Budgeting and I have a long and sordid history. I’ve started and stopped more budgets than I can remember. I’ve struggled with planning for unexpected expenses. I’ve used pen and paper, spreadsheets, Mint.com, Quicken for the PC, Quicken for the Mac, and more recently, YNAB.
Having struggled with a budget for now more than 20 years, I finally have a process that works. It’s the result of a lot of trial and error. Through it all, I’ve found certain aspects of budgeting to be the most challenging. I’ll share those with you today, along with how I solved them.
As you’ll see, I’m a huge fan of YNAB. Most of the more difficult aspects of budgeting, at least for me, were solved once I started using YNAB. Many of the examples listed below refer to YNAB. But the tips we’ll cover in this article apply regardless of which budgeting tool you use.
Let’s start with the basics.
What is a Budget
This may seem like a silly question, but stay with me. Back in the day my interaction with budgets went something like this–
1. Some event, usually receipt of our semi-annual car insurance bill in the mail, would motivate me to get a better handle on our finances;
2. I’d open up a spreadsheet to create what I called a budget;
3. At the top of the spreadsheet I’d list our take-home pay;
4. Below that I’d list all of our monthly expenses;
5. Then I do the math, hoping that the bottom number was a positive one.
6. Now feeling better about our finances, I’d close the spreadsheet and forget about it until the next car insurance bill came in the mail.
So what’s the problem? The “budget” I created did not help us manage our money. I didn’t engage with the budget during the month, refer to it to understand our spending patterns, or even track our spending in any meaningful way.
The budget was, like a large dish of ice cream, a means to soothe my emotions. It was not a meaningful cash management plan or tool.
There’s one easy question you can answer to determine just how effective your budget is. Can your budget answer this question at any point in the month–how much money do I have left to spend until payday? If the answer is no, your budget is not helping you the way it should.
Once I started using a budget the way one should, however, I ran into some problems. How do I deal with credit card charges? Do I keep existing credit card debt separate from new charges on the card. How do I account for transfers from my checking to savings account for periodic expenses? These are the types of questions today’s tips will answer.
8 Black Belt Budgeting Tips
1. Your budget, not your bank account, tells you how much you have to spend
This was a big adjustment for me. There’s something comforting about looking at your bank account balance, knowing the money is there, and that it is available to spend. The problem is that just because the money is in your checking account doesn’t mean it’s available to spend. Here are some examples of when money in your bank account is NOT available to spend:
- Credit card charges–These should be reflected on your budget immediately, even though they don’t come out of your bank account until you pay your credit card bill a month later.
- Checks–They can take days or weeks to clear.
- Periodic Expenses–The money budgeted for future expenses (e.g., travel, gifts, insurance, emergency, or clothes) may still be in your checking account, but isn’t available to spend on other things.
Like keeping your head down when swinging a golf club, looking to your budget for your available resources feels a bit unnatural. But it’s an important habit to develop.
2. Budget credit card spending like your checking account
Charges to your credit card should be entered into your budget just like spending on a debit card linked to your checking account. True, the money spent on a credit card doesn’t come out of your checking account immediately. But it’s money spent just the same, and it should be reflected on your budget as such. If not, you’ll overspend.
Imagine charging $2,000 on everyday expenses AND draining your checking account at the same time. Where will the money come from to pay your credit card bill next month?
3. Periodic expenses should be budgeted every month
There are two kinds of periodic expenses–expected and unexpected. Expected periodic expenses including car insurance, life insurance, gifts, and travel. You may or may not know the exact amount of the expense, but these should not come as a surprise.
Unexpected periodic expenses include car repairs, home repairs, and other emergencies. We know these things will eventually happen, but we don’t know when or how much.
In both cases, we should do our best to estimate how much we should set aside every month to address these types of expenses. There will be some trial and error, and adjustments to your monthly budget in these categories should be expected.
4. Use a savings account to hold periodic expenses until needed
I do this for two reasons. First, it helps me to remove this money from my checking account. While this isn’t necessary if you follow Tip #1 above, as you should, I prefer to avoid the temptation of seeing that money in the checking account. Second, I want to earn the interest on a savings account.
5. Transfers between budget accounts do NOT affect your budget
This is another trick that took me some time to fully embrace. Early in my budgeting years, I didn’t record each credit card transaction. Instead, I had a budget category called “credit card payment.” Each month I simply budgeted the amount of my credit card bill. The problem, of course, is that this approach didn’t give me any insight into my credit card spending.
Recognizing this problem, I then began “splitting” my credit card payment up into categories. This was a feature available in Quicken. It was painful. Each month I’d spend up to an hour categorizing the transactions on my credit card bill.
Finally, I realized that I should categorize every credit card transaction just like I did every checking account transaction (see Tip #2). But that presented a new problem. How should I categorize my monthly payment of our credit card?
Since I had already subtracted each credit card transaction from it’s proper budget category, I couldn’t further subtract the actual credit card payment. That would be double counting. But I had this transaction in my checking account that I had to do something with. Enter YNAB.
YNAB uses the concept of a “transfer” between budget accounts. Here’s how it works. As discussed, each individual credit card transaction is recorded in YNAB as an outflow and assigned to a budget category. When it comes time to pay the credit card bill, that transaction is NOT recorded as an outflow and is NOT assigned to a budget category. That already happened with each individual transaction. Instead, it is simply recorded as a transfer from one budget account, our checking account, to another budget account, our credit card. The transaction has no effect on our budget.
The same is true, by the way, when we transfer money from our checking account to our savings account. We have set up both as “budget accounts” in YNAB. When I move money to savings for future expenses, it is recorded as a transfer, not an outflow. This makes sense as we haven’t spent the money, yet. When say the insurance bill comes do, we transfer the money back to checking and then pay the bill. Only then is it recorded as an outflow and deducted from our car insurance budget category.
6. A budget involves more than your checking account
All of this talk about transfers raises an important question–which accounts should be considered “budget accounts?” Remember, transfers between budget accounts are not considered outflows and are not subtracted from our budget. With that, budget accounts should include all accounts that meet one of the following two requirements:
- All accounts you use to pay for stuff
- All accounts where you park money for less than 12 months before spending it
The number and type of accounts that meet these requirements will vary. But generally budget accounts will include one or more checking accounts, savings accounts, and credit cards. They may also include prepaid cards, investment accounts, and even a PayPal account.
7. Treat existing credit card debt separately from everyday spending
Credit card debit is tricky. Not only do many people have to deal with budgeting new charges for everyday expenses, but they also have to deal with existing credit card debt they are trying to pay off. The key is to separate the two.
Exisitng credit card debt should be treated like any other loan. Since it has already been spent, there’s no way to go back in time to budget it. So instead, set it up as a debt and budget the amount you can pay toward that debt each month. In YNAB, they make this easy. It’s called pre-YNAB debt, and it is given it’s own budget category.
Once the credit card debt is paid in full, you can remove it from the budget and throw a party (paid for in cash, by the way).
8. Be realistic
The final tip is in some ways the most important–be realistic. Sometimes we try to cut our spending to the bone, only to become frustrated and give up weeks or months later. In some cases we grossly underestimate over overestimate the cost of future expenses. Sometimes we just forget about certain categories of expenses.
Experience will help us fine tune our budget. With enough data, estimating future expenses will certainly come easier. As you start out, however, strive to be as realistic and flexible as you can. Mistakes will be made and adjustments will be necessary. Just roll with the punches and keep moving forward.
For more help, check out these budgeting resources: