Tracking what you spend is an essential element to financial planning. But it is most valuable if you use the information to better direct your financial resources going forward.
One way to do this is to create an allocated spending plan. With such a plan, you decide where every dollar you make goes before you spend it. The ultimate objective is to have a purpose for all of your money and to optimize your cash flow to best meet your long-term financial goals.
How the Allocated Spending Plan Works
An allocated spending plan is a type of budget and is fairly straightforward. Each pay period, you simply allocate your money to different purposes. Here are the steps to creating one:
1. Figure Out Your Income for Each Pay Period
Most people are paid weekly, every other week, or once a month. If you are paid weekly, some months you will receive five paychecks, and if you are paid every other week, some months you will end up with three paychecks. Therefore, planning according to paycheck as opposed to every month can help you allocate your money more smoothly.
2. Allocate Your Spending for Each Pay Period
Next, look at the obligations you have within each pay period. Because I invoice my freelance clients twice a month, I divide up my expenses between those periods. Bills with due dates between the 2nd and the 15th of each month come from income received at the first of the month.
For example, my mortgage is automatically deducted on the 15th, so I pay for it with money from the first of the month. All expenses from the 16th of the month through the first day of the next month are allocated from my second paycheck. Groceries, expected spending on gas, and everything else can be easily allocated this way as well.
3. Don’t Forget to Save
One of the beauties of this spending plan is that you allocate for savings as well. Direct money toward your retirement account, emergency fund, summer vacation fund, and accounts for other financial goals.
If you have payments that are made irregularly, you can allocate for those as well. For example, if you know that your child’s extracurricular activities are going to cost you about $300 a year, plan to spend $50 for six pay periods to meet the cost. They don’t have to be consecutive pay periods and you can choose whichever ones will work best. Planning ahead is one of the hallmarks of the allocated spending plan.
4. Allocate “Fun” Money
Remember to allocate “fun” money. This includes money spent on entertainment, eating out, and purchasing video games and books. Many people also like to allocate splurge money to be used on whatever they want. This way, you don’t have to know exactly where every dollar is going, but you can still plan for it.
5. Write It Down
Your allocated spending plan can be hand-written or drafted on a spreadsheet on your computer. Additionally, you can look online for different allocated spending plan templates. These often provide examples of how others have set up their plans as well.
Remember that the allocated spending plan is meant to be a little flexible. It’s designed so you can tweak it if your expenses or your pay changes. Yet, it allows you to address your most important spending priorities first. You can also see how to improve your savings rate and make sure that preparing for the future is built into your spending plan.
Variable Income: Difficulties with an Allocated Spending Plan
For those with a steady income, the allocated spending plan works great because it’s easy to be consistent. In fact, some people can even set up an allocated spending plan for the entire year, which automates and simplifies their finances greatly.
If you have a variable income, on the other hand, you might run into a few challenges. For example, my income is different each pay period, so I’d have to create a new allocated spending plan each time I invoice my clients. On top of that, my husband works as an adjunct professor and distance education professor at two different schools with three different payment systems. Since his income is staggered over the semester, it’s hard to determine exactly when his paycheck will come through.
In fact, we’d have to have two different allocated spending plans, each filled out and tweaked every time we get paid. If you also have a side business or investment income, it will have to be taken into account as well. In other words, the more variable income streams you have, the more unwieldy your allocated spending plan becomes.
A Modified Spending Plan with More General Allocations
Fortunately, you don’t have to allocate every dollar in order to participate in a modified allocated spending plan. Instead, you can more generally direct your financial resources, so that your most important priorities are always funded. This works especially well for people with variable incomes like myself, for whom its difficult to be pinned down to a rigid plan.
In fact, I have been using a modified allocated spending plan for years. It’s just not based on zeroing-out my income or allocating every single dollar in a written-out budget format. Thus, though I don’t plan where every dollar will go ahead of time, I still scrupulously track where every dollar has gone using personal finance software like Mint.com.
So how does my family implement our modified allocated spending plan? In order to allocate our financial resources, my husband and I start with our general “base” income each month. We consider our financial goals, such as saving for retirement, building an emergency fund, giving to our church and charity, contributing to a HSA, and putting money in a 529 college savngs fund for our son.
We also know that we have certain expenses, such as our mortgage payment, our car payment, student loan payments, insurance premiums, and utilities. These items are all more than covered by our “base” income. Most of our regular contributions and obligations (e.g. loans and investment accounts) are automated, so the same amount goes into them each month without the need to write it down.
After the most important spending priorities are out of the way, we can spend the money left on what we want or set it aside for future things like vacations, home improvements, and more. For example, “extra” money from my husband’s job, investments, or other income sources are often used to pad retirement accounts, the emergency fund, the college fund, or to boost the HSA.
Having some sort of plan for your money and being a director of your financial resources is a good idea. An allocated spending plan can be of great benefit to many people, especially those who have a regular income and are interested in zeroing out their income to know where everything goes.
However, the idea of allocating your resources can be adapted as well. In this way, those with variable incomes and a need for more flexibility can also plan in advance – even if every single dollar isn’t accounted for ahead of time.
Do you have an allocated spending plan set up? How has it worked out for you so far?