With Halloween behind us, the holiday spending season is here. And with the holiday season comes travel plans, parties, family gatherings, and, of course, gifts.
With all of that comes costs. Significant ones.
A study from PwC estimated that millennials spent over $1,000 on holiday-related expenses in 2017, up 26% from 2016.
I’m not writing this to say that holiday spending is a bad thing.
True story: I’m the lunatic who starts listening to “White Christmas” in October. 🎅🏻
Here’s my question instead:
From a financial planning perspective, how do you prevent irregular expenses from destroying your monthly spending projections?
It’s not Just about Holiday Presents
What do I mean by irregular expenses?
Spending that isn’t completely unpredictable, but doesn’t happen every month.
Breaking your leg and needing to pay for an x ray isn’t an irregular expense- it’s an emergency, and its why I encourage all my clients to have an emergency fund before focusing on other financial goals.
That’s not what we’re talking about here. Instead, we’re looking at the money you spend every year or so in a way that’s predictable, but not frequent.
Holiday spending is particularly relevant in December, but this isn’t the only irregular expense that comes up during the year. This also relates to:
- Thanksgiving travel (or hosting!) costs
- Car insurance payments (usually made twice a year)
- Renters or homeowner’s insurance payments
- Reoccurring medical expenses (for example, a refill on prescriptions or contact lenses every x months)
- Annual car registrations and inspections
- Car maintenance (ex: new tires every 60,000 miles)
Some of these are more predictable than others, but you get the picture. If you aren’t careful, you can have a huge, irregular expense in your budget every other month.
Getting back to the holidays, I’m not just picking on gifts. There are a lot of other costs that can add up around this time of year- travel expenses, shipping costs, decorating, cooking/baking, and Christmas cards, just to name a few.
So, what should you do about it?
There are two main ways you can approach irregular spending.
Holiday Spending Option 1:
Keep and Fund an Irregular Expense Account Using Past Average Spending
Personally, this is my favorite method to approach these issues.
In a nutshell, using this approach you would average out your yearly expenses across every month, and use these savings to cover the holiday spending and expenses when they come due. Let’s break it down.
Irregular Expense Account Step 1:
Estimate Your Yearly Holiday Spending and Irregular Expenses
In order to plan for your irregular expenses, you have to have a ballpark idea of what they are. While it can be difficult to calculate some irregular expenses, generally I recommend that you let your own spending history be your guide.
With bank account and credit card information online, it’s not terribly difficult to piece together a ballpark estimate of your past irregular expenses. And it’s well, well worth the time and effort.
For example, let’s say that on average, you’ve spent $1,000 on holiday spending – gifts/travel/decorating/cooking – every year in December, $500 every March and September on car insurance, and $150 on annual car registrations and inspections. If these are your only irregular expenses, your total for annual irregular spending is $2,150.
Just to be on the safe side, let’s round up by a couple percentage points and use $2,200 instead.
What does this mean? On top of your monthly budget for rent, food, etc., you need an extra $2,200 to cover your expenses each year.
Irregular Expense Account Step 2:
Break It Down By Month
In this step, we’re going to divide your annual irregular spending into an average amount per month. Then, add that amount to your current monthly budget.
The idea here is that rather than only thinking about holiday spending in December, it’s best to set aside some money every month so that when the holidays roll around, your budget stays intact.
Going back to our example, if you spend $2,200 on irregular expenses every year, averaging that out every month means that you’d spend $183.33 per month on these items if you spent it evenly throughout the year.
So, how do you stop irregular expenses from blowing up your budget?
Estimate them on a monthly basis, then save that amount each month. That way, when it comes time to buy that holiday gift or get your car inspected, you can use cash you’ve saved up in advance to cover it.
Is it easy to save $183.33 each and every month?
It might be, or it might not be, given your budget. That isn’t really the point.
The point is that if you did the first step correctly, you’ve been spending that money already in the past year or two. Rather than dealing with it in large chunks, you’re planning ahead to make it easier on your wallet when the time comes.
Irregular Expense Account Step 3:
Where to Put the Money in the Meantime?
Saving a set amount each month to cover sporadic expenses and holiday spending is great.
But that begs the question- where do you put the savings?
I’m a big believer and proponent of having multiple savings accounts for different goals.
Assuming you aren’t paying fees on your savings accounts (if you are, you shouldn’t be! There are plenty of free options out there), the only drawback to having multiple savings accounts is keeping track of them.
I’d argue that it’s much easier to keep track of your money if you have different accounts earmarked for different purposes, rather than one or two accounts holding the money for everything.
Your emergency fund is different than your irregular expense fund,
which is different than your travel money,
which is different from your savings to buy a house….
You get the picture. One of the easiest ways to keep your money allocated for the correct purpose is to use different accounts.
So, if you set up a separate irregular expense account, your goal should be to contribute to it evenly each month to fund these expenses. Make it easy on yourself, and automate this savings. Schedule a direct deposit from your paycheck, or an automatic debit from your checking account, once a month to make sure you’re saving what you need to be saving. Your wallet will thank you when the holidays roll around!
Irregular Expense Account Step 4:
I work with all of my comprehensive financial planning clients to update their financial plans annually.
There’s a good reason for this: things change, and change often. What worked for you this year might be too much or too little next year.
Set your targets based on what you’ve done in the past, but make sure to reevaluate at least once a year to make sure you’re saving the appropriate amount.
We need to have a brief time out before we go to the second option for how to keep holiday spending from blowing up your budget.
So far, we’ve only talked about irregular expenses.
But, irregular income works exactly the same way.
If your cash flow increases once or twice a year, either earmark those funds toward a long-term savings goal, or average out this income each month to treat it more like a raise than a bonus.
What am I talking about here?
For people who have seasonal income, this definitely applies to you, but I bring this up to primarily speak to one irregular source of income that most of us receive each year- your annual tax refund.
If you get $500 back from the IRS every April, build it into your monthly income budget for the rest of the year, just like we did for your irregular expenses, rather than spending it all at once.
Time to talk about the second option for handling irregular expenses.
Holiday Budgeting Option 2:
Benchmarking and Flexibility
Let’s say that the thought of diligently setting aside money in January and February that you won’t be able to touch until December gives you some anxiety. What do you do then?
The short answer, of course, is that you need to come up with a way to pay for your holiday spending and expenses in real time. This can be challenging, but there are a few good ways to go about it.
Benchmarking and Flexibility Step 1:
Set Spending Caps
Before you start your shopping, set some hard caps for yourself.
Again, this best done in conjunction with your historical spending, but the key is to come up with a realistic number and hold yourself to it.
For example: this year, you might commit to only spending 1.5% of your annual income on holiday-related items.
That’s a great first step, but now it’s time to divide it up.
Let’s say that 1.5% of your annual income is $1,000 (if your post-tax income is $66,666.67). How are you going to spend that?
- $50 for decorations
- $75 for baking expenses
- $75 for Christmas cards
- $250 for a train ticket home
- $550 for gifts
From there, divide each category down even further. Of the $50 you’re spending on decorations, $35 might go toward a Christmas tree, $15 toward lights. For your gift budget, break it down by person.
This way, once you’re browsing your favorite online stores, you have your targets in mind before you buy.
Benchmarking and Flexibility Step 2:
Of course, limiting your expenses this way is great, but it doesn’t completely solve the problem of where the money is going to come from.
Hopefully, by putting reasonable caps on your holiday expenses, you’ve made the burden light enough to solve the problem through some flexibility in your budget.
Obviously, your rent and electric bill still need to be paid. But most people I’ve worked with have some discretionary money built into their budget somewhere.
Maybe its money you set aside for eating out on the weekends, or for going to the bars. Maybe you like to go to the movies or to sports games. All of those things are great, and they absolutely belong in your budget. But, when these irregular expenses come up, they should be the first place you look to cover the costs if you haven’t been setting aside money for them.
Saving and cutting down on discretionary money isn’t fun, but your wallet will thank you come New Year’s if you plan accordingly!
The Elephant in the Room
If you’ve made it this far, you may have noticed I left out a step. I’ve made an assumption and left it unaddressed until this point, but it’s an absolutely crucial one.
I assumed you have a monthly budget.
I don’t think anyone actually likes budgeting. But, I can’t overstate the importance of a monthly budget if you want to make financial improvements in your life.
I was in this position a few years ago. I never sat down to budget how much I was spending on food, transportation, entertainment, etc. each month.
And guess what? I wasn’t saving anything.
I also know that in order to achieve just about any financial goal you have, the first step is going to be to make a monthly budget.
It’s okay if you’re still getting your finances organized. I can help.
If you want to learn how to do this and (more importantly) how to make yourself stick to it, click here to schedule a free intro call.