The truth is that while the concept of budgeting may be a simple one, actually doing it is not so easy. Just like businesses our households involve managing overhead, changing financial needs, and the unexpected. Each of these adds a layer of complexity, and then top that with the fact that many of us have never really learned how to budget. How often do you hear advice about how to make more money, how to invest it, and how to spend it? Managing it is not a sexy topic, but it is always the cornerstone of financial health. Even millionaires have gone broke due to poor money management.
What follows are some simple ideas for developing and maintaining a budget. I am not a financial expert. I am just a cheapskate who keeps careful track of every cent, and these are just some strategies that have worked for me.
Do you need a budget?
Yes, yes, and yes! It is nearly impossible to live within your means without knowing how much money you bring in and how much you spend. Knowing what you are spending your money on is also important because this is key to reducing your spending should you need to. Once you start keeping careful track of your spending you may be surprised at how much of your money goes to things you don't need.
How much money do you have?
Knowing how much money you bring in on a regular basis is the first step in developing a personal budget. For most people this will be the amount of your paycheck after taxes although a few people might have other steady sources of income. Never count temporary or potential earnings because they are unreliable. If a bonus or few additional dollars should come your way, consider it extra money to be saved.
So once you know your total income, that is the money you have to work with when developing a budget, right? Not exactly. Assuming you have some long term expenses like a child's college education or retirement, you need to save some money. If you have not already done so, you will need to determine how much you need to save and how you will invest your savings. It is best to pretend that this money does not exist when it comes to everyday living. Subtract it from your income right off the bat. If you have a IRA or some type of investment that draws directly from your paycheck this will be simpler. If not, you must keep track of how much immediately goes to savings. Only then do you really know how much money you have to work with.
If you have the kind of job where your income varies considerably from month to month, figuring out what you are bringing in is more difficult, but it is best to try to even out your income. One way you could do this is by tracking your earnings over a six month period and then determining your average income. Save amounts that are above the average in an easily accessible account and draw from it when you are below average.
How much do you spend?
Once you know how much you make after taxes and after long term savings are accounted for you need to figure out how to live on the amount of money that you have. In some ways I think this was actually easier before banks existed. There is something about physically seeing your money on a daily basis that makes it all the more tangible. If you just divided your cash up into pots or jars according to different expenses, you could easily see how much you had and watch it as it dwindled away. Suppose your cash for buying clothing was all gone. That would be it. You would no longer have money and would have to wait until you put more into the pot before buying any more clothes.
Well, you can do this on paper. You can divide your spending into categories and think of these categories as pots of money. There are all kinds of fancy programs out there doing this, but the method doesn't really matter. Spreadsheets work well as do more rudimentary methods. There is nothing wrong with an old ledger book and a pen. I use a word document and a calculator to save paper. The point is that you record your receipts for everything you buy and you know whether you have spent that money on your mortgage, groceries, clothing, etc.
So how do you know which categories you need or how much money to put into each pot? You can guess, but there is a better way. If you have no idea where your money is going, I would suggest tracking your spending for at least a six month period, so you know how much you spend on various things. Then you will have a more realistic idea of how much to put in each of your pots.
Now just because you designate a pot of money for a specific purpose does not mean that you do not have the flexibility to transfer money from pot to pot should the need arise. Let's say that you have a clothing allowance, but you find that you need it for something more important in a given month. You can take some from you clothing budget. However, you must never borrow from the pots designated for fixed expensive such as housing and utilities. These must be left alone or you are headed for serious trouble.
Don't forget about any larger expenses that come up once or twice a year. These might be fixed expenses like car insurance or ones that vary like vacation expenses. You need a pot for these too. This is where I like the idea of having a revolving expense account. This is money that you can squirrel away into savings each month so that it is there when the bill comes. You can treat these expenses like your long term savings by keeping the money in a separate account except you want to keep the money where it is easily transferable so that it is on hand when you need it.
What if you are spending more than you earn?
A lot of people are climbing deeper and deeper into debt with each passing day. This is because they are buying things on credit, paying the minimum balance, and not paying any attention to where they are spending their money. A person can do this for quite a while before it becomes a problem. If, after you have tracked your spending, you discover you are one of these people, you will need to do some serious reorganizing and then make some budget cuts.
Look at your pots of money. They fit into three basic categories. One of these is fixed expenses such as your mortgage/rent, utilities, and car insurance. Another we will call fixed but unnecessary expenses. These are bills that stay the same each month but are things you might be able to do without such as your cell phone, cable television, or magazine subscriptions. The third category is comprised of expenses that can vary considerably such as food, clothing, and entertainment.
I think category three is the easiest to start with when deciding what to cut because it is the most flexible. Try to think of ways to reduce spending in each area. I will cover some ideas in future posts, but here is one example of what I am talking about. Suppose you have been going out for dinner once a week. Try cutting that down to once per month.
Category two is where you need to have a real heart to heart with yourself. Decide how many of those extras you really need. Could you go to the library instead of getting magazine subscriptions? You might not need as many channels on your T.V. service or find that you don't really need it at all.
Category three might seem like it can't be reduced at all, but there are ways to slim down even these expenses. Look into refinancing your mortgage or renting a less expensive apartment. Becoming super energy conscious can help lower those utility bills too although I would not consider it a reduced expense until you have seen several lower bills.
Finally, an added category to pay down your credit debt is absolutely essential. Try to find the lowest interest rate card you can and pay your other balances with that card. How much you can pay will vary depending on your circumstances, but it has to be more than the minimum balance. Treat this like your savings or mortgage payment. It has to be paid each month. Most importantly, STOP using the credit card (unless you keep close track of every cent you charge AND pay off the balance each month. I'll talk about how I think you can use credit responsibly and even benefit from it in a separate post.) If necessary, cut up the card. If you are concerned about emergencies, make it a priority to save up some emergency funds in that revolving expense account and then destroy the card.
What if you have extra money?
Woo hoo! Now you can go to Macy's and go on a wild spending spree.......Not so fast. You are used to the budget you have. Don't rock the boat. If you are lucky enough to come into some extra money that is not part of your regular income, I think it is best to either save that money using a conservative investment or pay off extra debt. I usually prefer to pay more on the mortgage because I like the idea of reducing interest, but either strategy is likely to benefit you. If you are particularly susceptible to temptation, try making a payment to your credit card right away instead of waiting for the regular bill. The relief you will feel later will be much greater than any pain you may feel in the short term from parting with this money.
Kicking your pride to the curb
Dealing with emotions is one of the hardest parts of budgeting. If you have run out of money, it might mean admitting to yourself and others that your budget simply doesn't have anymore leeway. Perhaps a friend our neighbor dresses more fashionably than you. Sometimes they will even try to make you feel bad about it. These are people who never left high school. Don't let them dissuade you from your goals.
Try not to let guilt be a factor either. Maybe you can't give anything to that girl scout who comes to the door. Giving to a cause is noble, but try to fit donations into your budget or be willing to sacrifice something for a time to do so. Also, try not to guilt yourself about having to tell your children that you cannot afford something they want. You love your children, and you want to give them everything. Remember, though, that you are also their model and that you are teaching them skills that could save them from tremendous grief later in life.
The art of budgeting
Budgeting is an art form a sort. It is something that takes hard work, practice, refinement, and sometimes takes years and trial and error to learn. The longer you do it, the better you do it. It does get easier. You can do it and even do it well with enough patience and perseverance. If you need help, you can always call in an expert, but remember that this will cost you and to be careful. Frankly, I don't have a great deal of faith in the "experts." So many of them have given poor advice in the last few years.
Here are a few websites that offer free tools and sources of information on personal budgeting. Try them before buying anything. There are a ton of products out there, and they are all more or less the same.
