Budgeting tip: Medical costs

You don’t know when you’re going to be sick and need to see the doctor. That makes it tricky to include an allowance for medical expenses in your budget.

Medical expenses are included under the category of “irregular expenses” in my budgeting approach. You save a regular amount each pay period into a dedicated savings pool from which you later draw when the expense occurs.

If you’re just setting up your budget and haven’t been tracking your expenses for the past year you can get an initial estimate of your annual medical expenses from a combination of these sources:

  • Medicare online – allows you to download past 12 months and shows you net out of pocket
  • Your private health insurer –  online access or just call them
  • Past credit card and bank statements

As you complete your tax return this year you may need your Medicare claims history. Keep this information each year and over time you’ll get better at estimating your medical expenses.

Yes, sometimes you’ll have an unexpectedly costly medical bill. This can be covered from your budget’s contingency, which I’ll write about soon (so stick around).

View more budgeting tips or read the introduction to my Better Budgeting method.

Budgeting tip: They don’t make things like they used to

When an electrical good suddenly gives up you can be faced with finding a tidy $1,000 or so to replace it. For many people this causes unwanted financial stress and can result in them funding the purchase through debt or other savings. Neither of those options is ideal.

My parents still have a refrigerator that has one of those locking door handles on it. You know the ones that a small child could lock themselves into. It must be 30 or 40 years old and it still works.

Unfortunately electrical goods aren’t made to last that long, yet they’re cost is significant.

When an electrical good suddenly gives up you can be faced with finding a tidy $1,000 or so to replace it. For many people this causes unwanted financial stress and can result in them funding the purchase through debt or other savings. Neither of those options is ideal.

Funding through debt just increases the cost courtesy of the loan interest.

Funding from savings that were earmarked for something else is frustrating as it can mean you miss out on that  other thing you were saving more. Clearly that is not what you want in your life.

Save for the predictable

Next time your fridge, washing machine or TV goes on the blink there is no need for you to blow a fuse.

It is reasonably predictable that your household electrical items will need to be replaced during your life time.

The exact timing is uncertain but you can assume items will last about one or two years past the expiry of their warranty. That’s just how items are made these days.

Similarly the precise cost is unknown but it can be estimated. Just take the current replacement cost and increase it for inflation of about 3% per year.

How to save for replacing household items

Knowing the approximate time and cost you can then calculate the regular amount you need to save each month so that money is there when you need it.

Don’t worry about including interest on your earnings in the calculation. In fact for ease just assume the interest earned on the savings will offset the inflation.

Just use a simple calculation of replacement cost divided by months until money needed divided equals regular monthly saving amount.

If the item lasts longer or costs less than your estimate that’s a bonus. You then have some ‘spare’ cash you can use for those items that need replacing sooner than planned or cost more than planned. This budgeting strategy can have an in-built contingency.

Household items to plan for

For an idea of what items to save for just take a walk around your house, both inside and outside and note the significant items you would replace when they break down. The household electrical items include:

  • Refrigerator
  • Freezer
  • Dishwasher
  • Oven and cook-top
  • Microwave oven
  • Washing machine and dryer
  • Television
  • Stereo
  • Computers and printers

View more budgeting tips or read the introduction to my Better Budgeting method.

Better budgeting

For many people the word “budget” conjures feelings of restriction. (Just like the word “diet”.) However a good budget should be the exact opposite. It should facilitate you having enough money for the things that really matter so you need not feel restricted. In this article I reveal a better budgeting technique using the model “Pay Yourself First (in practice)”

Cue Skyhooks tune…

Budget…is not a…dirty word! Budget…is not a…dirty word!

Once on live TV I was challenged to come up with a better word for a budget. The interviewer felt the word was too creepy.

The reality, as you can probably guess is that it has nothing to do with the word but the meaning we associate with it.

In fact the origin of the word “budget” is in the leather case or wallet that bureaucrats used to carry their financial plans.

Of course the problem is that for many people budget conjures feelings of restriction. (Just like the word “diet”.)

A good budget should be the exact opposite. It should facilitate you having enough money for the things that really matter so you need not feel restricted.

You achieve this this by following the wealth principle I call “saving for the significant and minimising the insignificant.”

Pay Yourself First (in practice)

It’s likely you’ve heard of the principle to pay yourself first.

Back when I was a graduate engineer I thought this principle meant to put a certain percentage of my income away for wealth creation. Then I wondered “what next? How do I manage the remainder?”

Now that I’ve had the benefit of working with lots of people on their cash flow I’ve created this model to help you create an effective budget that sets aside money for the significant things in your life plan.

(Download a PDF version of the model here)

Top-down or bottom-up?

To follow the principle of pay yourself first ideally you work from the top as you allocate your income into pots of savings.

However, if you find that you never have any savings and in fact spend more than you earn the top-down approach won’t feel possible – because it’s not yet. To extricate your butt from the spending fire first you need to get control. You do that by starting at categories 5 and 6 and working upwards as you increase your control.

In short if you are in stages 1 or 2 in the Six Stages of Wealth Creation you would start at the bottom and work upwards to improve your cash flow management. Everyone else can take the planning approach and go top-down.

Your pots of money

1. Financial Independence

The first pot you allocate is how much you need to regularly invest so you accumulate enough net wealth to “retire” – or make work optional – when and how you want it.

In addition you include the additional regular loan repayment s you need to make to ensure you are free of personal (non-investment) debt by your financial independence target date.

2. Pre-retirement Essentials

The second allocation is to all the big things you want and need to do, buy or experience between now and the point you achieve financial independence.

For example: car upgrades, major home maintenance, family holidays, replacing major household items, parental leave. (The list goes on.)

In my experience many people find these items either blow their savings or are funded by debt. Why borrow and pay interest on predictable expenses when instead you could be earning interest? Earning interest in advance actually reduces the true cost of the items and the amount you need to save.

3. Irregular Expenses

In this pot I include all expenses you pay at least every year but less frequently than monthly.

For example: clothing, utilities, insurance, gifts, parties, subscriptions.

Again from my experience it is often the irregular expenses that end up blowing the savings of otherwise consistent savers. The problem for them is that whilst they are saving, usually by automated pay deductions, they are not saving enough. Month-to-month they may have savings but not year-to-year.

Often when clients actually separate their irregular from their regular expenses they are shocked by how high a proportion are irregular expenses. That observation alone is an insight into why they may be spending too much.

The expenses may be out of sight but they should not be out of budget.

4. Existing regular commitments

This category is the allocation for repaying all of your existing debts as per the current minimum required repayment.

For many people this is the first line item they put in when working out their budget.

The reason loan repayments is item 4 is that when you take a planning approach you first allocate items 1 through 3 to work out how much you can afford to borrow.

The way many people actually work out how much to borrow is a combination of:

  • What the lender says they will lend them
  • Their income less the regular spending that comes to their mind (i.e. untracked)

5. Regular Essentials & Comforts

All the regular items you spend at least every month.

When you take the planning approach you get to this point and discover how much you can afford to spend on comforts. And some things you thought were essentials get re-categorised.

It’s at this point many people start prioritising between lifestyle now and future significant goals.

  • Which is more important to me?
  • If I don’t save up for that future goal, but still want it how will I create the money to afford it? (e.g. I’ll only be able to afford X if I get a promotion – so I’d better start investing in professional development.)

6. Impulses and Indulgences

The final category is a little allocation for spontaneity.

How much to allocate to each pot

If everyone were identical in situation and value-system then we could define a nice neat package of percentages to allocate to each pot.

But we’re not.

To create a budget that is meaningful and motivating to you it needs to relate to your goals for your money.

That’s not as hard as it may sound. You already know what you want – it’s in your head, you probably think about it regularly. Just get it out of your head and onto paper and then put a number and time frame next to it.

Automatic wealth creation

Once implemented good budgeting should also be as automatic as possible. That’s the next step of smart cash flow management.

If you’re interested in how to put this all into place talk to me about Cash Flow Coaching.