The Family Budget Process

Every year or two, I make up a family budget as a planning tool, so that we have a sense of what we can afford and what we cannot. It is subject to change as events overtake us, but it is a plan which is useful for evaluating major purchases and figuring out how many minor purchases are reasonable.

The first and most grueling part of the process, I undertook today. I looked at every single after tax expense transaction, by way of check, credit card, cash withdrawl or automatic fund transfer in the past year, and classified each one both for tax purposes and by budget category. In theory, cash is an untraceable pit, but in practice I spend the vast majority of it on lunches at work, movies, and parking meters in fairly predictable proportions. The most confounding transaction in our records, in practice, turns out to be purchases from Target, because they are often a mix of groceries, household goods, clothing, alcohol and gifts, crossing my budget categories, sometimes in the same purchase. This is one more reason, given Target's arrival on my shit list for its pharmacy practices (and I refuse to patronize their pharmacy even in the over the counter section), to consider reducing purchases there even more. The task of reviewing a year of transactions took about eight hours, resulting in me missing dinner. But, it is done now. Admittedly, if I were a naturally organized person, I'd probably have spent about an hour a month each month doing this, but I'm not, and so I didn't.

Now that we have a solid foundation of actual expenses for the year (which means that we are not likely to deviate from those expenses even if we are simply acting on intuition, unless we intend to do so - there is a natural tendency otherwise to underestimate discretionary expenses), the next phase will be for me to make estimates for each category of expense for the coming year on a status quo basis.

For the most part, this simply means taking last year's expenses and plugging them into the New Year, but this isn't always the case. For example, I have a much shorter commute now, so my gasoline expense will go down somewhat, even accounting for higher gasoline prices, but my parking ticket expense is realistically going to be higher now that I am spending more time downtown where parking enforcement is strict, rather than in the Denver Tech Center, where parking is usually free. Likewise, recurring payments will be based on current payment amounts, rather than the average over the past year. Particularly tricky will be estimating a health insurance expense, as I plan to change insurers (from COBRA to a firm health insurance plan) during the year. Also, this requires backing out extraordinary events from the past year, and including expected major expenses for the coming year, like a significant car repair that didn't get done over the holidays amidst a busy social calendar (by my standards anyway).

After this, I will estimate my income before and after taxes. Most years, this is elementary, but, now that I am in a new job and no longer on a straight salary this is not necessarily easy. My wife is also considering taking on a part time or full time job after many years primarily employed as a homemaker, but fitting that into the equation is too much brain damage to handle. If and when she gets a job, we will modify the budget accordingly.

Next, I will try to reconcile my expected after tax income with my status quo expenses and make adjustments as necessary to make them match and to allow for a reasonable allowance for savings towards retirement, college educations for the children, and a next car purchase, as well as maintaining a health emergency fund. While this step of the process isn't terribly time consuming, it requires many judgment calls and requires considerable normative decision making. How would we prefer to reallocate our spending? What is reasonable to spend on this, that and the other thing? What do we spend too much on now, and what would we like to devote more of our resources to?

I will then prepare a balance sheet to accompany the budget with our assets and liabilities listed at their end of the year statement values, and accompany them with a brief discussion of how we are doing in keeping on track with our goals of increasing savings, affording major projected purchases (like our next car and any home renovations and any major vacations) and reducing our debts over the medium to long term. This will be highlighted by a number showing how much we should save per month to meet our goals while not breaking our budget, and with ideas about how we might want to reallocate our mix of savings, investments and debts (e.g. should we pay off the mortgage early or keep funds in an emergency fund or keep funds in a longer term investment of some kind). Typically, one or two of the possibilities will wind up as winnners for the dollars we don't spend. Some judgment is required here to make reasonable estimates, but the judgment is more technical than normative at this stage.

Once all of these steps are done, I will present the draft budget to my wife. It will be arranged with the most difficult to adjust items (like taxes and mortgage payments) on top, and the most flexible items (like gifts, entertainment and clothing purchases) on the bottom. She will remind me of several expenses she would like to see on the budget that aren't there, will express shock at certain of the actual expenses from the past year and resolve to live in utter privation, and will inform me that I have to cut certain line items pertinent to me or increase our income to pay for them. I will then make adjustments accordingly, while keeping the budget in balance, will show her the revised version, will hear from her that she is happy with it, and will move on to doing our 2005 tax returns.

Now, of course, this doesn't exactly involve my wife at every step of the process, but given that I have spent a fair amount of time as a tax professor and worked in a College For Financial Planning, this is one thing I can contribute to the household so that we don't have to pay someone to do it for us. And, given the fact that my handyman and plumbing skills are rather poor, I have to pick up the slack somewhere.