Avoid Budget Busters Part 3: Plan on Budgeting Surprises

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Monopoly Doctor's FeeThrift is having a sure hand that controls your spending so your spending doesn’t control you. The goal isn’t to be rich but instead to be thoughtful, industrious, content and thrifty.

To avoid unplanned budget busters, set three rules for your spending: Set a dollar limit, wait at least a week each time you’re unsure of a purchase and be aware of the categories where you are most likely to make impulse purchases.

But raising your awareness on impulse purchases is only part of the battle.

Many budgets are doomed to failure because of the challenge of planning for unplanned spending. Here are some of the items you either did not put in your budget or they shouldn’t be in your spending.

Interest on debt

The average American family carries close to $10,000 in commercial credit. At 18% interest, that’s $1,800 a year or an unnecessary $150 every month per household. If you put that payment into the markets every month over your working years earning an average 10% return, you would retire with an additional $1.5 million.

There’s no reason to buy anything on credit. If you find yourself considering an expensive purchase and then trying to find the payments in your budget, you are planning for failure. The only two loans you should even consider are a home mortgage loan and a student loan for an education or training that increases your earning potential. Money makes money. Credit does the opposite. Debt breeds poverty.

Paying bills late

Debt is terrible. Paying bills late is just bad. By establishing a system for paying your bills on time, you will save every $15 payment from getting a $35 late fee tacked onto it. These foolish expenses add up over time and will quickly undo your efforts at frugality.

Many people believe that paying bills as late as possible gains them a few days of extra interest. In reality, a year’s worth of interest isn’t worth even one late payment. Late payments also hurt your credit score, which ultimately will mean getting charged a higher interest rate. Pay your bill early, and put your efforts to better use.

Organized people are simply disorganized people who have found a system to help them get things done. Don’t think being disorganized is an innate unchangeable quality. It is common to everyone before they take the time and effort to get organized.

Pay monthly bills at least twice a month in order to be on time. These cannot be postponed. Many people find the assistance of online bill pay systems invaluable. It may also help to have a calendar reminder system or a bill organizer. Others have their credit or debit card charged automatically so they are never late.

Unknown unknowns

None of us can anticipate all our expenses. Every stage of life brings a whole new set. Perhaps extensive study and research could help you prepare. But it is easier simply to budget 10% for unknown unknowns.

The first question I usually get asked regarding this category is “Like what?” The truth is that even after identifying every expense you can think of, there will still be significant new expenses that may push you toward deficit spending. But every surprise expense is an opportunity to anticipate and plan for that expense in the future.

Insurance deductibles

Review the insurance coverage for your car and home. A deductible and perhaps a 20% copay often apply. Out-of-pocket expenses could run several thousand dollars. It is more important to limit the maximum expense than to make sure the deductible is low. Budget for the deductible and copay expenses.

Medical costs

Medical expenses are rarely planned. To prepare your budget, have some insurance in place that will limit your catastrophic loss. Second, set up an emergency fund that will cover your expenses if they reach that limit.

For families who are relatively healthy, we recommend Health Savings Accounts (HSAs). As long you spend the funds you save on qualified medical expenses, all contributions, capital gains and withdrawals remain untaxed. And like any other bank account, HSAs come complete with debit cards and checks.

To protect you against catastrophic medical expenses, Health Savings Accounts are coupled with a High-Deductible Health Plan (HDHP). The deductible can be as high as $6,000. Because you might be required to spend up to your deductible, you need a savings plan that funds your HSA up to your deductible within two years. For example, if your deductible is $6,000, put $250 a month into your HSA. Once you have amassed at least that amount, you can take comfort knowing you can at least cover your deductible from your medical savings.

We have coverage for a family of four with a maximum out-of-pocket expense of $3,500. We pay $322 a month to protect our budget and cap our potential losses. We are also allowed to contribute $6,150 a year pretax into our HSA. So we know the most our health-care costs could be is $614 a month and we budget for them accordingly.

Unfortunately, “Obama care” threatens to eliminate consumer-driven care like HSAs by requiring minimum packages and removing the freedom to choose using insurance for disaster coverage. Forcing families to have low deductibles and be pooled with everyone else is like requiring grocery store insurance for the first dollar spent. Frugality disappears, and everyone tries to buy filet mignon.

Insurance should be only used for disasters, not everyday expenses, which provides just the right amount of negative feedback. The first $3,500 as an out-of-pocket expense works as a natural incentive to keep medical costs low.

Car repairs and replacement

Your car won’t last forever. It will need major repair at some point and ultimately replacement. Decide how much you are willing to spend for the lifestyle you want, and then budget for it. Don’t buy a new $30,000 car and think you won’t have any car expenses for the next five years. Even if you plan on driving your new car for the next decade, you have to start budgeting for repairs and your next new car now.

Whatever you pay for your car, new or used, start budgeting to purchase another car in five years. Prices will be higher in the future, but maybe you can stretch the time to seven years so it will all work out.

If you buy a new car for $30,000, you must be able to set $6,000 aside every year ($500 a month) for the next new car. Don’t borrow to buy a car and then start making payments. That’s nearly always a bad idea and simply ensures you won’t save, invest or grow rich. If you can’t afford to save the payments in advance, you are stretching too much. Buy used or wait.

House repairs

Owning a home and surprise expenses are practically synonymous. The roof might leak. The plumbing could need replacing. A tree may need to be taken down before it falls. The heating or cooling system could need repairs. The carpet will need to be replaced.

Set aside at least 1% of the value of your house for repairs, not enhancements, each year. If you have an older home, increase the minimum to at least 2% of its value.

Emergency travel

Another unexpected category is emergency travel. Family illnesses, weddings or funerals impose themselves on a family’s budget with some regularity. Sometimes even family vacations, graduations or other gatherings can strain finances. If you are both of humble means and have a large extended family, your budget could break under the strain. These are not easy decisions.

Here are some alternatives to help you cope. Perhaps you could send a letter to be read or a videotape. Maybe not everyone in the family has to attend. Consider sending a representative. Ask for help with travel or accommodations. I know that family expectations can seem unreasonable, but speaking the truth in love is always a good response.

Avoid sacrificing or jeopardizing the finances of your family simply to attend the birth of another family or a distant wedding. If you are rich in both time and resources, that circle can include a plethora of friends and family. But the rest of us need to be on a more modest plan.

No budget can anticipate every major expense. Life serves up surprises with some regularity. Putting a healthy margin in our daily living expenses gives us the stored resources to weather these major bills and then better plan for them going forward.

Photo by Megan Marotta

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President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.