The dictionary defines a budget as “an estimate, often itemized, of expected income and expense for a given period in the future.” Budgeting, the quintessential money management tool, should identify where we spend our money so that we can make better spending choices. While there is no one right way to budget, the purpose of any budget should be to give us the information we need to make smart spending decisions.
But what if it’s your budget that’s killing your finances. Imagine, you take the time and effort to prepare a budget in the first place, and the budget ends up causing more harm than good. Or at the very least, your budget doesn’t get you the results it should.
To help you avoid this, and to maximize the benefit of your budget, here are seven budgeting pitfalls and how to fix them:
7 Budgeting Pitfalls and How to Fix Them
1. Missing Expenses: Does your budget have a leak? With automatic bill pay, it’s easy to forget about regular monthly expenses. We recently lost track of an expenses that was charged to our credit card each month. It wasn’t a lot of money, about $15 a month, but every dollar counts.
The Fix: Take the time each month to carefully review each credit card and bank statement. Make sure you understand where your money went, what automatic payments were made, and what was charged to your credit cards. This doesn’t take a lot of time, but in the hurry and rush of life, it’s an easy thing to forget.
2. Unrealistic Budgeting: Have you or someone you know ever gone on an extreme diet? In their desire to lose weight, they deprive themselves of food in a way that’s just not sustainable. The result is almost always to gain more weight when the diet crashes. The same thing can happen with our finances. We put together an unrealistic budget that deprives us of any fun, and eventually we crash through the budget with a big spending splurge.
The Fix: We need to keep our budgets realistic by providing for some measure of enjoyment in life. Whether that’s eating out, buying books, traveling, or whatever, our budgets need to reflect in a reasonable fashion who we are and how we want to live our lives. If you are looking for a place to start, try the 60% budget. Sixty percent of gross income should cover your fixed expenses: Mortgage, food, clothing, taxes, insurance and so on. The remaining 40% gets divided into 10% portions for retirement, long-term savings, short-term savings and fun money. These numbers are just a starting point, but it should help you to keep your budget realistic.
3. Too Little Information: A budget should arm you with the information you need to make smart spending decisions. One type of budget that works for many is to “pay yourself first.” That means to save a portion of your paycheck first, and then spend the rest without worrying about where or how you spend it. While this can be an effective and easy way to budget, the lack of information on how you are spending the rest could be causing you to spend more than you should.
The Fix: Every few months, track how you spend the rest. This doesn’t have to be a monthly exercise. A few times a year works for many people. And you don’t have to track your expenses for an entire month. Track expenses for a week or two. Armed with information on how you are spending money, you can make spending decisions that may allow you to save even more or accelerate debt reduction.
4. Too Much Information: To much information can be a real problem, too. It’s a lot of work to track where every single penny goes. While there are good budgeting tools (see below) that make tracking expenses easier, for many, tracking everything is overwhelming and unnecessary. And the result can be frustration and a budget that ends up in a drawer.
The Fix: Limit the spending areas you track to those that really cause you to overspend. If eating out is your financial Achilles’ heel, use a cash-envelope system for just that one category. In fact, many people overspend in just one, two or three categories. Tracking just those categories can move a family’s finances from red to black.
5. No Real Time Data: We make hundreds of spending decisions every month. As you make those decisions, do you know how much you’ve already spent and how much you have left to spend? This is where real time data is important. While looking at how you spent your money after the fact can be helpful, there’s nothing better than knowing where you stand financially right now.
The Fix: There are several budgeting methods to help you know where you stand at any given moment. The old fashioned cash-envelope system mentioned above is a good one. So is using debit or credit cards and reviewing your spending data online or downloading it into a personal finance software package like Quicken or Money. The key is to know where you stand at any given time, but only for those categories that you must track to properly monitor and control your spending.
6. Using the Wrong Budgeting Tools: While there is no one “right” budgeting tool, it is important to use a tool that works for you. Use the wrong financial tool, and frustration can quickly end any effort at budgeting. While many swear by Quicken, for example, for us its budget function just didn’t work. We use it for everything else, but just not budgeting.
The Fix: Recognize that there are many free and paid budgeting systems available. Take some time to review them, and give a couple of them a try before deciding. You can check out this list of online budgeting tools to get some ideas. You can also check out one of my personal favorite paid budgeting software systems, You Need a Budget.
7. Forgetting Periodic Expenses: This one use to get us every time. We thought our budget was looking good, and then the car insurance bill arrived. I can still remember the feeling in the pit of my stomach as I realized we weren’t doing as well as we thought. But there is an easy fix for this budget pitfall.
The Fix: Develop a Freedom Fund. Add up all of your periodic expenses such as car insurance, gifts, life insurance, vacation expense and so on, divide by 12, and save this amount each month. It takes some discipline at first, but there is no greater feeling when that car insurance bill arrives than knowing you have the money in the bank to pay it.