Budgeting has a bad reputation among a lot of America households who view it as a way to strip all the fun out of spending money. No more shopping. No more eating out at restaurants. No more golfing on weekends.
That is not the purpose of a purpose of a budget.
A budget simply shows how much money you have coming in and how those funds are spent. It’s one of the most important tools in building a successful financial future, because it helps you get the most out of your money.
Regardless of economic standing or which generation you fall into, every consumer can benefit from creating and managing a budget. A budget gives people a sense of control over their money. Think of a budget as a financial foundation. Each person’s foundation is going to be different, just as each financial situation is different.
Choosing a Budgeting System
There are four basic ways to create, track and monitor a budget. Each system uses different techniques, but they all center on organization and attention to detail.
- The Notebook and Pen: This is the oldest method for budgeting, and it’s also the least expensive option. With this method, you simply write down all your sources of income and all your expenses. If they balance, you’re good to go.
- The Spreadsheet: The most popular spreadsheet software for budgeting is Microsoft Excel. Many websites offer free samples of Excel budgeting worksheets that consumers can use, instead of trying to create their own. A spreadsheet lets you organize a lot of information easily and does the math for you.
- Free Online Software: There are several free web-based software programs that can help with budgeting. Such programs like Manilla and Mint.com allow you to create and group your expenses into categories and track your spending, so you can see exactly where your money is going as soon as the transaction takes place.
- Financial Software: There are also financial software programs, but you need to be computer-savvy to use them. Quicken is a leading product.
- Dave Ramsey’s Zero-Based Budgeting: Popular financial personality Dave Ramsey recommends a zero-based budgeting system where you pre-assign all of your dollars at the beginning of the month using envelopes.
You can also check with your local credit union or bank for tips and tricks. Your saving institution may even have budgeting worksheets on hand to get you started. If you prefer, the U.S. Financial Literacy and Education Commission (FLEC) has numerous budgeting worksheets and resources to help you at any stage of life.
Creating a Budget
Budgeting strategies and techniques vary across the board. There will be differences, for example, between what works for a first-year college studentand one for a retiree. But there are five basic steps in creating a budget. They are all important because they build on one another, helping you organize your finances sensibly.
Step 1: Set Goals
There are two types of financial goals: immediate and long range. Immediate goals focus on using your money today, while long-range goals deal with saving and spending over decades. Both are important, and complement one another: Saving money today affects what you spend now but also how much you’ll have later in life.
You need to determine which goals address necessities and which ones cover luxuries. Then, you can prioritize your financial goals accordingly.
Immediate financial goals include covering current expenses. Some of these are obligatory and include your mortgage or rent payment, car loans, utilities bills, child care, food, cell phone and household supplies. Secondary goals, called discretionary items, include non-essential clothing, subscriptions, dining out and taking vacations. Long-range financial goals could also include retirement savings, investments and charitable donations. If you have debt, paying it down can be both obligatory and discretionary. Making required payments is essential to financial solvency, but paying debt early, while not required, can make long-term sense.
Step 2: Calculate Your Income and Expenses
After you determine your financial goals, you need a plan for reaching them. To do this, you need to evaluate your income and your expenses. Most people budget monthly because most bills follow a monthly schedule.
Start by making a list of your monthly income sources, including your salary (after taxes), any bonuses you incur on a regular basis, and child support or alimony payments. If you don’t know the exact amount, you can use an estimate. Once you have your numbers, add them up. The total is your monthly income.
The next part of the equation is your expenses, which fall into three categories: fixed committed expenses, variable committed expenses and discretionary expenses.
- Fixed committed expenses: These have a fixed monthly amount, such as your mortgage or rent.
- Variable committed expense: These vary from one month to the next month based on need, and would include groceries and gasoline.
- Discretionary expenses: As noted, these are optional expenses and include recreation and entertainment. A gym membership would also fall into this category. Discretionary expenses often make life more fulfilling, but they should be the first expenses to go if you can’t afford the basics.
If you fail to pay off your credit card bills each month, you’ll begin to pay a great deal of interest. This can play havoc with any budget. If your carried-over credit card payments eat up more than 10% of your monthly income, you should consider speaking with a nonprofit credit counselor. Over the telephone or online, a free credit counseling session will walk you through your budget and recommend expenses that can be reduced or eliminated. If you qualify for a debt management program, you may be able to reduce your monthly debt payments as well.
Step 3: Analyze Your Spending and Balance Your Checkbook
The goal in budgeting is to make sure your expenses do not exceed your income. If they do, and more money is going out than is coming in, then you need to make adjustments. This doesn’t necessarily mean you need to start penny-pinching; it just means it is time to revisit the discretionary cost category and see where you are willing and able to cut the fat.
If you make any payments by check, your checkbook register can help you keep track of incoming and outgoing money, and what you spend money on. Although paying by check is becoming rarer, those who stick to this payment method should keep their checkbooks balanced. This will help you avoid overdraft fees or bounced checks, and it can shed some light on your spending habits.
Here are the basics:
- Keep records for all your deposits and purchases. Record each one in your check register, which the bank will provide you.
- Print out or download your monthly bank statement if you aren’t already getting one in the mail. If you’re doing everything online, there is software that can make this step — and budgeting — easy.
- Do your own math for deposits and withdrawals to make sure your bank hasn’t missed anything or taken liberties with your money. Reconcile line by line, making sure your record of checks is the same as the statement.
- Find the ending number from each monthly statement and work backward, check to see what has cleared, and what has not cleared. Deposits that haven’t cleared will need to be subtracted from your balance. If your checks haven’t cleared, they will have to be added back to your balance until they do.
- Go line by line and account for any fees you’re charged. Seeing them up close may prompt you to call and ask to have some removed, which the banks often will do if you persist. Also, add the pennies of interest you may have received.
- Again, if you have access to a computer, or even a smartphone, this process can be automated using financial software or apps, saving you time and frustration. The goal is to review your cash flow, look for errors and learn from what you see.
Step 4: Revisit Your Original Budget
After you’ve had a chance to monitor your income and expenses for a month or two, you will be more aware of areas that need adjusting. Maybe your initial monthly income estimates were off, or perhaps you didn’t account for expenses like car repairs or veterinary bills. Make adjustments, but always balance inflows with outflows.
Once you work out all the kinks in your budget, you need to commit to following it. No budget is forever, however, so periodic reviews are key to success.
If you get a promotion, for example, you can increase your discretionary spending as well as your savings goals. On the other hand, a layoff or fewer work hours could mean cutting back on spending until you restore your income.
Savings should be part of the plan. Financial planners recommend that your savings cover six months of income, enough to compensate for a job loss or other emergency. You might find it useful to open a separate savings account and fund it gradually until you reach the goal. Keeping a separate account will make it more difficult to raid the emergency fund to cover non-essentials.
Step 5: Commitment
Creating a budget is a great step in working toward a more financially sound future for you and your family. Committing to your budget will get you there. Remain realistic, evaluate it often and don’t be afraid to adjust. Budgeting is all about balance.
Managing Your Budget When Unexpected Bills Arrive
As mentioned, an emergency fund is crucial to financial security. Start by setting aside $50 per week. In a year, you would have $2,600, plus any interest, for when the refrigerator stops working or when the transmission blows.
Experts recommend looking at your withholding taxes to find hidden cash. If you receive a large refund every year, perhaps you need to change your filing status to receive additional money in your paycheck to put toward an emergency fund. Unless, that is, you are putting your tax return funds into that fund.
Medical crises in particular can turn a balanced budget upside down. Negotiate large medical expenses, such as an emergency hospital stay, with the hospital. Almost all hospitals negotiate fees. Often if you contact them immediately instead of waiting until the amount goes into collections, the hospital or provider’s office can set up a payment plan.
If not, a medical bill consolidation may help, as it allows you to combine all your medical bills into one lower monthly bill through an agency or a bank loan. This not only makes it easier on you, but the arrangement protects your credit score because you are able to make on-time payments. The downside is it may take you longer to pay your debt in full.
Benefits of Budgeting
Everyone can benefit from taking a pronounced and proactive approach to control their finances. Committing to your budget will help guide you into a much better financial position.
Budgeting can improve your life because it:
- Reveals waste. Creating a budget sheds light on areas that many people neglect on a day-to-day basis.
- Directs priorities. A budget allows for people to look at the big picture of their spending habits and set new priorities to maximize their money’s potential.
- Creates new habits. When people get a clearer picture of how they’ve been using their money, it allows them to shift expenditures into different categories, making them more conscious of unnecessary spending.
- Reduces stress. Finances are one of the top stress-inducing situations. When there is a sense of control over the money coming in and the money going out, the stress can transform into a feeling of empowerment.
- Educates. Having a budget allows people to view money as a tool, shifting the mindset to focus on long-term goals and future needs.
Creating a budget is the first step, but maintaining the budget is where you start to see real growth in yourself and more stretch in your dollar. Sticking to a budget can be a difficult task for people who aren’t used to spending boundaries or self-discipline in their finances, so it’s important to maintain a positive attitude toward the process.
Staying motivated can help alleviate some of the pressures of budgeting. Consider setting aside some money each month so you can look forward to a relaxing vacation at the end of the year.
Finally, set realistic goals. Start slowly, building up to a plan that works for you and your lifestyle.
The Finer Points
Wants vs. Needs
“You Can’t Always Get What You Want”, one of the Rolling Stones well-known 1960s hits, touches on an issue many of us face all the time. The message is you might not be able to get things you want, but if you try, you’ll get what you need.
How do you separate wants from needs and why bother? For many of us, knowing where to draw the line can mean the difference between creating a successful budget and going broke. So what’s the difference. Most needs are synonymous with non-discretionary expenditures. They include shelter, which demands payment of rent or a mortgage, and food, which results in grocery bills. There are plenty other items that are basic and non-negotiable, but the non-negotiable category leaves room for choice.
For instance, if you need a car to get to work, you could buy a used Kia sedan or a new BMW. The price difference is huge, and the Beemer is certain to impress your friends and offer a fine driving experience. The question is what can you afford? If you make a $500,000 a year, the BMW might be yours without stretching your finances. But if you’re taking home $40,000, it’s better to stick with the Kia.
The same rule applies to housing – should you rent a one-bedroom apartment or buy a $400,000 house? Again, both offer shelter, but at radically different costs.
There’s also the difference between needs and items that you could get by without. Think about taking a vacation to Thailand versus a week driving to state parks near your home. Both can offer satisfying and relaxing places to spend your downtown, but the costs are radically different. Also think about impulse buys. Say you go to home improvement store to buy some lawn fertilizer and leave with a lawnmower you hadn’t planned to buy. You might need a new mover, but it’s a good idea to research models and prices before putting your money down.
Knowing the difference between wants and needs is a key to a successful budget. You can budget for some impulse purchases or product upgrades, but understand what you’re doing, show restraint and always make sure your budget balances.
A sizable amount of your money is likely to go to one-off expenses that arise over the course of a year. Examples include holiday presents, birthday gifts, summer vacation costs and back-to-school spending. Some seasonal expenses are for stand-alone items like presents, others are for basics. Heating you home is an issue for the cold-weather months, for instance, and a higher water bill might coincide with irrigating your lawn in the summer. Clothing is also seasonal, with swimming suits for the summer and heavy jackets for the winter.
When you draw a budget, study your outflows during the past year or two and estimate the impact of seasonal costs, then build those costs into your plan. If your summer costs are much higher than springtime, make sure you save enough in the spring to fund spending in the summer.
Checking in on Your Budget
Budgets are living documents. Just as life is constantly changing, the demands on your budget change too. For that reason, it’s good to regularly review you budget to adjust for changes in income and expenses.
What should you consider? On the income side, you should make adjustments if you get a raise or receive a windfall like an inheritance. You need to adjust if you lose your job or move to a new one. Getting married or divorced requires a massive reworking of your budget. So does having a child. Sometimes the changes are smaller or temporary, things like a medical insurance copayment might require a temporary adjustment.
You don’t need to overhaul your entire budget when changes happen. Your rent is rent, and what you spend each month on your car is unlikely to change. But other things are more flexible. If you income drops, you might eat out less. If it goes up, you could save more, pay off debt quicker or make a discretionary purchase.
There’s no hard and fast rule about when to review your budget. Some financial consultants suggest doing it constantly, others suggest every several months. It’s probably good to consider revisiting your budget when life-changing events occur, and set intervals to adjust for smaller stuff like inflation and changes in fixed costs.
Automatic Saving and Recommended Percentages
You should strongly consider making automatic saving a part of your budget. What is automatic saving? It’s the money you set aside for funding an emergency account, paying for Christmas gifts later in the year or creating a college fund for your kids.
Automatic saving is best handled through paycheck withholding. If you’re saving for retirement and you company offers a 401(k) plan, sign up and have money withheld from your paycheck. Many employers also offer medical and childcare savings plans, which are typically tax exempt. You can also have your salary automatically deposited in a checking account, then transfer part of the pay to a savings account that you don’t plan to touch.
There are many strategies for automatic savings. Talk to a financial adviser to learn more about the options and what amount of saving you can afford. Once you implement a plan, stick with it. Percentages will vary, but if your company will match contributions to your 401(k), save at least the maximum amount that will be matched. Other savings will be largely determined by your income and expenses. If you need to withhold 20% of your paycheck to cover the rent, make sure you do it. Knowing how much money you need and saving for it will make sure you meet your expenses and prepare for the future.
Financial experts have come up with recommended percentages for spending to help people budgeting for the first time. For example, it is suggested you spend no more than 30% of your gross monthly income on housing, whether you’re renting or owning.
Automobiles are the next biggest expense for consumers and probably the biggest temptation to overspend. The best idea is to keep spending between 10% and 15% of your monthly income. Anything beyond that stretches you thin, especially if a financial emergency arises.
Student loans might be another variable in your monthly budget. There are several income-based repayment plans that limit your payments to 10-15% of your income. That’s a safe number, but often will extend payments a few years and end up costing you a small fortune in interest charges. Try using 20% of your budget, especially if you don’t have a car payment or are splitting rent with roommates.
Other suggested percentages for ongoing expenses include utilities (10%); food (10-15%) and savings (10-15%).
Timing Your Budget
You should commit to staying on budget until you see results. The best way to accomplish this is to create an annual plan that covers your fixed costs like rent and car payment, your seasonal costs like holiday presents and vacations and your discretionary costs like eating out and buying clothes. Work all these things into a 12-month projection and follow it.
If you find flaws in the plan or your cashflow changes, you can modify it. Otherwise, try to stay with it. Consider using budgeting software or apps to help you. If you discipline yourself, you’ll be surprised as debts get paid, savings grow and your needs are met.
Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it seven years ago, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering college and professional sports, which are the fantasy worlds of finance. His work has been published by the Associated Press, New York Times, Washington Post, Chicago Tribune, Sports Illustrated and Sporting News, among others. His interest in sports has waned some, but his interest in never reaching for his wallet is as passionate as ever. Bill can be reached at firstname.lastname@example.org.