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 keeping 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 settings you need to make!
A budget also gives you allowances that you cannot go over. For example, you might have a $150 food budget for yourself while you are in college each month, assuming that you will be buying groceries and cooking nearly every meal yourself. If you end up going out with friends a few times more than expected for burritos, you might go ‘over budget’, and you know that you will have to take that money from somewhere else in the budget to make it work.
A Spending Plan, on the other hand, is much 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 separating your spending between “fixed” and “variable”, your rule-of-thumb should be that if you need to change an item month-to-month, it should be part of your variable spending, whereas if it is something you don’t have the ability to change easily, it should be part of your “fixed” spending.
This also means that when you want to start controlling your spending habits to increase your savings and build wealth, any spending you can reduce 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 make a big impact on your long-term strategy to build up your savings, investments, and wealth.
When you are building your spending plan, it is essential you specify how much you are earning each month as your take-home pay (how much you actually deposit in the bank), not your salary, or pre-tax income. This way you can build an honest, realistic plan based on what money you actually have at your disposal.
Savings and Investments
Your savings and investments are also extremely important in a spending plan, but where they fit in will change over time. For the first few months of using a spending plan, your savings and investment will be what is ‘left over’ from all your other discretionary expenses.
Once you have a few months of experience to know how your spending usually falls, you can take your average savings and move it into your ‘variable spending’. You will then need to decide how to split this between a cash savings account and other investments, but you will be able to make regular monthly deposits in both. You know that some months you will be able to save more than others (around November and December you might need to spend more on gifts, for example), so you can adjust your savings and investments accordingly.
Once you are more established with your spending habits, you can move part of this expense into your “fixed” spending – this is to remind yourself that no matter what, you know you can afford to put a certain amount of money aside every month to prepare for emergencies, retirement, or investing for the future. You can still keep a smaller amount in your variable spending – often people will separate their retirement savings as a ‘fixed’ expense, with their other savings and investments as ‘variable’. More importantly, make sure to remember to put anything you have left over from your discretionary spending every month directly back into your savings!
Saving Versus Investing
Saving and investing are similar, but they are not the same. Saving can be almost any form of stored value – a savings account, government bonds, even cash hidden under your mattress. Investing, on the other hand, involves some risk. You can buy stocks that lose value, for example, while money saved in a savings account will retain its value.
Saving in your retirement account can be both. Low-risk stocks that pay dividends can stand aside government bonds and other low-risk assets as part of your savings. Investing is generally considered to be part of saving for most people, but as your investments gain more risk, you should consider them less of a part of your savings plan.
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 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. Another way to think about it is that before you pay your bills, before you buy your groceries, even before you pay your rent, you have already made your minimum deposit into your savings accounts as a completely non-negotiable expense. You can add more later as part of your variable spending and discretionary spending, but you know you are always starting with a baseline to grow from.
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 should consider giving to charity in the same category as investments. This means that 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
|Fixed Spending||Variable Spending|
|Car Payment **||$135||Mother’s Day||$60|
|Health Insurance ***||$260||Charity||$100|
|Total Fixed||$1,810||Total Variable||$460|
*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. *** Health insurance is based on a 23 year old in 2014 in the United States at the national average. See HealthPocket.com for reference. **** A $200 monthly savings for a 23 year old is enough to save a million dollars by age 69, earning an 8% annual rate of return. Click Here to download this sample as a spreadsheet and update with your own spending habits
Outside Factors That Influence Your Spending Plan
There are a lot of factors that can cause your spending plan to change. Some things can be huge, but some might be so minor that you might not even notice.
Marketing is what influences you to buy what products. The commercials you see on TV, the advertisements you see on the internet, and even product packaging are all working to sway you between buying or not buying, and which brand (and what price) you pay. This is not a bad thing – you might not be aware you wanted something until it was marketed to you, but you should always be aware when you are spending exactly what marketing is at work to make sure you are making an informed decision.
What you will notice is how your life changes can impact your spending plan. When you are dating, you will need to allocate more spending towards going on dates, buying gifts, and making sure you are always dressed to impress. If you have children, it will probably be the biggest factor in your spending plan for the next 10 years!
This is one reason to always take time to regularly re-visit your spending plan and make adjustments. As your life circumstances change and evolve, always take a close look at your fixed spending, and see which parts of your variable spending plan is growing or shrinking according to your previous estimates.
Sticking To Your Spending Plan
One reason that spending plans have started to become more popular than full budgets is that they are easier to stick to, and easier to adjust as needed. In our example before, our “burrito spending” would have needed to be added to our budget and carefully planned out, whereas we can just count it as part of our discretionary spending.
Using Automatic Payments
These days you can likely set up all of your fixed spending as automatic payments from your checking account – including your core savings. For the “Budget Challenged”, this can be a major improvement, but it also has a major downside.
When all your bills are being paid with automatic payments, you still need to make sure you have your spending plan in place so you know how much money is going where, and when. For example, a person without a spending plan might not remember which payments for a month have been made and which are still coming up. This means when they just check their bank balance and see $1,000, it is not possible to know how much of that is available to start spending and how much they need to save because their rent payment will be processed next week.
Spending Plans and Wealth
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.