your bills, you likely can’t set aside enough cash on the 1st of the month so you’ll need to stagger your transfers. I would recommend making automatic transfers set up on a weekly basis. Having these transfers on a weekly basis will be much easier to control your spending compared to once a month.

Finally, how much money should you aim to have in your Main Checking account? I like to end the month with one month’s worth of paychecks in the account. This allows a decent amount of budget buffer to make transfers without worrying about the Main Checking account being overdrawn.

Final Thoughts

Creating a budget can be easy - actually sticking to it is hard. With the strategy detailed in this post, you are creating a systematic flow of money that streamlines the budgeting process to take as much guesswork out as possible.

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About The Author

Shaun Melby, CFP® provides fee-only financial planning and investment management services in Nashville, TN through his company Melby Wealth Management. Shaun has over 15 years of experience as a financial advisor in Nashville. Shaun created Melby Money to educate the public about finances.