Budget – Grow the tree upside-down

Many people cringe at the thought of a budget. Budgeting sounds like nit-picking about finance and a lot of work to keep tabs on expenses, planning etc.

It sounds highly restrictive in the traditional sense. However there are ways to simplify it and make it automated, so that once you set it up correctly it works by itself.

There are many books and resources on the internet on budgeting techniques. Some of them ask you to be mindful of every dollar while others are more liberal in that they talk about setting and adjusting ratios (30% invest, 40% expenses and so on).

In my experience, a simpler technique worked wonderfully and nicely adapts to changes in income and lifestyle choices.

I call it the repeated divide into 3 parts and allocate.

To keep this short, lets take an example and work this budget out.

Income = $50,000/yr [Average range in America, taken just for illustration]
Taxes = $12,500/yr [It will vary based on filing status etc. average 25%]
Take home = $36,000/yr [$37,500 reduced by 401k contribution etc.]
$36000/year = $3000/mo

The first divide and allocation goes towards 3 main goals.

Investment – Remember the Pay Yourself First?
Expenses – You have to live, don’t you?
Housing and Miscellaneous – Typically for most people, this takes about 30%

So from our example, now you have 3 categories – $1000 to invest, $1000 to live on and $1000 on housing.

This automatically challenges you to live within your means, invest and allocate money to whats important. And yes, without a ballooning credit card debt.

Now lets apply the next level division on each of them.

First we will take the Expenses.

3 major categories are Food, Transportation, Utilities. I know there has to be the fun part too, but we will come to that later.

Here for simplicity or to start with, you can equally allocate:

$300 for Food, $300 for Transportation and $300 for Utilities.

Keep $100 for variation in any of these.

Over time, the ratios will be adjusted as you learn the spending pattern more. The reward – $100 towards fun if you are able to discipline yourself to keep the 3 categories within $300 each. More rewards follow, read on.

Next is Investing. Again we may divide by 3 into the simplest asset allocation.

$300 – Stocks, $300 – Bonds, $300 – Cash

[Keep $100 for variations]

These can be varied based on your risk profile, age etc. but to keep things simple or to get started, what works is an equal emphasis to all. The cash component is for safety factors (towards your emergency fund) or you can invest in REITs (Real Estate Investment Trusts), if you already have a safety cash cushion.

The last $1000 is for housing and miscellaneous.

Now here there can be multiple scenarios. Lets consider some, or you can be creative applying the divide-by-3 rule according to your situation.

$400 – Rent or mortgage.

$300 – savings for other goals – vacation, maintenance, taxes

$300 – Flexible. This is the amazing part – you have just budgeted yourself for free money.

I don’t care what you do with this, but having this is a huge peace of mind.

It is a reward for sticking to the divide-by-3 rule and making it work.

Conclusion

The budget grows like a tree upside-down. You can grow it as you further divide your categories. For example, Transportation can be broken down into gas, insurance and car payments.

Similarly savings can be broken down into vacation, maintenance or down payment for a gadget/car/home.

This model of the budget also adapts to raises year after year. All your branches will increase enabling you automatically to invest, save and spend more.

The more money you put on the top, the richer it makes you at the lower nodes, and improves your lifestyle, savings and investments. It directly encourages you to invest in your talent, increase your income and enjoy that dinner out.