Disclaimer: I am not an accountant or financial professional in any capacity. The following is based on my personal opinion and experience. Please seek the advice of a professional for a definitive answer about your particular situation or if you want to have a budget created by an expert.
If money is tight every month and you’re not quite sure why: you need a budget! It’ll let you spot exactly where the problem is. If you want to retire someday, buy a home, go on a big family vacation: you need a budget! It’ll let you know when you can achieve those goals. A budget will help you get out of debt faster, allow you to build an emergency fund, help your kids pay for college and stop worrying so much about money.
The first step in creating a financial plan is coming up with your budget. Read this article I wrote if you want to know why you should have a financial plan and how to create one.
In this article, I will list the steps you need to follow in order to create a realistic budget. You need to look at where and how you’ve earned money and spent money in order to shape and predict where & how you will earn and spend in the future. It’s quite a simple process.
Your budget needs to be a true reflection of your current situation.
Otherwise, it is no help to you at all. It would be like having a map of Paris when you’re in Miami. Useless!
Why is “budget” a bad word?
For some reason, the word “budget” is a negative word. The assumption seems to be that you must be bad at managing your money if you have a budget. I believe that every person, every family, should have a budget since it helps you reach your goals and live your dreams.
Here’s a list of common reasons why people don’t want to create a budget:
- It’s restrictive. A budget isn’t meant to hold you back! It’s meant to help you reach your goals. A budget is simply a true reflection of how you earn and spend your money. It helps you make better buying decisions. In order to do this, it can’t be too lenient or too restrictive.
- It’s boring. Well, I won’t lie. It can be time-consuming and a little dry. If you can’t imagine sitting down for hours looking at your finances, break it up into smaller chunks. Instead of looking once a month, do it once a week or even daily. Hate computers? Grab a notebook. Don’t want to write? Use an app! Whatever floats your boat.
- It’s too stressful. Actually, I’ll venture that the stress is because you feel like there’s not enough money and you have no control over it. Have a look, keep track and create a plan. See how you feel. What have you got to lose?
- It’s confusing. Handling your money properly doesn’t require any special skills, just a bit of knowledge and a willingness to look at your habits. You’re earning and spending money now, aren’t you? Why not make a list of where and when? That’s all the first step is. Just keeping track.
Stop doing these things now:
- Wonder if your credit card will be declined
- Avoid calls from creditors
- Put off one creditor in order to pay another
- Regret purchases, such as Christmas gifts, when the bills come in
- Fight with your partner about money
Budgeting can be fun
Really! I’m not off my rocker, I promise. I guess fun is a strong word. Liberating, like taking a load off. Is that better? Seriously, there is no better feeling than that of knowing where you stand, exactly, with your money. You will feel so much more secure, even if your budget only confirms how little money there is to stretch.
From this day on you will have a realistic budget. You will:
- Know where every penny goes.
- Make conscious decisions about your expenses.
What is a budget anyway?
A budget is a snapshot of your current financial situation. A budget allows, or forces, you to have a truly honest look at your assets, obligations and habits. Once you know where you are, it’s easier to stay the course or to make necessary adjustments.
The best way to go about it is to gather all your receipts along with your bank and credit card statements. Create categories, such as Food, Insurance, Transportation. I suggest using a page per category in a cheap notebook. Do this for a couple of months to be sure you’re not missing any expenses. The seasonal ones are easy to forget about during the off-season, for example.
I know there will be some surprises in there for you. In my case, it was groceries. I knew we spent a lot on food but I wasn’t quite prepared for the total.
After a month or two of keeping track of your spending, you will have a true idea of how much to allocate for each category of spending.
It might also shock you into being more careful! You do however have to make sure you budget is realistic. It has to be doable, not some pie-in-the-sky unattainable dream. You’re not going to be able to cut all your expenses by 90% and quadruple your income.
Before you start, remember:
Budgeting is for everyone
Make sure both you and your partner are involved in this process even if (or especially if!) only one of you does the everyday stuff. You both need to be aware of and have access to, everything financial.
Hold regular budget meetings. A monthly review is a good idea. It keeps everyone on the same page and motivated.
Budgets can, and should, change
Just because something works for a while doesn’t mean it’ll work forever. Your income may change, your expenses may change over time, your goals can change too. Adjust your budget to reflect your current situation. Read more about setting your priorities here: How to create a financial plan (and why you need one).
Ready? Grab a notebook, open up a spreadsheet, use an app like Mint or one available through your bank. There’s an interesting MoneySense article regarding apps that you can by clicking read here.
The important thing is to use whatever works best for you, that you feel comfortable with and will use consistently.
Here we go!
Income can come from a variety of sources. Include them all! Day job, side jobs, interest on savings, in short anything that put money into your pocket.
You will notice that each month is not necessarily like the others, even if you have a single steady job. You are lucky, in a budgeting sense, if you are paid twice a month because your months do resemble each other. For the rest of us, those who are paid every two weeks or weekly, our monthly income can fluctuate.
Did you just realise why some months are tighter than others?
There are several ways of dealing with a fluctuating monthly income. I prefer Dave Ramsey’s method of using your lowest paid month from the previous year but I put a twist on it. For my purposes, because I don’t want to go back to last year, it means pretending each month is a 2 paycheque month. That way any third pay in a month is a bonus. I encourage you to create this bare-bones budget.
Speaking of bonuses, please don’t count them as income even if you’ve received the same bonus for years. I would hate for you to have a nasty surprise with potentially devastating consequences.
Now that you’ve tracked your expenses for a couple of months, let’s create a budget. Clean up the categories you created, put them in an order that makes sense to you. Allocate an amount to each category according to your tracking.
I like to divide my expenses into two parts, as do most experts: the ones that are fixed (and don’t change from one month to the next) and the ones that are variable (the ones you have some level of control over). Create those two sections on your budget sheet when you’re figuring out your categories.
Here are expenses you might include in your budget, divided into categories as I see them:
- Savings: emergency fund, retirement, education.
- Housing : mortgage payment, rent, property taxes, repairs & maintenance, condo association fees
- Transportation: car payment, gas & oil, repairs & maintenance, insurance, license plate fees, taxi or uber, etc.
- Utilities: electricity, gas, water & sewer, trash, phone, cell phone, internet, cable
- Food: groceries, restaurants
- Clothing: adults, kids, dry cleaning
- Entertainment: anything you do for fun, so movies, concerts, sports and vacation
- Medical/Health: medication, dentist, optometrist, vitamins, etc.
- Charity: tithes and donations
- Taxes: this is important if you are self-employed
- Insurance: life, car, home, disability, long-term care, identity theft
- Personal: pet expenses, childcare, cosmetics & hair, education including tuition, books, subscriptions, pocket money, music & technology, gifts, child support, alimony, furniture
- Debt: credit cards, student loans, personal loans, etc.
Now you have your total income and your total expenses in one place.
Your income is what it is.
Your fixed expenses (like rent or a mortgage payment) are what they are until you next have an opportunity to change them.
Where you have control is with your variable expenses. Take your groceries, for example. You do need to eat, but you can make some conscious choices here. For example, you can meal plan, pack you own lunch and shop sales. This is where you can “play” with the numbers to make your budget balance out.
A budget history
Hang onto your monthly budget sheets and review them at the end of the year. You’ll be surprised at what you see. You’ll spot some trends, I’m sure.
There is nothing like tracking your expenses to keep you honest. By that, I mean that you might find yourself redefining your priorities when you see the numbers on the page. You might start researching how to change your habits. Debt might start decreasing steadily as you see the numbers creep down. Savings might become a new obsession. Perhaps you’ll be prompted to increase your income. I’ll be curious to hear what you discover!
Dealing with long-term goals
If you find yourself discouraged by how long it’ll take you to reach a certain goal, such as saving for a down payment on a home, break it down into smaller chunks. For example, if you want to save $20,000 within five years and the count-down is depressing, change it up! It’s $4,000 per year, which is more attainable. That’s $333 per month! Personally, I feel motivated by checking a small goal off every month rather than just watching a number go up. It really brings home the fact that each month brings me a step closer to my goal. It’s also fun to think about what I could do with that money each month once my goal has been reached.
You may find these two articles interesting:
I leave you with a final question: do you prefer using paper or electronics for your budget? I’m creating a few budget checklists and spreadsheets and am interested to see where I should focus first! Let me know by email or in the comments below.