Budgeting and Debt Management

Everyone’s favorite topic: Budgeting and Debt Management.

I know, I know, can’t we just get on with our lives and not have to deal with pesky things like budgets and boring old debt management? Well, you certainly could; plenty of people live their lives every day with no financial budget and with plenty of debt. However, living this way can cause serious consequences for your future and ultimately, your retirement. But you’ll say to yourself, “I’m a responsible adult, I don’t need a budget”. Unfortunately, even the most responsible and well-meaning people can experience financial wake-up calls when there is no budgeting and management in place.

Smart budgeting and debt management are crucial to achieving your short-, medium-, and long-term goals, especially for those living abroad. As the old saying goes, if you fail to plan, you plan to fail. So, let’s jump into it with some simple guidance to follow.

Budgeting

If your employer has already taken out taxes and benefits, you are left with your take-home pay. What do you do with it? Well, of course, you have to pay for rent, energy, food, maybe some student loans, but what to do with the rest? That’s where a budget comes in! There are basically four ways to set up your budget.

1. Zero-based budgeting
   1. Every dollar you earn is assigned to a specific category until your paycheck minus each category equals zero
2. The Envelope System
   1. You divide cash into labeled envelopes for each spending category and only spend what’s in each envelope (of course the modern version is all digital – I do not recommend using actual cash as that is very impractical)
3. 50/30/20 or 70/20/10
   1. You allocate 50% of your income to needs, 30% to wants, and 20% to savings and debt repayment
4. Reverse Budgeting (Pay Yourself First Budget)
   1. You set aside a specific amount of money for savings and investments before spending on anything else

If you’re just starting out, for simplicity’s sake, I recommend starting with zero-based budgeting because it’s easy and achievable. You can even start with a simple pen and pad. Put your paycheck amount at the top, then subtract your essential expenses first. This would be your rent, utilities, food, transportation, household supplies, student loan payments, etc. Next is where the strategy comes in a little. Assuming you still have money left over, you can now decide how much to allocate each month to savings, investing, charitable giving, travel, entertainment, etc. Below is a very simple example:

The categories in the bold outline would be where you allocate your money first, as these are essential. The categories below the bold line are where you can decide how much you want to spend in each category. However, I highly recommend putting a portion towards investments and your savings accounts. Let your money work for you and set yourself up for retirement. You can’t work forever!

The $0 just means that you assigned every dollar to a category; it does not necessarily mean that you are out of money. It just means each dollar has a home to go to, not sitting in limbo. Personally, I used this method along with the envelop system (digital) and have a category labeled “miscellaneous”. Which does not sound very precise, but just goes to show that a little flex in your budget is totally fine. But at least I know where all my money is going each month.

Debt

Now, debt is a sober conversation that I think more people need to have, especially in the U.S., where consumer debt has reached an all-time high of $18.04 Trillion…yes that’s Trillion with a capital “T”. This number mostly includes mortgages, however 4.49 trillion of this debt includes just credit cards, car loans, and student loan debt. Student loan debt is mostly okay (depending on how much you owe) because the assumption is that your education was an investment in your career and future earnings. Car loan debt is ehhh/bad debt depending on your interest rate (you don’t want to pay interest on something you own that is constantly going down in value, unlike a house, which typically goes up in value). Credit card debt is just plain BAD debt. Avoid this at all costs! The interest rates some of these credit card companies are charging are insane… 18%, 23%, and even upwards of 30%!

So, what if you have debt? What do you do about it? First of all, if you do have debt, this should be a line item in your budget each month to pay it down. There are two simple ways to pay off debt: the debt snowball and the debt avalanche.

Debt Snowball

This is where you list all your debts from smallest balances to largest, regardless of interest rates, and pay off the smallest debt first. As each debt is paid off, you roll the payment into the next debt on the list, creating a “snowball” effect. This strategy helps you build momentum and is helpful for people who are overwhelmed by their debt and need a motivational boost. Seeing smaller debts eliminated quickly gives you encouragement to stick with it.

Pro: Motivational and good for emotional spenders

Con: You will spend more money in interest by paying down smaller debts if you do not think about the interest

Debt Avalanche

This strategy prioritizes paying off debts with the highest interest first. Once the highest-interest debt is cleared, you move on to the next highest, and so on.

Pro: The most efficient way to pay down debt and pay the least amount in interest (unless you count debt consolidation to a lower interest rate but that’s more advanced and takes work to set up)

Con: Can lose motivation if you do not “see” the progress right away

Personally, debt avalanche makes way more sense. Simply put, you pay much less interest and pay off debt faster. However, there is a component to the debt snowball that is certainly helpful for some people, and hey, if that’s what helps you to pay off your debt, then by all means, go for it! The important thing in all of this is that you are actually making a dent in your debt, however small or large.

So, there you have it! Use my example above to create your own beginner budget. Try to stick with it each month by staying true to each category. Also, as a side note, try reframing your thinking about a budget. It can be a dirty word, but in reality, it can free your finances and help you make decisions. For example, my wife and I have ‘personal budgets’. Each month, we get the same amount of money to spend on whatever the heck we want, no guilt! This prevents conflict over purchases and gives you the freedom to make that impulse purchase of a pair of shoes you saw at the store or the bag you saw online. As long as you don’t go over that amount each month, you’re in the clear. Again, stay consistent each month, create and follow your simple budget, pay down and get out of debt, and you’ll be on your way to financial freedom in no time!

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