Dan Reiter, CFP®, CPA
This post is the second of a two-part series on building your first post-divorce budget and introduces the bucketing method. The bucketing approach is a simple system that uses separate accounts to categorize your income and expenses. It's perfect for recent divorcees who are starting fresh and want an easy-to-understand way to manage their money.
How Buckets Work
Think of your income as a giant bucket of water. The bucketing approach involves creating smaller buckets, each dedicated to a specific spending category or group. It might be helpful to help illustrate the concept with an example:
Linda, age 57, is recently divorced. She has worked with her financial advisor to create her first budget and has a few months behind her in working it. Although it was not perfect at the start, she has made a few adjustments and is feeling more confident each month in her understanding of her financial situation.
Linda’s total income each month is $10,000, which is deposited in her checking account she uses for all her bills and to pay off her credit cards every month. While reviewing her budget worksheet, she feels that it makes sense to split her expenses into three categories:
Regular Monthly Expenses. This category includes all those expenses that are incurred every month. This includes her mortgage payment, utilities, health insurance, groceries, gasoline, and utilities.
Her regular monthly expenses make up the largest portion of her budget, so she designates $6,500 for this category. Since these expenses occur every month and a large portion are put on her credit card, she leaves this portion in her checking account. She also sets up her credit card to be automatically paid off in full each month from her checking.
Gifts, Clothing, and Annual Taxes. This category includes a few larger expense items on Linda’s budget that occur infrequently but regularly throughout the year. Linda’s priorities include creating a memorable experience through gifts for her children each year for birthdays and Christmas, buying clothes, and making sure she has enough to cover her year-end taxes.
From her budget worksheet, she estimates that these items all add up to about $18,000/year, or about $1,500/month. As such, Linda sets up an automatic transfer on the first of each month from her checking account to a separate savings account nicknamed “Gifts, Clothing, and Taxes Account” in the amount of $1,500.
Every time Linda purchases a gift, goes shopping, or pays her year-end taxes she transfers the exact amount spent from this savings account back into her checking.
Travel. Linda’s main source of entertainment and passion is travel. She loves world-wide travel and has a separate goal of visiting every major national park. She also regularly pays for family members and friends to travel with her.
Linda budgets $36,000/year for travel, or $3,000/month.
She sets up a second automatic transfer on the first of each month from her checking account to a separate savings account nicknamed “Travel Account” in the amount of $3,000. Every time she incurs a travel expense on her credit card, she shifts an equivalent amount back to checking to make sure she has enough in checking to pay the card off in full.
Visual:
As you can see from this example, Linda budgeted every dollar of her income. She simply divides her income into three accounts to help her know immediately how much she has available in each category with a quick balance check. Also, the balance of each account and how quickly the accounts are depleted help track how much is being spent in each category.
Why Buckets Work
Here's why the bucket approach is helpful:
Clarity: It separates your "needs" from your "wants," making it easier to prioritize essential expenses.
Control: By seeing the money allocated in each bucket, you can avoid overspending in one area and neglecting another.
Peace of Mind: Knowing you have funds set aside for bills and living expenses reduces financial stress.
Ultimately, we find that many individuals that implement the bucketing approach find that they can eventually stop tracking each individual expense and line item in their budget every month. If every dollar that is left in checking each month is designated for regular monthly expenses, you can simply spend the balance of the account every month! It may still be a good idea, however, to periodically review your detailed budget on a line-per-line basis at least once per year. Doing so will help you understand where adjustments need to be made on your regular transfers based on how your expenses change and evolve.
Creating Your Buckets
Everybody’s buckets are unique based on what is most important to them. At a minimum, though, you will want to designate enough to keep in your checking account for regular monthly expenses. Recall that, in our example, Linda’s buckets included annual gifts, clothing, travel, and year-end taxes. Here are some other potential buckets ideas to get you started:
Car Replacement Fund: If you do not currently have a car payment, you might consider setting aside an equivalent amount to a normal payment into a separate account to budget for a future car purchase.
Home Improvement Goals: Are you someone who likes to regularly make updates and refresh your house? If so, it may be good to keep this as a part of your regular budget by setting aside an amount each month.
Charity. If charitable giving is important to you, but you typically support charities with larger contributions made irregularly throughout the year, you might have an account designated for this purpose.
When setting up your bank accounts, you will want to do so at a bank that is user friendly in transferring funds from one account to another. Some banks also allow you to “nickname” accounts when you log in online. This is useful to see at a glance the designated purpose for each account and balance without having to recall the account purpose based on the account number.
Final Tips for Recent Divorcees
Be Realistic: Don't be discouraged - adjust your buckets as needed.
Automate: Set up automatic transfers to your savings and debt payoff buckets. This "set it and forget it" approach ensures you stay on track.
Consider Seeking Professional Guidance: A financial advisor can help you tailor a budget and plan for long-term financial goals.
Remember: The bucketing approach is flexible. You can add or remove buckets as your financial situation evolves. As you gain confidence, you can delve deeper into budgeting strategies. Most importantly, creating a budget empowers you to take control of your finances and build a secure future.
Divorce may be a new chapter, but with smart financial planning, you can write a story of success!
If you would like to schedule a 30-minute no obligation call to discuss your situation, click here or give us a call at (816) 587-7526.
Investment advice, financial planning, and retirement plan services are provided by Prosperity Planning, Inc., an SEC registered investment advisor. The information contained herein, including but not limited to research, market valuations, calculations, estimates and other material obtained from these sources are believed to be reliable. However, Prosperity Planning, Inc. does not warrant its accuracy or completeness. The information contained herein has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or to participate in any trading strategy. If an offer of securities is made, it will be under a definitive investment management agreement prepared on behalf of Prosperity which contains material information not contained herein and which supersedes this information in its entirety. Any investment involves significant risk, including a complete loss of capital and conflicts of interest. The applicable definitive investment management agreement and Form ADV Part 2A will contain a more thorough discussion of risk and conflict, which should be carefully reviewed before making any investment decision.
