Creating a budget is the first step on the way to any financial goal. However, this first step can also be the hardest—even harder than actually sticking to that budget once it’s made! Why? There are surely countless reasons, but an important one is that our finances are unpredictable.
Life is full of out-of-the-ordinary expenses. Unlike recurring monthly costs like rent and utilities, things like wedding gifts, medical bills, and random fees are often impossible to see coming. And unlike a large, one-time purchase like a car or a flight ticket, these unexpected expenses can come up again and again, sometimes in different amounts (like when your prescription price changes or you change your hair stylist).
Expenses like these were the biggest challenge I faced when designing my personal budget. Through trial and error, I discovered that there are two possible extremes when it comes to budgeting. The first is to be so detailed that it is virtually impossible to meet your goals. The second is to leave things so open-ended that you might as well not have a budget at all. I tried both and was satisfied with neither!
Creating a budget within a budget
That’s when I started setting aside a “discretionary fund.” This catch-all category completely streamlined my budget process. I work on a month-to-month system, based on my income from the previous month. Rent is paid first. Next, I transfer my monthly savings to my savings account. Next, I budget set amounts for regular, predictable expenses such as groceries and my phone bill. Then I budget a set amount in my discretionary category; each month I have a determined amount of money that I can spend on not-yet-determined expenses.
Consider this your “budget within a budget.” A limited fund guards against mindless spending, but its relative flexibility allows you to pursue multiple, smaller-scale goals without changing your overall budget. It may include transactions both large (like car repairs) and small (a new bottle of mascara at the drugstore). I tend to spend this money differently, depending on the month. For example, a few months ago when my other expenses were down, I was able to use my discretionary fund to refresh my summer wardrobe. This month, I focused on more practical expenses, like school books and a co-pay at the dentist’s.
What should you do at the end of the month if you still have leftover discretionary funds? It all depends on your personal goals. To get ahead on your savings, set whatever you don’t spend into your savings account. To save towards a specific goal, like a vacation or a dream purchase, set those extra funds aside into a separate account. You can also invest those extra dollars, a process that is easier than ever with mobile apps like Acorns. Alternatively, you can roll the funds into next month’s discretionary budget, or use it as a back-up if you go over budget in another category. (And if you’re looking for thoughtful advice on how to get your financial affairs in order, check out Verily Cents!)
Creating your discretionary fund
How much of your budget should go towards your discretionary fund? This will depend on your personal preferences and needs. Once you have set aside money for non-negotiable expenses, like rent and utilities, it’s a good idea to set your savings goal next. The conventional advice is to save at least 10 percent of your overall income, and of course, don’t forget about investing in your retirement fund either.
The next step to drafting your budget is creating a list of categories based on costs that remain relatively stable every month. My personal budget is divided into a handful of categories: rent, bills/utilities, groceries, restaurants (including take-out coffee), charitable donations, savings, and discretionary. Other categories to consider might include loan or mortgage payments, insurance, gas or public transportation costs, clothing, entertainment, childcare, pet-related expenses, memberships and subscriptions, and so forth.
Once this is done, note the remainder of your monthly income. This is the ceiling on your possible discretionary fund. I highly recommend setting the figure for your discretionary fund a little lower than the remainder of your monthly income, just in case: this extra wiggle room provides peace of mind if you go slightly over budget.
Now is also a good time to think about your money personality and why you spend the way you do. For example, are you so anxious to save money that you routinely find yourself turning down invitations to go out with friends? If you designate a discretionary fund, you can relax and enjoy group activities and meals out knowing it won’t hurt your nest egg. Or do you tend to leap at the chance to treat others and give gifts, without checking your bank account first? With just a little extra planning, you can use your discretionary fund to cover the tab, and avoid spending the money you need for food and bills.
Getting the right number might take time
This fund is a good reminder that there is no one-size-fits-all budget. As Verily Cents has explained, financial success looks a little different for everyone. (In other words, you can keep your takeout coffee and still be financially successful!)
The next step is to play around with your budget figures over the next couple weeks to see what works and what does not. While deciding whether your budget is right for you, the usual basic financial advice applies: always prioritize saving, pay debt as fast as reasonably possible, and avoid unnecessary credit card debt.
This trial period is the perfect time to decide whether to include a given category in your discretionary fund or not. For example, over the course of several months, I found it very helpful to have a set figure to shoot for when grocery shopping throughout the month. Setting a ceiling for this expense encouraged me to cut unnecessary (and often unhealthy) items from my shopping list to save money and waste less food by buying versatile ingredients that I could use in multiple recipes. However, it was nearly impossible for me to stick to a set figure when it came to gas money. Not only did the price of gas fluctuate when I was trying to stick to my budget, but so did the amount of time spent in the car. Some months, I only needed to refill my tank once, and other months it was every week!
As time goes on, I have found the discretionary category to be the easiest way to stick to a budget. Before developing this strategy, I wasted a lot of time feeling stressed about my crazy detailed budget. Even though I was still living within my means, every uncategorized expense sent me into a panic. Sure, I could technically afford to pay that parking ticket from when I forgot it was cleaning day on our street, but should I take the money from my grocery fund, gas fund, or both? Nowadays, there’s no need to redraft the rules every time a new expense comes up. The discretionary fund makes it possible to adjust my lifestyle on a monthly basis to accommodate my ever-changing needs—including the occasional parking ticket.
Try incorporating this one simple trick into your monthly budget, and see if it works for you. And consider subscribing to Verily Cents at Verily Yours. Not only does it include practical insights on managing your finances, but also fresh ways to think about your relationship with your money. Understanding how your money fits into your life can help when it comes to making those day-to-day discretionary choices.