How to budget like a Wall Street banker

Budgeting can be the most important step in successful financial planning. But the way we’re told to budget is usually counter-productive. The reason most budgets fail is that they are doomed from the start. They don’t work. People think about a typical month. Massively underestimating what they actually spend.

The way I like to think about budgets is how Wall Street bankers value companies (and how I valued companies in my previous job).

The mind of a banker

There are two ways to value a company:

  1. forecast all the future profits of a business and add them up; or
  2. find similar companies to the one you’re valuing and use these as a benchmark to value your company

When budgeting is usually explained to people, it’s done so using Method 1. You estimate all your expenses in advance and guess how much you’ll be spending on any given item in the foreseeable future. But this method is much more difficult than Method 2!

The issue is that it’s very difficult to forecast reliably into the future. It’s even more challenging when starting from scratch. It’s daunting and it puts a lot of people off.

For example, how are you supposed to know how much groceries are going to cost you in any given month? Most budgets also look at a typical month and will miss out things like contingencies, emergencies, and unplanned life events.

In my opinion, the better way to start budgeting is using Method 2. Here’s the step by the step guide of how to budget like a Wall Street banker.

Step 1 – Dragging up the past

The first step is to gather your own historical spending data. When a Wall Street banker is valuing a company they need to make sure that they’ve got their own accurate track record for the company they are valuing. You do the same with your finances. There are 3 common ways people gather this data:

  • pen and paper – each time you spend something you write it down (or use an app for this, such as Wally or Monefy)
  • download your transaction data from your bank – almost all banks now make it possible to download your transaction history (this is what I and Mrs YFG do every month: we get a glass of wine and “do the expenses”. Aren’t we cool!)
  • Use an app or software – there are lots of really cool apps that will download the data from your bank account automatically and categorise the data for you. For example, to name a few, there’s Mint, Money Dashboard, Spendee. (We don’t do this because we are reluctant to give a third-party access to our bank accounts!)

The underlying principle behind this tracking is the need to be comprehensive. Every single item is accounted for. Every penny you spend is recorded. It won’t necessarily catch cash transactions unless you manually input them. But it will catch you taking the cash out of your bank account and so will record it that way. There’s nowhere for your expenditure to hide!

Believe me, this process makes you a lot more aware of what you spend. A lot of the time, we are on autopilot and completely forget what we bought and why we bought it (Mrs YFG is bad at this). By doing this data-gathering exercise, you’re actively reminding yourself what you spend each month and you see the figures add up. It can be surprising at the end of the month when we’ve spent a couple of hundred pounds just on lunches!

Step 2 – Reading the entrails

After gathering the data, the Wall Street banker will categorise and summarise it into tables and spreadsheets. Calculating averages and aggregates of the key numbers on an annual, quarterly or monthly basis. So what we need to do is to take our historical data and calculate how much we spend each month and in what categories:

  • Housing (rent, mortgage, home repairs)
  • Utilities (gas, water, electric, mobile phone, internet, TV)
  • Groceries
  • Entertainment and eating out
  • Clothing and beauty products

Here are the categories we use:

House Cash Games
Gifts Council Tax Cosmetics
Food Energy Insurance
Lunch Broadband Eating Out
Coffee Mortgage Holiday
Pigs Water Amazon
Salary Shop Clothes
Interest Health Media
Dividends Investment Charity
Travel Mobile TV
Transfer Books Website

You can create whatever categories work for you. Likewise, you can use those from a website or an app you may use (such as, these are the categories on Mint). If you use an app that gathers the data automatically, then categorising and aggregating is trivially easy.

We personally have our own spreadsheet where we download the data export from our bank accounts. We select a category for each item from a drop down and all the sums and adding up is done and summarised.

Whatever method you use (app, your own spreadsheet or somebody else’s spreadsheet) once you’ve inputted the data, you’re left with a monthly run-down of how much you spend and how much you’ve spent it on.

Step 3 – Keeping up with the Joneses

Before the Wall Street banker can value his company they need to gather the comparable data for his similar companies. To make our budget comparisons we need to find out what people similar to ourselves spend. We can start with finding out what an average household, or a household similar to ours, spend on things.

For example, in the UK, you can get this information easily from the Office for National Statistics (which creates does an annual cost of living survey) or the Money Advice Service (which has a budget planner that compares your data to the UK average). In the US you can get this information from the Bureau of Labor Statistics (which produces a consumer expenditure survey).

We use these average figures to get a rough idea of what a similar household to ours spends and in what proportions. This gives you a very easy baseline budget that you can use.

One of the key benefits of doing this is that we find out what Mr Average spends. This is important. If you spend/save the average, you will get an average result (i.e. not FI and working for the man!). The idea of FI is you spend less than the average and save more than average. This baseline gives you a target to beat, so to speak.

Step 4 – What to compare when you’re comparing

The Wall Street banker has their data. He now needs to start doing the comparisons. The first comparison is very simple: will this company go out of business or not?

For us, the comparison is: am I spending more money than I earn? We compare money made to money spent in the same period (i.e. monthly salary vs. monthly spending, annual salary vs. annual spending). News flash: if you’re spending more than you earn, you will eventually go out of business. Beauty is in the eye of the beholder, but the banker will value you at $0.

The banker will then compare the profit margins, revenue growth and various other metrics of their company compared to the metrics for the average companies in the market. For us, this means comparing our current expenditure to the averages you acquired in Step 3.

There are two benefits to this: (1) if we’re spending more than the average person that implies there is room to cut down, (2) we can find out which areas we spend more on than others (i.e. clothes, cars etc) and this can highlight the areas where we can start to save money.

Equally, it gives a sign of the areas or pursuits that mean a lot to us: for example, a person might spend a lot on Motoring because they enjoy jumping on their motorbike and going for a ride. This process can help us reflect on the passions in life that bring us happiness. These are the things to focus on, the spending on the less important things can be reduced.

Congratulations, you have a working budget

Having done the comparisons and set up our budget, we can now start building up our detailed financial history. Once we have enough data we won’t need to compare to the average, we have our own average.

We can compare our current spending to previous spending and start to recognise patterns or trends. It’s now possible the “true” one-offs, the unexpected expenditure or when we are starting to fall to the siren calls of Amazon.

At this stage, the Method 1 we talked out before is a lot easier to do. That’s because you actually have the detailed data to forecast correctly. We’re not starting from scratch and have something concrete to build from. The Wall Street Banker will use both Method 1 and 2 to cross-check one another. That’s something we can do by using our last year’s expenses as a forecast and seeing whether we end up spending more or less and why.

From time to time we can compare our spending to the average. For example, are we paying too much for certain utilities or can we get a better deal? Our housing costs too high, is there somewhere cheaper we can live?

What do you do?

I hope you enjoyed the post. Thank you for reading. I’d really like to know whether you budget, and if so, how do you budget? Do you have any tips or tricks for creating a successful budget? Are there any tools, apps or spreadsheets you would recommend?

 

All the best,

Young FI Guy

Comments

      1. I was imagining porkers in the basement 😉

        I still use the program Quicken from 2004 to track and categorise spending, and I’m glad I now have the official justification for using this rear-view mirror approach 😉 I’m doing it like a Wall Street banker, not just being an idle devil that CBA to do a ‘proper’ forward looking budget using Method 1…

        1. When people say we live a “frugal life” they should see how much we spend on the Guinea Pigs. They eat Ocado veg! A very decadent life indeed.

          I’m really glad you’ve ‘came out’ and said you don’t do “proper” budgeting. I never have either! I think for most people it is just too much faff. And when ‘budgeting’ is the first thing you are told to do to get your finances in order, and you are never able to finish, is it a surprise that lots of personal finance advise doesn’t help?

  1. I suggest GNUcash, for those hardcore enough. I don’t think it can be hooked into any online banking (though the website says it can do “QIF/OFX/HBCI import”), so I manually enter all transactions (including cash expenses), which really makes me think before giving myself yet another transaction to enter.

  2. Hi YFI Guy, really enjoying your website. Would it be possible for you to share the outline of your expenses spreadsheet (with made up numbers of course)?

    Cheers,

    Calum

    1. Hi Calum, welcome to the site and thank you for the kind words! It’s on my to-do list to create a user-friendly version of my expenses spreadsheet. (although my to-do list seems to keep getting longer!)

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