Navigating Your Personal Finance Journey

Where are you headed?

One of my favorite quotes as of late is “All models are wrong, some are useful,” which is generally attributed to a British statistician named Dr. George Box. I take it to mean that in our desire to understand things, humans inevitably try to create a model of the phenomenon under study. Although models are useful, they are simplified approximations of a thing. At best, they describe or predict facets of the phenomenon. But I think every model will eventually have a point where is ceases to be useful. Please keep that in mind as you read the rest of this post.

In order to focus my discussion of personal finance, I'm going to consider a model that focuses on the interplay of three things: behavior, goals, and mathematics. Together, these three are components of one's personal finance journey. Goals set the destination. They are where you think you want to go right now. Goals might change along the way as you experience the journey. Mathematics outlines the possible paths to your goals. Some paths a long and easy to traverse. Others are shorter and require a lot more work. Behavior is your means of transportation. Some forms of transportation work on many paths but are not necessarily optimal for any particular path. Other kinds of transportation work well for one kind of path but poorly with other paths. 

I believe that developing stability and financial independence requires taking an active role influencing your destination, path, and transportation. Whether you start with a specific destination (goals), a clear path (mathematics), or a reliable means of transportation (behavior), you’ll need to engage in all three ideas in order to influence the journey. Focusing too much on only one of the ideas might lead you astray. For example, let’s say you’re an excellent saver (behavior) but have not really engaged in thinking about how to manage your savings (mathematics) or what you are saving for (goals). I imagine you'll accumulate large numbers in a financial account, but you might miss on opportunities to effectively grow you money through sensible investments, retirement vehicles, etc. Focusing only on saving might also result in missing on opportunities to accomplish particular goals that require a certain level of physical health or are only achievable at specific times of your life.

This blog is focused on goals, behavior, and mathematics in an effort to help other educators in their personal finance journey. In my last post, Focus Less on Numbers, I argued you should  be careful about spending too much time getting swept up in making numbers bigger or smaller. Yes, numbers are important, but I think that destination, path, and transportation are more important. With the remainder of this post, I’m going to focus on something that I think you SHOULD consistently spend time on in your personal finance journey because it connects all parts of the model: understanding the flow of money in your life.

At the core of this model of personal finance, the thing that weaves in and out and connects all three parts, is the flow of money. If you are an educator reading this because you want to achieve financial stability and independence, then your first assignment before setting goals, changing behavior, or determining mathematical outcomes, is to understand your spending and saving habits. You need to understand them well enough so that a friend could ask "How much do you spend on groceries each month?" or "How much are you saving each year for retirement?" and you can have an immediate ballpark number. The way to do this is by building and maintaining a budget. Overall, this goal of a budget should be to help you develop awareness. As Carl Richard’s noted in The One-Page Financial Plan, budgeting is all about awareness.

Since there are many approaches to constructing a budget, I think it’s important to explain how I’m thinking about it. When I say budget, I am not talking about a restrictive, rigid document that tracks and attempts to allocate every cent. Although this is a type of budget that can work for some, particularly for those in financial crisis, I think making a budget that tracks every cent can be overwhelming. That said, if you are interested in a detailed discussion of building this kind of budget should read How to Manage Your Money When You Don't Have Any by Erik Wecks or Your Money or Your Life, Vicki Robin and Joe Dominguez. Also, search for zero based budgeting and you’ll find a bunch of resources.

Instead, in this blog I am using the word budget to describe an adaptive, guidance document. Rather than trying to track every cent, it attempts to provide a reasonable approximation for expenses. This kind of a budget is a living document that you review routinely as conditions change. It can be used in monitoring behavior, crafting goals, and making projections. At minimum, I think your budget should provide two things:

1. An at-a-glance understanding of how money is flowing in and out of your life. It should be helpful in identifying what is working with the way you manage money and what needs attention. 
2. Categorization of expenses and with estimated rates of spending for each category. For those constructing a budget from scratch, I’d begin with the standard three categories: needs, wants, and retirement. These form a basic framework but should not be a limiting set. As you refine your budget, you can add additional categories for things like charitable giving, short-term savings (sinking funds), etc. 

So what level of detail should you aim for with your budget? What grain size does it need to have to be useful? Initially, I think the should capture the following typical big expenses:

• Needs: rent/mortgage, food, car loans, utilities, student loans, property insurance, life insurance, phone, internet service
• Wants: subscription services, dining out, gym memberships, etc.
• Retirement: Contributions to Roth IRA, 457, 403b, brokerage accounts

Don’t get fixated on tracking every penny with this budget. Instead, give a reasonable estimated cost. You will refine the numbers later as you use the budget. Also refrain from judging yourself as you make this initial budget. Right now, you are interested in creating an accurate representation of the flow of money. One that you could give to someone to help communicate your current financial context. There will be time to dig deeply and think about behavior change, goals, and mathematics later.

If you use credit cards, they can be helpful and unhelpful in the process of budget construction. Helpful because reviewing a few months of statements can provide lots of detail for identifying spending behavior. Unhelpful because credit cards can be a catch-all in your budget for expenses like gas, eating out, that you might not really think about (or want to think about). I’ll write another post about credit cards at some point, but right now I will say that if you have a predictable monthly spending and always pay off your credit card balance every month, then I would try to separate all expenses that you've accounted for which might be in your credit card bill and then make a credit card expense in the wants part of your budget as a general catch-all. However, if your credit card is serving as an emergency fund or you are carrying monthly balances and not paying the credit card off, then shifting away from the credit card needs to be a top priority after covering your needs. Your financial boat is probably struggling to float and credit cards are just letting more water in. You need to stop using credit cards, shift to cash whenever possible, eliminate as many wants as possible, and develop a plan to pay off the existing debt. This isn’t easy and I’d advise engaging with a financial coach or other resource to help and support.

Once you have a budget drafted, you need to commit to reviewing it monthly or quarterly to adjust and refine. Your goal is to take what you have and improve upon it by breaking up big categories, providing more accurate estimates, etc. If you put in a credit card catch-all, this is the time to start pulling it apart. Moreover, your budget should become a planning document that you reference whenever you think about goals, mathematical paths, and or behaviors. Make sure you have an easy to access bookmark. Side note, I'm also assuming you're using a spreadsheet program to build this budget. If you don't know how to use a spreadsheet, that should be a goal alongside building your budget. You'll just be using some sum functions and simple formulas. Search for tutorials on Youtube.

Okay, so now you have a budget. What's next? First, if you have a partner, you need to engage them in the budgeting process. I think it is common for one partner to take the lead on finance things, but everyone should have an awareness of the budget. Second, I think you should talk about parts of the budget (if not all of it) with your close members. Why? These are the folks who will likely be accompanying you on your personal finance journey. They are probably in your financial boat or journeying alongside your boat. You're all part of the same convoy. The more you can foster communication about finances with these folks, the more you’ll all be able to help and support each other. Talking about a budgeting can be a good initial step. There will no doubt be financial storms that occur as you navigate life, I encourage you to be proactive, flexible, and transparent about personal finance with those in your convoy so that you do not have to brave the storm alone.

First published July 13, 2024.