This blog contains some simple tips and advice from two regular guys. We're not accountants, financial advisors, or brokers, so follow, ignore, or discuss our ideas as you see fit.

Sunday, July 25, 2010

Crash Budgeting

Posted By Paul

As someone who has spent nearly all of their adult life budgeting, saving towards goals, AND trying to live a fairly healthy lifestyle, I was intrigued by the thoughts that came to me after reading the following article:

Why Budgets Fail: Leave My Latte Alone

It's a list of reasons why people are unable to stick to budgets and ways to help. I noticed the entry in the article called the "Gung-Ho Backfire":
The Gung-Ho Backfire - You set up a strict budget and then wonder why you can't stick to it. By trying to cut spending too drastically, you create an unsustainable budget that is sure to buckle under pressure.
I realized that the unhealthy approach described here was like the "crash diet" for saving money, where you create a goal that is so hard to maintain that you are practically guaranteed to fail.

For example:

I had a friend who was carrying some credit card debt that they wanted to eliminate (a great goal for sure). I was talking with them about the budget they had set up and discovered that they had set a goal of putting aside a certain amount of money each month to pay off their credit cards (I think it was something like $500 a month). I told them that I thought this was a great goal and since their debt wasn't huge they figured that they would be able to pay it off in about 6 months at this rate.

What actually happened? Well the first month went well. They managed to hit their goal and pay down their debt by $500.

The next month an unexpected car repair came up and since they didn't have a "rainy day fund" set up that had to come out of the money they hoped to set aside for their credit card debt.

The month after that they decided to splurge a little since the last two months had been all about saving, saving, saving. So they went on a shopping spree that ended up eating the savings for that month.

Things got worse after that and before long the budget and goal were simply forgotten.

I realized just now that this whole experience felt a lot like someone who was going through a crash diet.

By creating this specific savings goal my friend had slashed their budget to the bone. They had left no money for incidentals or the occasional bit of fun. Sort of like the crazy diet where you decide you'll only eat celery in anticipation of the pounds melting off of you.

The car repair was kind of like the holiday season or the vacation where you find it impossible to stick to your diet. So you get discouraged and feel like a failure, and you feel like maybe the goal is impossible.

The month where they decided to treat themselves is like the cheeseburger and ice cream sundae splurge after the miserable time spent on your crazy diet.

What follows is the same phenomenon you see with crash diets where the person can't stick with the diet and ends up quitting early. They often lose the dramatic results they gained at the start of the program (my friend quickly re-accumulated the credit card debt and then some).

At the time I thought the problem was that my friend didn't have the discipline to follow through on their plan, but now I think that a big part of the problem was that they set their expectations too high (just like with a crash diet).

You might be able to live the "pinch every penny" lifestyle like that for a while, but when you just can't keep it up anymore you give up on the plan AND the goal. This is too bad since the goal was probably attainable if you had just been able to accept a more moderate change with less dramatic results.

By creating such a hefty savings goal my friend had put budget constraints on them that were so strict that they couldn't follow them for more than a couple of months. If they had set a savings goal of $250 a month they might have been able to stick with their program and payoff their debt. Sure it would have taken twice as long but they would have reached it. It's the same way with a more moderate weight loss program where you make more moderate changes. Your results won't be as dramatic but at least you'll create a system that you'll be able to live with and maintain.

Maybe the problem with "crash dieting" and "crash budgeting" is that the goal is to create a temporary process so that you can fix a problem and then forget about it. What you really need in both cases is a long term plan that you can maintain so that the results actually last.