Written By: Mrs. Horizon
Mr. Horizon and I don’t have a budget. Not a traditional one, anyway. This is shocking to most people. When co-workers and friends have asked about our budget and I tell them that we don’t have one it generally provokes the question, “How?” We simply follow the “pay yourself first” principle which is not a new concept. At its core it means that you invest in your future first. In the book The Millionaire Next Door they call this “creating an environment of scarcity”. Generally when you research how to make a budget it leaves saving to the end which usually results in very little actually being saved. When we put our “budget” together we start with our savings and when you pair this with automated investing it feels like you aren’t on a budget at all! You can read more about our take on automation here. I affectionately like to call our budget “backwards” since we do it in the opposite order of most traditional budgeting instructions!
Here is how we break it down and build a backwards budget!
Does your employer provide a retirement savings plan? If they do it is always a good idea to take advantage of it! Many times, they will also provide a match so at least putting that percent of your income into your 401k is always a good idea! Any money that can be saved in your 401k you will not see in your take home pay and it will continue to grow tax free until you withdraw after the age of 59 ½ when the government will take their cut of it. This can save you a bundle in taxes! If you can, try to max it out!
2. Traditional IRA
For very high earners there is no real tax advantage here but for others it is a chance to save $5500 a year, tax deferred! Every individual is different and some time will need to be taken to decide whether to use a Traditional or Roth IRA as you cannot max both accounts. It gives you the same advantages of a 401k (except the possible company match) but you are limited to $5500 while a 401k maxes out at $18,500 annually. Be sure to look into your income limitations here.
After you subtract out your contributions to a 401k (if applicable) how much will you be taxed? This is important to know and plan for. You will get to deduct the Traditional IRA at the end of the year if you choose to open a traditional account.
4. Roth IRA
A Roth IRA has a max like its traditional counterpart but it is taxed before you put the money in and grows tax free. Remember though the $5500 limit is any combination between the Roth or Traditional IRA. The investor cannot put $5500 in each. There is a different set of income limitations for high earners who wish to use a Roth.
5. Personal Brokerage
With all the retirement savings options out there why would you need a personal brokerage account? You are not able to draw money out of your 401k or Traditional IRA without penalty until you are 59 ½. There are withdrawal strategies that allow you to get it earlier but it takes some time so in the mean time you will want some money to withdraw from. Vanguard is a popular option for a personal brokerage due to its low fees. Personally, I use Betterment because of my hands-off nature when it comes to finances. Mr. Horizon and I will be doing some reviews of these accounts in the future.
Now that we covered all the savings, we can look at expenses!
Expenses may be necessary but the amount you pay may not be. Mr. Horizon and I both agree that saving is non-negotiable but expenses need to be inspected and rationalized.
Whether you rent or own you will probably have housing expenses. The thing about housing costs is that it is controlled by you! Do you need a 2500sqft house or will a smaller one meet your needs? Do you need to rent the brand-new apartment for $1500/mo or will the slightly older one for $600 do the trick? Obviously, all of these prices are dependent upon your area just remember to think about the cost vs. reward for the housing you choose.
Although many expenses are up for debate insurance is not one of them. Home, vehicle, and renter’s insurance can cost a bit of money but try checking out insurances that are only available in your state. Insurance that is localized doesn’t usually go up due to fires, floods, and tornados that happen in faraway places. Shopping around for insurance is always a good idea!
It may seem like you don’t get a say in how much your utilities are and technically you would be correct but you do get a say in how much you use. If you keep your usage of water, electricity, and heat down then you can save on your utilities! Use electricity in off peak hours as the rates will be cheaper and reuse gray water to water your outdoor plants or garden. In the winter, think about lowering your thermostat by just a few degrees. It can save you a bundle!
Saving on food generally has the added benefit of also being healthier! Less eating out and more grocery store purchases is better on your pocketbook and your health. Mr. Horizon and I struggle in this category but we are doing an experiment to help us track and motivate us to eat out less. Get in-season fruits and vegetables as they are typically cheaper. Also, not eating meat consistently can save you money. In college I almost never ate meat due to the cost. Substitute with beans or extra veggies and you will be contently full, healthier, and a little richer!
There are many different ways to save on transportation. Just like housing, you should buy just as much car as you need, not what you perceive to need. When I was buying a new vehicle a truck, SUV, or even cross over was more than I needed but a small hatchback had all the qualities I wanted and a gas mileage that far exceeded larger vehicles. While in college I used the public transport system as often as possible to save on gas and paying for parking. Where you live and how you live has a large impact on your transportation options. Between buying a used car, carpooling, owning and not leasing, using public transportation, or biking there are a huge variety of ways to save on vehicle expenses.
Anything extra at the end of the month can be applied to the principle on loans or mortgages to help save you money on the interest of these loans. Any money that hasn’t been used for these categories is money that you can spend on non-necessary items like new clothes, electronics, vacations, and other things. It still is not prudent to go all out with your “extra” money. Always look to save some money on purchases and before you buy something you don’t need, always let yourself think it over for a few days. Will this purchase create long-term happiness? If yes, will it create more long-term happiness than your financial independence? At the end of the month when all of your bills are paid, look and see how much you have left and consider saving more. Saving more is investing more in your future!