Spending Plan

If you want to start building real wealth, your spending plan is the first thing you need, and part of your core strategy at every step. You will need to keep referring back to your spending plan as you plan out your financial future, and the careful balance you make between your spending and savings is the key to building up wealth over time.

Definition of Spending Plan

A “Spending Plan” is exactly as it says – a plan of what you will be spending each month. There are usually two parts – your “fixed” spending and your “variable” spending. The fixed part is usually the same every month, with things like rent/mortgage payments, grocery bills, insurance, and car payments. The variable part changes a lot from month to month, and can include things like Christmas shopping, buying new furniture, and paying for repairs.

You can then balance what you need to spend for the month with your take-home pay, and use whatever is left over to allocate as you wish – going out to the movies, adding to your investments, or depositing in your savings account.

How is a Spending Plan different from a Budget?

Spending Plans and Budgets are similar in a lot of ways – you’re making a list of your expenses in order to allocate your income. The biggest difference is that when you make a budget, you are allocating how you are going to spend just about every dollar you earn – take a look at our Home Budget Calculator and see how many choices you need to make!

When you set a budget, you are allocating nearly all your money to specific costs or expenses (like “Groceries” and “Rent”). If you end up going out with friends a few times more than expected for burritos, you might go ‘over budget’, and know you need to cut back somewhere else to make up for it.

A Spending Plan, on the other hand, is more simple. You make your list of fixed, hard expenses that do not change from month to month, and then each month you add your other essential expenses. This means you are left with your ‘discretionary income’, or the money you can spend on whatever you like. If you want to use your discretionary income on a few extra trips for burritos, go right ahead! This only means you have less to spend on other discretionary expenses, not that you went ‘over budget’ and need to start from scratch.

Spending Plan Terms

Fixed And Variable Spending

When you are reviewing your spending and deciding whether items should be “fixed” or “variable,” you should follow this guideline:  If spending in a particular category (such as groceries) changes from month to month, this item is a variable cost.  If this item’s cost remains the same from month to month (such as your car payment), it is a fixed cost.

This also means that when you want to start controlling your spending habits to increase your savings, any spending you can cut out from your “fixed” expenses will have a bigger, long-term impact.

For example, if you decide to move into a new apartment, a $50 difference in rent will not make a huge difference in your per-month spending, but it adds up to over$600 per year. In contrast, if you skip out on a variable expense, like a dentist appointment, you might get a one-time savings, but it will have a much smaller impact on your long-term ability to save.

Income

When you are building your spending plan, it is essential that you use your take home pay as your income amount.  (This is your net pay, not your salary or pre-tax income, and it represents the amount actually deposited in the bank.)

Savings and Investments In Your Spending Plan

Your strategy for saving and investing is an essential part of your Spending Plan.

Your Savings is money you have set aside and do not plan to spend, usually in a separate savings account. This has very low risk, and is mostly set aside in case you need cash quickly for an emergency. Investments, on the other hand, would be things like stocks and bonds – an “asset” that grows in value over time. Investments are used to build a retirement account, or simply a way to try to earn higher returns on your money (but there is always risks when investing).

• First, you need an Emergency Fund. This is money set aside, usually in a separate savings account, for emergencies. Your goal should be to eventually save up 6 months of expenses in your Emergency Fund.
• Second, you should also plan to set aside extra money each month for regular saving and investing.

When building your spending plan, these two items should be listed separately. Your “Regular Savings/Investing” should be treated as a “Fixed Expense”, where you always plan to save at least this much each month. If your emergency fund does not yet cover 6 months of expenses, then you would need to set this aside as an extra “Variable Expense” until you have it fully-funded.

Pay Yourself First – A Saving Strategy

The idea behind “Pay Yourself First” means that you should think about your savings and investments as a necessary, fixed expense. By adding in your savings and investments to your Fixed expenses, you are reminding yourself that it is not an optional part of your personal finance strategy. This is usually accomplished by automatically depositing fixed amounts every month from your bank account into your savings or retirement account with a direct deposit.

This is one of the core pieces of your savings plan. Every time you consider a new expense, you should be able to automatically visualize how it will impact your ability to save before it impacts your ability to spend more discretionary income.

Charity and Donations

Giving to charity is also an important part of your spending plan, but how much you can give (and where you give it) can vary wildly between two otherwise identical people. You might not be able to make it as part of your fixed spending every month (at least not at first), but it is important to identify charitable organizations you want to support and keep them as part of your overall spending strategy.

Sample Spending Plan

*Assumes $1,600 monthly rent split between two people. Utilities are also halved ** Car payment assumes a$7,800 used car purchased at a 7% interest rate with a 48 month term loan. For more details, see the Car Loan Calculator.
*** Health insurance is based on a 23 year old in 2014 in the United States at the national average. See HealthPocket.com for reference.

Spending and Non-Spending Alternatives

There are many ways you can convert time and money, and how you balance these will have a serious impact on your income and spending. Always keep in mind that most spending decisions you make will impact this balance – how much you value your time plays a huge role in how your spending plan is shaped.

Imagine you want to eat spaghetti with tomato sauce. There are many choices you can make to get that delicious pasta and sauce which will tip the balance in one way or the other between lowering the time it takes and lowering the spending it needs.

• Do you just go to a restaurant and order it? This is the quickest, but most expensive.
• Total time cost – 10 minutes to get to the restaurant
• Total spending – $10 • Added bonus – Professionally-prepared food is tasty! • You can also buy it as a frozen dinner. This is less expensive than a restaurant, but takes more time. • Total time cost – 10 minutes to get to the corner shop, another 5 minutes to heat the food and clean your dishes after (15 minutes total) • Total spending –$7
• Total time cost – 10 minutes to the store, 15 to cook, 10 more to clean up (35 minutes total)
• Total spending – $4 on sauce,$2 on pasta ($6 total) • Added bonus – You probably get 3 meals out of this, so your per-meal cost is$2, and you can make 2 more meals later for only 5 minutes each (but that doesn’t help you now)
• What if you make your own sauce?
• Total time cost – 10 minutes to the store, 3 hours to simmer a delicious sauce, 10 more to clean up (3 hours and 20 minutes)
• Total spending – $2 on tomatoes (you already have some spices at home),$2 on pasta ($4 total) • Added bonus – You probably get 4 meals out of this (since you get a lot more sauce when you make it than from a jar), so your per-meal cost is$1, and you can make 3 more meals later for only 5 minutes each (but that doesn’t help you now)

Each of these alternatives has a different balance of time, spending, and extra bonuses. These same balances apply to many spending choices too. Do you want to wash all of your dishes by hand, or buy a dishwasher? Would you rather repair your shoes with epoxy or buy new ones if the sole starts to break? Do you want to buy wood and build a bookshelf, or buy one from a furniture store? Each decision has a different factor of spending, time, and added bonuses to consider.

Pop Quiz

If reading this article was an Assignment, get all 10 of these questions right to get credit!

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1 of 10) Which of the following is NOT part of a Spending Plan?
1 out of 10
2 of 10) What does it mean to "Pay Yourself First"?
2 out of 10
3 of 10) Why is saving necessary before investing?
3 out of 10
4 of 10) What is an Emergency Fund?
4 out of 10
5 of 10) If you want to buy something and already know it is better than all the alternatives without checking, you probably…
5 out of 10
6 of 10) Which of the following will have the smallest impact on your long-term spending plan?
6 out of 10
7 of 10) Which of the following changes can you make to your spending plan that will have the biggest impact on your long-term wealth?
7 out of 10
8 of 10) Where should you factor spending on charity to your spending plan?
8 out of 10
9 of 10) What factors should you take into consideration when making any purchase?
9 out of 10
10 of 10) On average, how much can you save by going to a 2 year college as part of your 4 year degree program?
10 out of 10