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There are so many things you’d rather be doing with it than making a budget. But in the end, you’ll save money and time if you get this one thing out of the way now. So let’s dive in.
- Add up your monthly income from all sources
- Add up your fixed monthly expenses (like your car payment) and variable expenses (like your gas)
- Adjust the costs you can to free up cash
By making and sticking to a budget, you can achieve what you want — paying off debts faster, increasing your savings, or indulging in an expensive hobby. It takes planning, but it does work.
Are you thinking of budgeting because you love having fun with numbers? Try Sudoku instead.
Most people create household budgets because they want and need to take back control of their personal finances. That desire is often driven by a particular goal. Many want to reduce their debts. Others want to save, perhaps for a:
- Down payment on a home, investment property or car
- Home improvement project
- Emergency fund that will provide a financial cushion if disaster strikes
- Once-in-a-lifetime vacation
- Business opportunity
- Investment fund
Taking back control of your money is empowering. Of course, it can’t create cash out of thin air. But it can feel that way.
Some people seem to think that budgeting robs you of choices. They believe that having a budget means you’ll never again eat in a great restaurant, you’ll never have riotous nights out in bars and you’ll never take another vacation. But that’s not it at all.
All of those can be built into your budget. But they’ll be alongside other priorities you’ll choose. Budgeting doesn’t determine what you spend. It gives you the knowledge and power you need to consciously decide your spending choices.
To budget, you need to identify precisely your net income (after tax and other deductions) and expenses. For many in steady employment, knowing their monthly income is easy. But it can be a bit more complicated if you’re self-employed, work in the gig economy, rely heavily on tips or bonuses or have extensive investment income streams.
Look back through previous bank statements and other sources to see how much you typically earn, and build any seasonality into your monthly budgets. For example, if you get a big bonus every December, show that income in December’s budget rather than spreading it across the year.
Determining your spending can be tricky. It’s easy to know your fixed costs (a.k.a. “non-discretionary spending”) because they’re predictable. They’re the sums that go out regularly on commitments such as mortgage/rent, loan and minimum card payments, insurance, utilities, property taxes, homeowners association dues and so on.
In other words, they’re the things you can’t stop paying without major consequences.
Phone, utilities, cable, internet, insurance
Your discretionary spending is everything else. These are your variable expenses over which you have more control. Of course, you can’t control all of them completely. For example, you may be able to reduce your spending on gas a bit, but you still have to get to and from work and maybe drop off the kids at school.
And you should probably continue to feed your family. Still, it’s within your discretionary spending that you’ll find opportunities to make savings. Most people can cut discretionary spending by ten percent without harming their lifestyles. And many can go considerably further.
Trouble is, the only way to find them is to analyze your variable expenses in fine detail. Not long ago, that meant spending hours with ledgers, notebooks and pens. Now, there’s an app for that.
Of course, there’s nothing wrong with the traditional method. If you find the allure of inky fingers, green eyeshades and sleeve garters irresistible, go for it.
Similarly, if you’re an Excel expert, you can go the spreadsheet route. However, those options feel slightly dated when you can download a free app (most have paid-for premium options) for your smartphone that will do the hard work for you. Search for “best budgeting apps” and read some reviews to find the one you want.
That work primarily involves breaking down your discretionary spending into categories and sub-categories so you can see where your money’s going. Those might include:
- Lunches at work
- Coffee-shop purchases
- Entertainment — Cable TV subscription, movie theater and concert tickets, newspapers and magazines and non-work books
- Entertaining — When you host family and friends for lunch, dinner, drinks or a barbecue
- Eating out and takeout — Fast food, fine dining and home deliveries
- Booze— Both in bars and purchased for home
- Clothes — Essentials and the items with designer labels
- Gas and car maintenance/repairs
- Vacations and short breaks
- Gym, sports, golf and country club subscriptions
- Phone, smartphone and internet costs — Don’t forget equipment upgrades
Depending on your hobbies and lifestyle, there may be a few or many more categories. But your objective is to identify where every single cent you spend goes.
Once you can see where your money’s going, you can start to make choices. The cuts you make will depend on how much you value a particular pleasure and how keen you are to reach your debt-reduction or saving goals.
So if your homeownership ambitions are your overwhelming passion, you might decide to slash or even eliminate certain types of spending. And if you need to cut your debts is now past-urgent, you might have no choice but to be similarly radical.
But if you’re saving for something over a number of years, you may need only cut back on things you’ll hardly miss.
Goals, limits and feedback loops
Your first task now is to set yourself some goals: How much do you want to save or put into debt reduction, and what is your time frame?
Let’s look at an example. Supposing you save nothing at the moment, and want to have $6,000 in 30 months’ time. You’ll need to find savings of $200 a month ($200 x 30 = $6,000).
You’ll now have some milestones to measure your progress. After three months, you should have $600, after a year, $2,400 ... and so on. Set aside an hour a month in your calendar to monitor your progress. As well as looking at your totals, check each line to see where you’re under- or overspending.
If you’re like most people, telling yourself you want to save $200 a month won’t be enough. So run through all your categories of spending line by line. You may be shocked by just how much some “little” luxuries are costing you.
Don’t feel you have to eliminate all your luxuries. Start by finding ways to cut down on things. How often do you watch premium cable TV channels? Is there a less comprehensive package that would serve you almost as well? Could you live with reading your favorite newspaper on a tablet or phone instead of buying a hard copy?
Would your marriage be as happy if you were to have two or three date nights a month rather than weekly ones? If you like swanky restaurants and have to pay a babysitter, that saving alone could see you reach your goal.
Of course, many need to save a lot more money in much less time. If that’s the case for you, you’ll have to make deeper cuts across the board. And some of those will likely be painful. Being able to make informed choices about where those cuts should be made can minimize that pain.
Feedback loops are the breakfast choice of champion accountants. Well, maybe not. But they are an important part of the budget process.
You’re already monitoring your progress each month to see how you’re getting on with your savings. A part of that is recognizing what’s going right and what’s going wrong. And a feedback loop lets you put what you learn to good use.
Suppose you originally resolved to stop making coffee shop purchases. You planned to drink office coffee only but just can’t stand it. That doesn’t make you a failure! Increase your coffee shop budget and find an equivalent saving somewhere else. Remember: you’re taking back control of your money, not ceding control to an app.
Too many people give up on their budgets because they fail to stick to them in every detail. When you find a spending limit impossible to keep, change it.
That cuts two ways: If you find you’re consistently spending less than your budget allows, cut your limit for that category. That might save you some pain elsewhere. Or, better yet, it could allow you to increase your saving goals.
Thinking inside the envelope
Some of us are slaves to the impulse purchase. We have an almost supernatural ability to kid ourselves that buying something we want will be okay because ... well, we want it.
If you’re one of us, you may find sticking to a budget impossible. That’s why some personal finance experts suggest an envelope solution, especially for those with problem spending habits.
At the start of each month, you withdraw all your discretionary spending for that month in cash — minus the amount that you plan to save, which you transfer to a savings account.
Obviously, leave enough in your checking account to cover your non-discretionary spending and you’ll settle your bills via checks, electronic transfers, automated payments or however you normally pay them.
Cash all the way
You put your cash into a series of envelopes. Label each envelope with its spending category and put into it the amount you’ve budgeted for that category.
You then lock up your plastic cards somewhere safe at home. Your bills are paid, your savings are safely salted away and when your cash has gone, it’s gone.
That’s a fast way to learn one of life’s most elusive lessons: You get to spend each dollar you earn only once.
Your budget — no matter what sort you choose — should help you to actively target each of those dollars in the way that best meets your personal needs, wants and desires. See yours as a path to financial freedom and wider choices. It won’t be something that sucks the fun out of your life unless you let it.