Money Talks, So Should You

Q&A: How to account for irregular expenses in a monthly budget

Mitch Marsden
by Mitch Marsden , NAPFA

Perhaps this scenario rings familiar to you and your family: you sit down, alone or with your spouse, and craft a new master monthly budget that looks and feels perfect; it includes some regular long term savings, everyone's needs will be met and there's even a little left over to splurge on something you like. 

The Problem

Everything goes well and you feel so good, excited and empowered ... for a couple of days, weeks or maybe as long as a month or two. Until you get that annual bill for the HOA fees, your annual auto tags/tax bill comes due, or your quarterly life insurance premium needs to be paid. You then realize that your monthly budget completely ignored these and other normal, but non-monthly expenses. You abandon your budget, or worse, rob the savings you had already put away, in order to make ends meet given these "new" expenses that always seem to come up.

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Then come the feelings of disappointment, discouragement and vulnerability.

You wonder why you even bothered with a budget in the first place and why it seems like you can't control your money. Those long-term savings goals you made? What a joke. And since everything gets spent in some way, you reason that you should still at least enjoy a splurge on yourself every so often for all that you endure which just intensifies and continues the problems.

You decide to just let whatever happens with your money happen. 

Eventually, the guilt of your low-balance savings account or the simple misery of the month-to-month lifestyle gets to you and you get the gall to try again, only to fail again. So goes the poor budgeting cycle that leads to nowhere.

So how do you end the cycle, stop treading water, and actually get somewhere with budgeting and savings?

A Solution

A client couple of mine called the concept I am about to introduce to you the "pot account" and so I have adopted the name.  No, it isn't the pot of which you may be thinking. It is an effective (and completely legal) way to deal with those irregular expenses that often destroy budgets and savings plans.

The idea is simple: estimate the total needed throughout the year for these irregular, but normal expenses for you and your family. Divide this "pot" of expenses by 12 to come up with a monthly pot expense amount to include in the monthly budget.

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Sounds easy enough so far, right? Here's the twist. In order to make it all work smoothly, I generally recommend setting up a separate savings account to be designated as the pot account. Pre-fund the account with as close as possible to a years' worth of these irregular expenses. Then, each month, put your monthly pot expense money into this account. As the actual irregular expenses come up throughout the year, they are paid for from the pot account. 

If done right, the pot account will start out with a year's worth of irregular expenses and then end with about the same amount. In between, it fluctuates depending on the actual timing of the expenses.

A Few Tips

When you are identifying and estimating the pot expenses, you might look at past bank or credit card statements for help.  Additionally, here are a few common pot expenses to get you started: vacations, non-monthly insurance premiums, property taxes, membership dues, subscriptions, clothing, regular car maintenance, Christmas and birthday gifts, holiday expenses, HOA or condominium association fees, tuition, books and other education fees, tax preparation fees, other professional fees (e.g. attorney, financial planner), unreimbursed work travel, etc. The list could go on and on and is dependent on your specific circumstances. Note that these are not emergency expenses that would be taken care of with an emergency fund. 

Taken a step further and you can use this concept to help fund even larger and less frequent expenses such as car replacements or furniture and appliance replacements.

For some expenses, you will know exactly how much they will be. Others may be murkier. When you have to make a guess, be reasonably conservative. Don't go to extremes, but err on the side of caution. It's also a good idea to expect the unexpected and include a miscellaneous pad in your pot total.

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Pre-funding the pot account may be a difficult thing for you. That's okay  there aren't many who can just pre-fund this thing out of the blue.  If this is a problem for you, start by simply including your calculated monthly pot expense in your normal budget. That won't solve the problem completely, but it will be a helpful start. Then, really focus your future savings and any extra cash (gifts, bonuses, etc.) on building up and pre-funding such an account. It is a foundational piece that, if you set it up right, will help protect your future budget and savings capabilities. It will also save you a lot of financial grief and frustration.

Final Word

The concept is simple, but actual implementation of the pot account can be tricky and will take time. Be patient with yourself and keep refining your use of this tool. It may need tweaks every month and definitely at least every year, but you will get better and better at it as you practice. Before you know it, you will become a master of your budget and in turn, a master of your money.

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Mitch Marsden is a member of the National Association of Personal Financial Advisors (NAPFA), a fee-only professional association and a Dimespring knowledge partner.