Budgeting is great, but forecasting is the future

The future doesn’t have to be fuzzy

Have you ever found yourself on the edge of a big change but fuzzy on how things would play out financially? Maybe you're considering changing jobs, moving to a new city, or pondering a large purchase.

I've been a budgeter for years but have often found that budgeting alone wasn't able to help me wrap my head around the ins and outs of an uncertain situation. This is where forecasting comes in, and it's a big part of how I think about and plan my financial life.

The questions are different

To understand the difference between budgeting and forecasting, I think it's helpful to look at the kinds of questions each one answers.

Budgeting seeks to answer the question: What's the best way to handle my situation today?

It begins with looking at the money you have in your current possession and asking yourself how each dollar can best serve your interests. Should I spend this $100 eating out with my friend, or is it better to save it for that bag I've been pining after?

The fine folks at YNAB have an awesome philosophy that starts with "Give every dollar a job." This perfectly shows that budgeting is all about allocating what you already have today. It’s not about playing with fictitious dollars you might have in the future. Budgeting is fact-based and very helpful for making decisions in the near term.

Forecasting, on the other hand, seeks to answer the question: How might things look when my situation changes?

Forecasting is all about smartly predicting the financial future using historical data, current trends, and good old-fashioned research. It's like looking into a well-reasoned crystal ball. Unlike budgeting, which is concrete and fact based, forecasting is all about dealing with hypotheticals and exploring the contours of different scenarios.

For that reason, forecasting is a more strategic exercise, helping to sharpen the focus on where you might want to go over the next six to 24 months. Budgeting by contrast is more tactical, pragmatically illuminating the path before you heading into the next 30 days.

Let's take a look at three common examples that neatly illustrate the difference between budgeting and forecasting.

Example 1) Paying down debt

Budgeting tells you precisely how much of your income goes toward debt payments every month, as well as how much extra you can afford to pay to get out of debt faster. 

Forecasting tells you how many months it will take to pay off the debt, how much interest you will have paid along the way, and the precise amount of time you will save if you pay extra each month.

Example 2) Buying a car

Budgeting will tell you how large of a monthly car payment you can afford today, given your current income and expenses.

Forecasting contextualizes that monthly payment by revealing the details of the car loan the payment implies. These are details you can tinker with. How do things shake out if you add an extra $1,000 to the down payment? What happens if you pay the loan off in 24 months instead of 60? How much extra will you end up paying for that slightly higher interest rate? 

Forecasting enables you to play with all these variables at once and gives you certainty and confidence as you take on new debt. Moreover, having command over the financial dimension of a decision goes a long way towards helping you assess what matters most in the car you buy. Maybe those leather seats aren’t as important to you as killing off your monthly payment in three years instead of five.

Example 3) Changing your financial profile

By dispassionately comparing your income to your expenses, your budget will give you a clear and impartial sense for exactly how healthy your financial situation is today.

Forecasting, on the other hand, gives you the ability to peer into the future and assess how your financial health is affected by various mixes of income and expense. This is especially handy if you're considering changing jobs, if you or your partner is considering leaving work for a time, or if you’re toying with the idea of moving to a new location.

They work together

Taken together, budgeting and forecasting work hand in glove to give you a high-fidelity picture of what your finances look like today, as well as what they could look like in the future.

They also depend on one another. The more accurate your budget, the better informed your forecast will be. Conversely, the decisions based on the forecast you create today will very likely shape your budget tomorrow.

Lucky for us, forecasting isn't hard to learn, and once you know how to do it, it's a skill you can apply any time you're faced with a big decision or find yourself entering a period of uncertainty.

Where we go from here

Forecasting is a topic I love dearly, and over the years I’ve made extensive use of it as I rolled with the punches of serial layoffs, gamed out rent and mortgage economics for at least three different moves, and determined salary requirements for new jobs.

I’ll be digging into examples of common forecasting situations like these over on my YouTube channel, where I’ll be teaching you how to use spreadsheets to create your own financial forecasts. In fact, I’ve made a companion video to this essay where I riff on these topics a bit more. Be sure to check it out:

YouTube is awesome for teaching the step-by-step method for working on a spreadsheet, whereas essays like this are ideal for laying out concepts and ideas. I’m excited to work through both as I share some hard-fought lessons I’ve picked up along the way, and I’m thrilled to have you along for the journey.

If you’ve got an area of interest that’s been keeping you up at night, please let me know. I’m keen to learn about my readers’ interest and to help lend my skills wherever I can. See you in the next one.