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Budgeting in any way is significantly better than not budgeting at all. But if you’re going to do something… might as well do it as well as possible.

I’ve tracked every single penny I’ve earned and spent for five years now. Since my wife and I merged our finances a couple years ago, I’ve also tracked every penny she’s earned and spent (sometimes she calls me “Big Brother”).

But even with all this hyper-disciplined budgeting and tracking, I made some big mistakes…

…for YEARS.

The thing about mistakes is that you don’t make them intentionally. You think you’re doing things the right way. As you learn more and gain more experience, you discover better ways that weren’t apparent before.

Here are the 3 most prevalent budgeting mistakes I see:


Mistake #1 – Not Separating Interest and Principal Payments

Your mortgage payment. Car payment. Student loan payment. Credit card payment if you’re paying down balances. All of these are not single payments, but multiple payments wrapped up together.

You have a principal payment, which pays down the debt balance, and an interest payment, the cost of borrowing the money. In fact, a mortgage payment has even more payments wrapped up together — property taxes, homeowner’s insurance, and PMI until you reach a loan-to-value ratio of at least 80%.

When budgeting and tracking expenses, it’s important to separate these items out so you fully understand where your money is going.

For a full year, we were making the required payments on my wife’s student loans. Not to mention the years she was doing it before we merged our finances. It was set up for automatic withdrawal so I didn’t look into the details for a long time. I was just focused on making sure the payment processed on time each month. With a monthly $240 payment, I thought we were making progress on this 50k mountain of student loans until one day it dawned on me…

This balance was never going down!

When I finally looked into the details, I almost had a heart attack. We were paying the balance down $7 per month.

That’s right. SEVEN.

On fifty THOUSAND dollars.

And $233 were going to interest.

I never had student loans so I was unfamiliar that there could be different payment structures.

Student Loan Structures

On standard repayment plans, the payment amount stays the same and the principal percentage increases over time (aka your typical loan).

On graduated repayment plans, the monthly payment amount increases every two years. The assumption is that your income will rise over time so increasing your payments accordingly will be less of a burden.

But in the end you pay more in interest… which is a bigger burden!

On top of being a graduated repayment plan, this was also an extended repayment plan where the loan term was 20 years instead of the standard 10 years, which increases the interest burden even MORE.

Separating the principal and interest payments creates awareness of the true cost of borrowing.

When you see the reality of how much money you’re paying in interest, you’re much more likely to become motivated to get out of debt. I immediately added $450 to each payment to start making actual progress on paying down the debt.

Separating the payments is also necessary in order to avoid the next mistake…

Mistake #2 – Counting Principal Payments as Expenses

Principal payments are not expenses.

I repeat — principal payments are NOT expenses.

I see almost everybody getting this wrong. Perfectly understandable. I got it wrong for years. Interest payments are expenses, or costs incurred, but principal payments are reductions of liability.

If you spend $200 on a fancy dinner, that’s money you spent which resulted in a decrease in your net worth. On the other hand, if you used that same $200 to pay off extra student loan debt, your net worth remains the same because you also reduced your liabilities.

It’s simply an internal transfer.

Not only do principal and interest payments need to be separated into different line items (Mistake #1) but they also need to be separated into different categories altogether.

The interest remains in the Expense category while the principal goes into a Principal Payment or Debt Repayment category. These principal payments have no effect whatsoever on your monthly net income.

But they do affect other numbers…

Mistake #3 – Looking at One Bottom Line Number

Most budgets I see are broken down like this: a section for income and a section for expenses. Then there’s a line on the bottom that subtracts total expenses from total income to get your monthly net income.

Heck, even my Expense Tracker 101 which I used for years is set up this way.

The problem?

This isn’t your net income because of Mistake #2. As discussed above, principal payments are not expenses so they should not be affecting your net income. But they obviously must be affecting something… which is why it’s important to look at multiple bottom line numbers.

When does income minus expenses work correctly?

When you are completely debt-free.

Which is exactly how I started making this mistake. I was completely debt free and only looked at income and expenses… then I purchased a home… and then I married into student loan debt.. and then we purchased a car. But I kept my methodology the same and added mortgage, student loan, and car payments into the Expense category.

All of a sudden our net income was averaging around $0 and I was like, “We’re not making any money!”

This wasn’t meant to be a zero-based budget. It was meant to be a realistic budget with the goal to drive that net income number as high as possible. Even though I knew I was baking in debt payoff as well as retirement contributions into this number, seeing $0 (or even worse a negative number) would seriously stress me out.

3 Layers of Budgeting

In reality, there are multiple layers to where your money is going. Here are the three layers (or bottom line numbers) to look at every month:

1. Net Income

Net Income = Revenues – Expenses

When you are correctly categorizing expenses, you can see how much you’re actually making each month (net income). The actual profit realized that is increasing your net worth.

Well, hopefully it’s a profit.

If net income is negative, you have a major financial problem because your current lifestyle is unsustainable. Time to cut expenses and find some side hustles.

Ideally both.

2. Net Cash Flow

Net Cash Flow = Net Income – Principal Payments

Out of that net income, the money you made could be going to different places. Typically to debt payoff, retirement accounts, or bank accounts. It’s sort of a seesaw as to where to allocate money. If you increase the allocation to one, it will lower another.

Debt payments have minimum mandatory payments and then are discretionary beyond that. They are cash outflows (but not expenses!), which afterwards leaves your net cash flow, the money you actually have at the end of the day… or in this case month.

You could have positive net income but negative net cash flow. That means you’re covering your expenses but not your expenses AND debt payments.

In that case, you’d be surviving off savings.

3. Net Liquid Cash Flow

Net Liquid Cash Flow = Net Cash Flow – Retirement Contributions

Your net cash flow is the money you brought in during the month. So where do you put it?

These funds can be put in liquid places (bank accounts) or illiquid places (retirement accounts).

Retirement contributions are fully discretionary, so you can elect how much to contribute each month. After taking out debt payments and retirement contributions from your net income, you’re left with your net liquid cash flow, the amount of money you’re putting in the bank (or other non-retirement investments).

At the end of each month, a little summary like this easily shows all your money flowing through the different layers:budget-cash-flows

Once you’ve built up a sufficient emergency fund, it’s perfectly acceptable to maximize debt payments and retirement contributions such that net liquid cash flow is zero.

In fact, I’d recommend it.

But if you’re trying to build up a lump sum of money for something like a down payment (or for trading stocks like I did), you may have to scale back on debt payments or retirement contributions in order to have positive net liquid cash flow.

Paying attention to these dynamics helps you be intentional with your money.

Bottom Line

It’s easy to see how all three of these budgeting mistakes are intertwined. You have to fix Mistake #1 and separate interest vs. principal payments in order to fix Mistake #2. You need to fix Mistake #2 and correctly categorize principal payments in order to fix Mistake #3 and look at your multiple bottom line numbers correctly.

If you’re making any of these mistakes at the moment, don’t feel bad.

That means you’re budgeting in the first place so you’re already ahead of the curve. Everything is a learning process and it took me years and years of experience to realize there was a better way. I’m sure I’ll even discover new mistakes I’m making right now without knowing!

By correcting these mistakes, I improved my budget planning, understanding of money dynamics, and own personal psyche. I’m hoping they can do the same for you! 

To make it even easier, check out my budget spreadsheet that has a monthly budget template already set up for the three budgeting layers.

P.S. I am fully aware of the irony in ending this post with a single Bottom Line section 😉

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