Budgeting 101

Some of my readers have requested a basic budgeting lesson. I am pleased to have this blog become an interactive forum driven by reader response, so here it is:

Budgeting is important. Basic budgeting concepts are easy. Budgeting well is a little bit harder. Here is how I do it, along with some tips to help you get started.

Part 1 – The Basics

To start, it helps if you have some idea what you are working with. A little research is required. Gather your pay stubs. Think about all your sources of income: salary, tips, investment income, alimony and child support, rental income, public assistance – everything counts. Gather up your utility bills and recurring expenses. If you have not done so yet, begin writing down everything you buy. (You can come back later and read about this topic HERE.) You need to know where you have been spending your money to make a budget that reflects your reality.

You can calculate your budget using just a note pad, but I recommend graduating to a simple spreadsheet file such as can be made in Excel. Doing this electronically will be so much easier. You can tweak the categories and numbers to your heart’s content, and the spreadsheet will do all the math for you. There are many commercially available budgeting programs, but I recommend a real K.I.S.S. (keep it simple stupid) system that I have created. E-mail me at my-moneytrip@cox.net and I will send you the file for free. 

It is important to do your budget before the new month begins. You should be doing your April budget at the end of March, your May budget at the end of April, your June budget at the end of May, and so on.

The file is set up this way:

A) At the top, list all your income for the month. If exact numbers are not available, make your best educated guess based on your earnings history. Total up this amount. This is how much money you have to spend for the month. If any changes happen during the month, such as a cash gift, unexpected bonus, or a drop in income due to a missed shift or delayed payment, you must update your monthly income totals as the changes occur.

B) Next, list all the expenses you will incur over the course of the month. I suggest starting with the big expenses that seldom change and must be paid, such as income taxes and social security withholding, medical insurance, life insurance, retirement savings, emergency fund savings, mortgage or rent payments. For me, this category also includes charitable giving.

C) Next, list your recurring and variable expenses, such as utilities, cell phone bills, car payments and life insurance. Include in this section savings for larger recurring expenses, such as that big annual car insurance bill, car repairs (unless you drive cars that don’t break down), home improvements and repairs, and also gifts. (Christmas will come this year; try not to act surprised.)

D) Next, list the day-to-day expenses of living; such as groceries, dining out and take-out food, clothes and clothing care, beauty supplies, salon visits, gym memberships, dues and fees, minor car maintenance, housewares and minor home maintenance, gifts, entertainment, and any hobby-related expenses.

E) Finally, add up all the expenses and subtract them from your income. Your goal is for the total of income minus expenses to be zero. If the total is more than zero (a positive number), then you still have money to spend. Congratulations! You can beef up your savings, give more away, and otherwise enjoy the fruits of your labor. If the total is less than zero (a negative number), then you have busted the budget. You need to go back and tweak all the numbers to get the total to equal zero, or you will overspend and incur debt. This is when playing good defense comes in handy (You can come back later and read about this topic HERE),  since creatively lowering your expenses will help you get to zero.

Part 2 – The Challenges

You will almost certainly fail! How’s that for motivation? Kidding aside, budgeting is a process. This can be hard at first! Budgets are based on assumptions, and sometimes those assumptions are wrong. Surprises will come and mistakes will be made. There have been times when just a few hours after I completed the monthly budget, I learned about some huge expense that totally disrupted everything.  A good budget allows for those surprises with an emergency savings category and a recurring expense category. Recognize at the start that It might take a while to get this just right and you will reduce your frustrations. 

The numbers won’t work. If you can’t get to zero, and you have gone over-budget, then you need to increase income or reduce expenses. Many expenses can be reduced with minimal effort. We tell ourselves it’s not possible, but of course it usually is. It’s just not always convenient or enjoyable. If your very life depended on it, would you be able to find an extra $100 a month in your budget? I’m guessing yes. So just for a while, pretend it does, and find some ways to reduce expenses so you can get this darn thing to work.

Some quick, down and dirty money saving ideas:

• Cancel cable. (You’ll live.)
• Quit smoking. (You’ll live longer.) My cousin recently quit and is on track to save $3,600 this year. That will bring her some breathing room – in more ways than one.
• If you have not been to your gym in 12 weeks, cancel the membership.
• Eat out less often, or not at all.
• Make your own coffee and save at least $60 a month.
• Discover your library and you will find free movies and discount passes to area attractions. And they still have books, too.
• Shop for things you need at consignment shops or on Craig’s List. Only underwear and toothbrushes must be bought brand new.
• Call your insurance agent and politely say, “It’s time to lower my premiums.” 
• Drive less.
• Cars are the number one budget busters for many of us. If yours is dragging you down, trade to a less expensive car.
• Wash it, fix it, do it yourself.

Pay yourself first. If you have never done this before, it’s time. This is not a new idea, but it remains the cornerstone of any financial plan. You simply must set aside something for the future. I recommend that your budget begins right at the top with 10% set aside for retirement savings. If this seems impossibly, start at a lower percentage, but not too low – it’s OK to let it hurt a little bit. Increase the amount whenever you are able. As you get better at budgeting, you will find money. 

Another way to find retirement savings money is to save your raises. If you received no raise this year, you would find a way to survive, right? So pretend there was no raise and beef up that percentage. If you are saving at 5%, and you get a 3% raise, save that raise so your savings rate becomes 7%.  Remember, I practice what I preach. I saved my raises for many years, and over time my retirement account contribution grew to 24% of my income. This was made possible by a constant re-examination of and reduction of expenses. Thanks to budgeting, my expenses went down as my income went up, and I saved the difference.

Part 3 – The Benefits

Feel richer. Budgeting done well will make you feel richer. I have found that careful budgeting reduces expenses, giving you a “virtual raise.” 

Smoother cash flow, more savings. One of the benefits of a budget is that it allows for an ongoing fine-tuning of your spending. A budget allows you to see exactly where the money is going, so you no longer have to wonder where it went.  If you are consistent in your efforts, you will get better at planning. As months go by, there will be fewer surprises, fewer mistakes, smoother cash flow, and more savings.

A budget allows you to see the RELATIONSHIPS between your categories of spending. Categorizing your spending and putting real numbers to each category allows you to analyze effectively.  You might see at a glance that if you had no car payment, all the numbers would fall nicely into place.  You might notice that you go over budget on food $100 every month, and perhaps begin to question the wisdom of that $170 cable bill. You might realize that it has been years since you shopped for a cheaper insurance plan. You might discover that your charitable contributions are less than your cell phone bill. You could realize that your spending at the coffee shop is greater than your retirement savings. Seeing the relationships between different categories of spending allows you to consider if that spending is in alignment with your goals and values. 

You will stay out of debt. If you budget well, stop overspending your income, and save for recurring expenses and emergencies, then you will no longer need to rely on credit cards to make up your monthly shortfalls.  This is important because debt is EXPENSIVE. Trying to do a budget and grow wealth while carrying debt is like driving with the emergency brake on.

Part 4 – Tips & Inspiration

Stay realistic. The primary goal of budgeting is to develop control and awareness. As the months go by you can work towards any secondary goals, such as reducing spending, increasing savings, or just making ends meet.  It might take a while to make the adjustments needed to get things right where you’d like them to be. Be patient with yourself, and give yourself a “pat on the back” for even making the effort. 

Use cash. When you shop, use cash, not credit cards. You will be much more aware of your spending, and probably spend less. (You can come back later and read about this topic HERE.)

Overcome the fear. This is important. This is worth it. Tend this garden, and it will yield a harvest. (You can come back later and read about this topic HERE.)

For richer or poorer. If you are married, then this is a process that must be done together. I believe that married couples should pool all resources. There should be no “yours” and “mine,” only “ours.”  This trip is taken on a tandem bicycle, with two riders, pedaling in the same direction. You must work together and agree on your goals and expenses. (Much more on this topic in a future post)

Look forward to the cool stuff. View this process as an adventure! A big reason why I budget is to get my money to do all the important stuff it needs to do so I can use any “extra” money to do some guilt-free cool stuff. Once the important stuff in your budget is covered (you responsible adult you!) then you can move on to the fun.  As you get better at budgeting, analyzing, and controlling your expenses, you likely will find that you have the money to enjoy more of life's pleasures.