Photo: 401 (K) 2013
Living on a budget doesn’t mean eating nothing but rice and beans, turning off the heat in January, or shopping only at thrift stores. It means being in charge of your money, instead of letting your money be in charge of you.
Living on a budget has a whole lot of benefits, including:
- Making you more aware of where your money is going
- Helping you save on everyday expenses
- Helping you pay off debt
- Boosting your retirement savings
- Increasing your credit score as you make on-time payments and better financial choices
- Freeing up money to give to your favorite causes
- Letting you set aside money for special things, like vacation
- Reducing anxiety about your finances
- And more
So, clearly, budgeting isn’t a bad thing. Yes, it takes time to create a budget and discipline to live on one. But your time and discipline can pay off with big rewards in the long run.
If you’re not sure where to begin, start with these five steps:
1. Figure out what you’re already spending
One of the main reasons many budgets fail is that they don’t line up with reality. Let’s say you’re spending about $600 a month on groceries for your family. You read a blog post from some supermom who clips coupons and feeds her family for $200 a month. So you decide that you’re going to allot $200 for next month’s groceries.
Know what will happen? You’ll fail miserably.
Yes, you can use a budget to cut back on expenses, and yes, you can probably cut your grocery budget by more than half. But it takes time, and your first step is to see where you’re at now.
So go through your bank account and credit card statements for the last month, preferably more like three months, which will give you a more averaged-out view of your spending. Write down how much you spend on things like groceries, gas, housing, clothing, etc.
2. Define your spending priorities
This step will determine whether your spending is in line with your priorities.
It’s helpful, when creating a budget, to look at average spending by percentage from a report like the annual BLS Consumer Expenditure Report. A report like this will tell you, for instance, that if you’re spending 25 percent of your income on food, you’re likely spending much more than you should.
But a generalized report, or some financial guru’s budget category breakdown, can’t tell you whether your spending is in line with your priorities.
So spend some time thinking about your savings goals and your personal or family priorities. Is it important to live in a certain area so your kids can go to a good school? Maybe you’ll allot more to housing than you would otherwise. Do you have to drive often to visit with family? You’ll need more in your transportation budget.
While you’re doing this, look over your recent spending. You’ll likely find areas where your spending doesn’t line up with your priorities. ($100 for a pair of jeans when you don’t care about clothes that much? Seriously?) This will give you an idea of where you might rein in your spending, or shift money from one category to another.
3. Create spending categories
Now it’s time to create a budget. But here’s where it can get a little tricky: how detailed should your budget be? It’s completely up to you.
Rob prefers very broad budget categories — two categories, to be exact. I, on the other hand, budget down to the dollar and down to quite minor categories. It’s a matter of personal preference, and it may take some time for you to figure out what works best for you.
If you’re having difficulty overspending in certain areas — on clothing, Starbucks, groceries, or whatever — set a budget for those areas. This will help you track spending so you aren’t overspending on the same things. That’s just a minimum, though, and you can get much more detailed if you want.
4. Add up all the categories
Now it’s time for the numbers part of the budget. You’ve got your spending categories, and you may have an idea that you want to spend less on groceries so you can spend more on clothing (or whatever). But now you’ve got to assign numbers to various categories.
Start with your average income for the month. (If your income is completely unpredictable, switch to this article on budgeting for a variable income.) Then, begin by writing down your must-be-paid expenses: mortgage/rent, utilities, car payment, other debt payments, insurance payments, etc. Subtract those from your expected income, and you’ll know what you have to work with in the rest of your budget.
At this point, your goal is to work those numbers until you fit everything realistically into your budget. So if you have $3,000 to spend, you might allot $700 for food, $300 for savings, $300 for extra debt payments, $100 for your cable bill, $200 for your cell phone bill, $200 for charity, $200 for gift giving (plan for holidays and birthdays early), and $1,000 for whatever.
(Note: These are made up numbers and have no bearing on reality or on my budget!)
Your goal will be to have nothing left after you subtract all your budget categories from your income. This is what’s called a zero-based budget, and it’s the best place to begin budgeting. After you get the hang of living within your means, you may not have to be quite as detailed as this, but a zero-based budget will help you get on track financially.
5. Spend within your budget for a month
Now you have to live it. To make a budget work, you have to work it out in your life. Otherwise, it’s just a piece of paper (or a computer program) you spend a bunch of time putting numbers onto.
How you track and spend is another matter of personal style. I don’t like to use plastic of any sort because I find it easier to overspend. But I know Rob uses plenty of credit cards (and racks up some killer rewards) while sticking to a budget.
If you’re not disciplined with spending, consider taking out cash for your variable expenses, such as shopping or dining out. That way, you can’t overspend.
Either way, you do need to keep track of your actual spending. For this month, don’t worry too much if you blow it. It’s bound to happen because you’re just getting the hang of this budgeting thing. (Just don’t go charging $300 on your credit card for that purse you have to have.)
At the end of the month, look at your spending compared with your spending goals (i,e., your budget) and see how they stack up.
6. Tweak as needed
Now it’s time to tweak your budget. Unless you’re a good guesser, you were probably off on some of your spending goals. Maybe you’ll find areas where you need to scale back your budget, or areas where you need a little more cash. Or maybe you’ve come across some spending areas where you need to scale back on your spending so that you can fit into your reasonable budget.
Whatever the case, now is the time to tweak your budget. Luckily, you’ve done most of the work, so this doesn’t take as much time. (Unless you happen to get a huge raise or take a pay cut, then your budget will need an overhaul.)
You’ll probably have to repeat this step most months. Extra expenses will come up, and others will fall away. There’s no overarching perfect monthly budget, so be prepared to tweak liberally at the beginning of every month.
Now you know how to create a budget that will help you meet your financial goals. If you’re unsure how to easily track your budget and spending, check out these online budgeting tools, which can be useful for sticking to your budget. Or, if you prefer a more old-fashioned method, use a spreadsheet. That works, too.