“If you fail to plan, you are planning to fail.” – Benjamin Franklin
The importance of creating a budget should not be ignored. It is one of the best things you can do to get on the path to financial freedom. Look at a successful business, and you will see that they are always planning and setting goals. You need to do the same thing for your finances, and the next step is creating a budget to help you achieve your goals. The first step is to gather all your financial data in one place (See KNOW: Where is all my money going?). Of course, the hardest part of a budget is sticking to it, so let explore some ways to create a budget that you will use.
Creating your budget
Creating your budget can be a big undertaking leaving you feeling stranded with the feeling of not knowing where to start. The best way to start is to use your Personal Capital or Mint account to see what you have spent money on over the last few months. Just take the last three months spending averages to use as a benchmark. Not only does this help you start. It also keeps you honest with yourself. Next, break your expense into fixed and variable expenses. Fixed expenses are things that stay the same month to month like your rent/mortgage, car payment, insurance, etc. Variable expenses are things that change month to month like eating out, personal care, pets, etc. The breakdown between fixed and variable becomes important later once you want to start trimming your expenses. Here is a list of fixed expense categories to help get you started:
- Mortgage(s) / rent
- Property taxes
- HOA / condo fees
- House / tenant insurance
- Utility bills (cable, cell, electricity, water, etc.)
- Lease / car loan payment
- Vehicle insurance
- Life / Disability / Extended health (or other) insurance
- Bank fees
- Debt payments for your debt reduction plan
- Daycare
Here is a list of variable expense categories to help get you started:
- Groceries
- Personal care items
- Fuel / public transportation costs
- Parking
- Clothing & shoes
- Eating out
- Entertainment
- Bars / tobacco / alcohol
- Babysitting
- Sports & recreation, other hobbies
- Haircare / salon services
- Magazines / newspapers / books
- Children’s lessons and activities
- Pets
We all have expenses that are not monthly and are quarterly, annually, or some other period. Make a list of all of the non-monthly amounts so you can make sure not to miss any. The best way to budget these is if they are large $500 plus (your threshold may be lower depending on your budget), then divide the amount to come up with a monthly amount to make sure you are saving enough. The non-monthly expenses are some of the worse if you are living paycheck to paycheck since you tend to forget about them, and then you are scrambling to pay, or you just put them on a credit card.
Example: $600 car insurance premium you pay twice a year. $600 / 6 months = $100/month expense
Once you have all your expenses categorized, write down all your sources of income. A lot of budgeting experts recommend starting with your income first, but when you start with your income, you tend to back into your total expenses, making sure you are not spending more than you are earning. Hopefully, you are making more than you are spending. If not, don’t worry, that is what we are here to fix. This realization is sometimes a life-changing realization for some.
Evaluating your budget
Now that you have everything organized. Go back through and make sure you were honest with yourself. A lot of people will create a budget and not put the $200 a month they spend at Starbucks so that it will show they are spending less than they are earning. Like I previously said, it is ok if you are spending more we will address that issue later. The most important thing is to create a budget that shows your ACTUAL income and expenses.
If you are spending more than you are making, then look for ways to save. Slowly cut back on spending in categories that you think you can spend less. Do not do this all at once and maybe pick one or two groups every week or month and try spending less on it. If you decide to do it all at once, you are more likely to fail, give up altogether, and not make any changes. This a baby step process that takes time but will have huge rewards down the road.
For a general rule, I encourage everyone to save at least 10%, but you must do what works for you. If you have a negative savings rate (i.e., Spending more than you make using credit cards), then your first goal should be to stop spending more than you make and start saving 1-2%. Then once you are saving 1-2%, start slowly increasing your savings every other month.
Monitoring your budget
Make sure to review your budget at least monthly and adjust as needed. Generally, your budget should stay the same from month to month. The most important thing is to create a realistic budget that you will stick too even if it is not where you want to be. You can create a future budget on what you would like your budget to be, so you have an end target. We will cover this in more detail in creating a wealth plan.
8 Tips to help you stay on track
- Remember, your budget is flexible. If you are too rigid, you are less likely to stick with it.
- Make budgeting part of your life with daily or weekly checkups. It should take you no more than a few minutes.
- Use financial software to aggregate all your accounts, so it makes the process faster and easier.
- Reward yourself when you stick to your budget by going to the movies or eating out. Just make sure to build the rewards into your budget.
- Include the entire family. It is essential to make sure everyone is on the same page.
- Do not try to start a budget around the holidays or other times you know you are going to spend more. The little wins of staying on budget, in the beginning, will help you stick to it.
- Go through your expenses and try to trim them. Use value-based spending. If it does not bring you joy, then maybe you do not need it.
- If you a spending more than you make, try to avoid using credit cards as it will typically make your financial situation worse.
Look for more posts on ways to save money and reduce your expenses when you are ready to continue your journey to financial freedom.