How to Budget Principle # 3

In this series of blogs, I look at the 5 core principles that made my Grandma’s budgeting system so simple yet so powerful. While we no longer budget using a collection of glass jars tucked away in the kitchen cupboard, the principles behind Grandma’s system are just as relevant today as they were 25 years ago.

In our first blog in this series, we discussed the importance of taking time to thoroughly identify all of our expenses. Not only do we need to know what our expenses are but we also need to know how much each expense is, how frequently it occurs, and, where appropriate, when it is next due.

In our second blog, we outlined the process and importance of converting all our income and expenses to a monthly figure so we know exactly how much we need to set aside for each expense each and every month. The logic behind this principle is that if we set aside 1/12^th of our future expenses each month we will have accumulated sufficient money ready to pay each expense when it turns up.

However, there is one glaring problem with this system when first starting a budget.

Setting aside 1/12^th of each expense works brilliantly if all my expenses are due in 12 months’ time but what happens if,  for example, my car registration is due in 6 months’ time?  I definitely won’t have enough saved to cover the bill. In fact, I will only have saved half the amount I need.

At Grandma’s Jars, we call this problem the ‘budget shortfall’, and everyone starting out in budgeting for the first time will almost certainly have a shortfall of some kind. Unexpected budget shortfalls undermine people’s confidence in their budgeting system and are one of the major reasons people give up budgeting.

In this blog post, I will discuss how to identify what your shortfall is, and the two strategies for dealing with it.

First, let me reinforce with you that a budget shortfall will only occur in your first year of budgeting; it will not be an ongoing problem. Each time you pay an annual bill for the first time on this budgeting system you will reset the clock and from that moment on you will have the full 12 months to save for the next year’s bill. The same goes for bills you might pay every quarter, half year, term etc. Once the bill have been covered for the first time, you will then have a full cycle to save for the next time it is due.

It is also worth noting that a budget shortfall will only typically occur on two types of expenses:

1)      Bills with pay cycles greater than monthly, for instance expenses that occur quarterly , 6 monthly, annually or for instance per term or semester. These bills occur according to a predictable cycle.

2)      Large irregular expenses due inside 12 months. When first starting a budget it is not unusual to find that there are large expenses looming that you are already committed to. For instance, you may have a holiday booked that needs to be paid for, or perhaps you have a major car service that has been coming but is not yet funded.

Regardless of which type of expense it is, we will deal with them in the same way. Hopefully you can see, however, that the list of expenses you are likely to experience a budget shortfall on is very small.

How to Identify and Calculate your Budget Shortfall

Below is an example table that I have used over the years with all my clients to help them work through the process of calculating their budget shortfall. You can find templates of this table in our budget worksheets which you can down load for free at the end of this post.

Any expense that has a due date that is greater than one month away but less than 12 months away needs to be included in this table:

This example assumes you are starting your budget in January

You can see from this example that we have a few bills coming up that would not be met in this first year simply by saving one twelfth of the bill each month.

All up we need to find an additional $1,532 to meet our anticipated expenditure; most noticeable is the $600 home and contents insurance which is due next month!

Most people have some sort of budget shortfall when they start budgeting and while it can look a little daunting at first, knowing what you are up against is half the battle.

There Are Two Strategies for Dealing with a Shortfall

1) Recalculate your monthly contributions to save more each month between now when each bill falls due.

Instead of saving one twelfth of each bill, you divide the bill amount by however many months you have left until the first round of bills fall due.

You will note that this will require you to put more aside each month until you have been through each round of bills once. However once each bill has been paid for the first time you can revert back to the lower monthly allocation i.e. 1/12^th of the annual expense.

2)  Use surplus funds to top up the jars in advance.

The second option is my preferred option if you can afford it because is a far cleaner way of getting your budget on track from day one. If you currently have some savings, or can get your hands on some additional money by selling something, doing a little overtime or redeeming some investments, you can use the funds to top up your jars in advance.

If you deposit the equivalent of your shortfall into your jars from day one your regular monthly payments will ensure you have enough money for each bill as and when it arrives.

Carrying on from our example above:

Regardless of which strategy we use we will have to find an additional $1,532 between now and when the first round of bills are paid.

It is likely that anyone with regular expenses will have some form of shortfall when starting a budget. This is the major stumbling block of the novice budgeter and typically provides the first ‘excuse’ to give up. However, once you have recognized and dealt with the budget shortfall, day to day budgeting becomes pretty straight forward.

Understanding how to deal with your budget shortfall is key to getting your budget off to a smooth start. As always if you have any questions please do not hesitate to contact us or leave a question on our forum.

Finally it is worth noting that if you are planning on using Grandma’s Jars online budgeting software, you will be pleased to know that the software automatically does this calculation for you as you enter the expenses into the system.