I will rarely quote Charles Dickens, but here’s a great quote from David Copperfield by the character Wilkins Micawber:
“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.”
Let’s translate this into English.
“When your income is $20 and spending is $19.98, the result is happiness. When your income is $20 and spending is $20.02, the result is misery.”
What this is suggesting is that if your income is slightly greater than your spending, you’ll be in good shape, but if your spending is slightly greater than your income, you’re going to be in trouble.
I think this is only partially correct.
Let’s talk about the misery. In this case, you spend slightly more than you earn. Even though it’s a paltry amount (the “six” referred to in original quote was six pence, where there were 240 pence to the pound), the result is still the same: you will eventually go broke, because you are “leaking” money.
Of course, the timescale on the “eventually” depends on how much you’re leaking, (2 cents a month will probably take a while to do much damage) but it’s the idea that’s important. You should not spend more than you make. Hard not to be on board with that.
You would think that I would be on board with the other proposition, that if you earn more than you spend, then you will be fine (or, in this context, at least not miserable). And on the surface it would appear that running a surplus is a good thing. Mo money each month. What’s the problem there?
The problem here is not one of earning or spending, it’s one of allocation. The point of having a budget isn’t to reduce your spending to as little as possible; it’s to determine exactly what your money is doing. All of it.
So extra money isn’t necessarily a good thing! Here’s why:
You may be restricting yourself. Sometimes people confuse budgeting with living like a monk. I reject that idea, because a budget should give you the freedom to spend! (Assuming you have the money, of course.) If you’re restricting yourself, by spending less than you budgeted, you may be on an unsustainable path, where you eventually crack under the strain of this unnatural restriction and go on a shopping spree. That’s no good.
But the big problem with extra money is that it is unallocated, and so may vanish. Money has a short attention span. Money is like the financial equivalent of ADD. And if you don’t give it some structure and keep it busy, it’s going to wander off. If you don’t have an allocation for that money, it will get spent without direction or purpose
So when you earn $20, the goal is to allocate neither $19.98 nor $20.02, but $20. If you find you’re spending less than you thought you would, you then capture that money and allocate it somewhere else. That could be savings, that could be entertainment, or any other category. (It still counts as an expenditure, even if you put it away in your piggy bank.) What’s most important is to keep track of where it all is going. If you do that, result happiness.
But enough about Micawber. Do you allocate all of your income?