For the past few years, I've been working hard to build up a nice net worth, but I'm starting to come to the realization I absolutely suck at budgeting. Just a brief background, I run two tech startups, own a few rentals... My budgeting skills don't just pertain to the personal side, but moves into my business and rentals too.
It seems I can never accurately predict my costs and as I become more leveraged I want to insure I don't end up in a situation that is hard to recover.
The last year has been rough on the old net worth, because of the huge amount of unexpected bills. Literally, in one month I had significant car repairs to my car which were not covered by insurance, had to completely renovate a bathroom at a property, remove a rotten deck at a property and this was one month after I just bought a new truck. Now, unexpectedly one of my business partners wants out on the real estate business, so I have to evaluate purchasing his shares.
This seems to be happening a lot this year. A series of unpredictable events. Is it possible to budget for scenarios like this? This year has to be the worse for unexpected costs, but it seems every year in one form or another I have a unexpected costs. How do self-employed people with random income, budget properly?
Last edited by phankinson; 2012-10-08 at 10:20 PM.
It is my opinion that money management skills are learned early in life. Those skills were taught to me by my parents who both feel very strongly about the need to save your money. Especially when times are good, that is not the time to buy all sorts of luxury items.
There have been a lot of threads here in this forum about investing and real estate but precious few threads on money management. I believe this, and your situation are a product of our consumer-driven society that puts the consumption of goods above the basics. Everyone hopes for the best and goes through life starry-eyed and thinking that everything will be fine. Not a good approach. You have to hope for the best but always plan for the worst.
My sig file refers to a personal situation that differs a lot from yours but IMO the concept is the same. Save the money first, build up your assets and don't go into debt to operate. Always have cash in the bank, ready to deploy in case of emergency.
Operating with debt and no cash is very poor policy.
I struggle with this-having to be strategic(im @ a lower level than you,(i own a company,managing a significant sum of money,both personal,business)but constantly don't know the right-way or if im doing it right(ie:allocating say 80-100k a yr of ''new money" that can be used for growing)The answer might be:a financial advisor that can run numbers and help you create a strong plan?a mentor(who has been in business and can coach you,and you can lean-on them-hard to find though id think)maybe a ''life" coach?
That is one of the toughest things about being self-employed!!it's hard because your learning in real time and you constantly have to ''deal'' with all the un-expected(this is what i find i have a problem with and i run a small company,just a handfull of people and just a little under 500k a yr,but never the less its hard)I want to wade into leveraging like you but im ''to be honest,scared.
I think the answer is outside help-i toss and turn at night wondering ''when" if i need it....or at what level this comes into play!curious to see the answers to this thread.
Save the money first, build up your assets and don't go into debt to operate. Always have cash in the bank, ready to deploy in case of emergency.
Operating with debt and no cash is very poor policy.
Agree - totally. That's why I do have my "Armageddon fund", lol. Basically everything I do, I have to have at least 6 months of cash on hand. If I buy a property, I have to have 6 months of everything involved (mortgage, property taxes, utilities, etc...). Guess my point was, I find it hard to grow my businesses / net worth, when I keep running into unexpected expenses.
As I wrote my original post, I thought about it a little more in-depth. I think a large portion of my problem, was not fully understanding how to budget for things I saw visually with our rentals beforehand. The deck was in OK shape a couple years ago when I first bought this specific property, I guess I should have naturally created a budget for a "deck replacement" because decks do rot...
There have been a number of threads here relating to budgetting, forecsting, expense control. Bottom line is there are almost as many approaches as there are members.
We use a very well developed system(20 years) that gradually evolved to match our circumtances and meet our needs. Lumpy, unexpected, expenses do cause poblems. In our case this is minimized by holding a large cash balance (maybe 50-100% of total yearly spend) that could absorb any unexpected expense.
This is difficult to do early in the accumulation phase. Some people use a sinking fund approach where they set aside a fixed amount every month to cover unexpected expenses. I think as long as you keep trying to budget and control your finances in some way,you will eventually hit upon a system that works for you. They key is not to give up.
Find a way to turn unexpected expenses into expected ones.
Annual auto repair expenses can be estimated and predicted, break it down into monthly chunks, and save it ahead of time.
I do have estimates on my car repairs and one year I could be at 50% of what I predicted and then the following year I could be at 400% more than what I predicted. One of the issues, I'm having with my car right now they have no idea what's wrong with it, maybe I just bought a lemon
All budgets are subject to uncertainty, which is why some people don't bother trying to keep a budget.
That said, one of the keys to successful budgeting is flexibility. Instead of thinking of a budget as a set of unchanging limits for each category, it's much more effective to view your budget as an iterative, constantly adjusting set of allocations. You start the month expecting to spend x on car repairs, but halfway through the month you discover that you need y. This forces you to figure out what other budget categories you must steal from in order to come up with y-x.
To me, that process is the key to effective budgeting, because it reveals your priorities. If you've allocated $500 to car repairs in October but you need $1,200, you have to look through the rest of your budget to find $700. Will you take it from the money you were going to use for your RRSP? Or your vacation? Or your groceries? The degree to which you're willing to "steal" money from your other category allocations to come up with the missing funds tells you a lot about what's important to you, and thus helps you fine-tune your budget in future months to reflect your true priorities.
I've become a big fan of the You Need a Budget approach, which is built around this kind of flexibility. Forget every stereotypic notion you may have about budgets -- the YNAB approach is based on flexibility. You take your income, and assign jobs to every dollar. Then over the course of the month, you roll with the punches, robbing from category A to cover unexpected costs in category B. Over time, you gradually build up a "buffer" that allows you to live on last month's income instead of this month's (or next month's in the case of people who charge expenses to credit cards). You can still use credit cards and pay them off in full the following month, but from your budget's perspective those charges are no different from those you make to a debit card: they apply to the month in which you charge them, not the month in which you pay them. That alone does a great job of keeping you living within your means and building up a safety net.
The way that I have managed this for myself is from a risk management perspective first, budget perspective second. Periodically, I review the things that could go wrong for us financially and then rate the likelihood of that thing going wrong (I'm not being very eloquent here; hopefully my message will be clear).
Example 1: Part of the roof on my house is aging and will likely need replacement in the next 5 years. I estimate a cost and then estimate the likelihood I will need those funds in the next 12 months.
Example 2: My car is aging and will likely need replacement within 2 years (this is a fictional example now; I did replace my car last month). I estimate a cost and then estimate the likelihood I will need those funds in the next 12 months.
At the end of this exercise, you have a list of financial risks you think you might be exposed to, an estimate of the costs if the risk materializes, and your guesstimate of the likelihood of the risk materializing over the next 12 months (it is important to note this is a rolling exercise, not a yearly exercise; you can't just end December and think you can start fresh in a new calendar year - all those risks that didn't materialize in the last 12 months are theoretically "closer" in time now than they were at the outset of the year!).
Once you have this list in place, you can then start to budget for the risks. If you think your car might need replacing, but estimate the likelihood of that happening in the next 12 months at (say) 30%, you could set aside 30% of the estimated replacement cost for this year. Or you could say, "this is a low-priority risk that I do not think will materialize this year so I am not doing anything about it" (these are kind of the two extremes of thinking about how to handle these risks).
After all that typing I'm not sure my message is, in fact, clear. My point is that I try to assess the risks I'm exposed to, and then go from there - instead of creating a budget which is (in my view) full of guesstimates with no probabilities. I've been very successful with this approach and as a result I am very rarely surprised financially. In particular, I don't get surprised by a lot of things failing at once, as in your first message. All of those issues (perhaps excluding the car repairs) are foreseeable risks.
I followed pretty much the same approach as MoneyGal for the past 20 years and it worked well for me too. But I did discover early on that while you can estimate costs, estimating the risks is in many cases just as much a matter of guesswork as any other exercise in budgeting. I would estimate that my computer would need to be replaced sometime in the next two years, and then a week later it would die. My assessment of risk was accurate ("sometime in the next two years") but not precise enough to be useful.
As a recent convert to budgeting, I like the fact that I can see (and to some degree control) the consequences of every decision and every event whose probability I misjudged. I have a bunch of "rainy day" categories in my budget, under which I set aside money for unplannable-but-likely things like car repairs, home repairs, etc. And I have bunch of "Savings Goals" categories in my budget, under which I set aside money for plannable things like replacing my car, replacing my computer, meeting my RRSP contribution target, etc. So whenever a low-probability event turns into reality, I look at my budget and decide how I'm going to shift my allocations to cover the cost. In some cases it may involve dipping into the funds I've saved in a rainy-day category or one of my savings goals, or it may force me to look at my allocations to other categories and think about how realistic they are ("do I really need to set aside $600 for that four-day vacation?").
What I like about that process is the sense that I'm in the driver's seat, that every dollar has a job to do, and there's no unconscious spending. On the other hand, it forces me to think a lot more and it's more work than simply setting up a series of savings goals, sticking to those goals, and spending the rest however I like.