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How to Budget

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April is Financial Literacy Month and to help kick off this month of financial education, I thought I’d go back to the basics with this edition of the Foundation Series. This post explains something that I think everyone should integrate into their personal finance routine – budgeting. Budgeting is one of those activities that sounds like a hassle, even if you’re a numbers person, but I guarantee that you will benefit tremendously from learning how to and implementing your own budget.

What is a Budget?

Merriam Webster Online defines a budget as “the amount of money that is available for, required for, or assigned to a particular purpose.” Whether you keep record of that money in a little notebook or in a complicated Excel spreadsheet, your budget is an allocation of your money to your monthly expenses.

I’m saving money each month, I’m spending less than I earn, why do I need to budget? Anything you track, you can improve. If you’re spending within your means (kudos!) and saving money each month, that’s very good. If you use a budget and plan everything out, you’ll save even more. We all have our unknown leaks and budgeting will reveal them so you can plug it.

Budgeting has three parts. The first part is setting up your budget, the second part is sticking to your budget, and the third part involves adjusting it as needed. We’ll discuss techniques for all three so you can easily establish and stick to the budget on your way to financial prosperity!

Setting Up Your Budget

The basics of creating a budget are quite simple, simply take a look at all your expenses, categorize them, and then assign a budget to each. When you add them all together, you have your monthly budget. How you go about this will vary based on how well you understand you spending.

The first step is to determine your categories of spending. You want as many categories as you need but you don’t want to get it too complicated to track. I like to have around 8-10 categories but my first budget started with seven:

  • Housing/Utilities: This included my rent or mortgage, my utility bills (electricity, water, trash), and anything related to those. These were typically fixed, with some variance in the utility bills.
  • Groceries: I have groceries separated from Restaurants because I wanted to know how much I was spending on “raw materials” for food and how much I was spending to eat out.
  • Restaurants: It’s important to know how much you’re spending at restaurants because you can spend a fraction of it cooking food at home. Restaurants offer amenities you don’t get at home, such as the ambiance or preparation skill, but knowing how much you spend can help you reduce it if it’s out of line.
  • Entertainment: This is one of the broadest categories, covering everything I did that was considered “fun.” An example of entertainment is if I rented a movie, it was included here.
  • Car: If it was related to transportation, from a car repair to gasoline to Metro tickets, it was included here. I simply called it “Car” because it was easier than writing out “Transportation,” which sounds nebulous.
  • Savings: Each month I would set aside a certain amount for the “savings” expense, which was putting money into a 401(k) or IRA or whatever savings goals I had set. I think having a “Savings” expense is crucial, it makes saving money an active activity, rather than a passive one where you “save whatever is left over.”
  • Miscellaneous: The catch-all “everything else” expense. If something went into Misc. too often, I would make it’s own category.

You can begin with those seven and expand as needed, those were merely the ones I started with and they served me well.

There are two ways to create your budget’s spending limits:

  • Guesstimate Your Expenses: Even if you have never done a budget, you might have a general idea of how much you’re spending in each area of your life. Use that guess to create your spending limits.
  • Track Your Expenses: If you don’t feel comfortable guessing, record your spending habits for a month and use those as a guideline.

Tracking Your Spending

This is step two of budgeting and you can make this step as simple or as complicated as you want. I’ve looked at five budget systems in the past and the one you end up using should be the one you’re most likely to stick with. The five I wrote about were envelope budgeting, reverse budgeting, tracking to the penny, tracking to the dollar, and doing nothing.

Don’t be afraid to try different way to track your spending and don’t feel constrained to use those the ones I listed. Tailor them to fit your needs and your tendencies. When I started budgeting, I tracked my spending to the penny. I’m a bit of a statistics junkie so I knew I could stick with it and make games for myself. If you don’t think you can track your spending to the penny, don’t! Track it to the dollar or try envelope budgeting where you don’t track anything. Do what works for you.

Create statistics about your spending. Just recording the numbers isn’t exciting for a stats junkie like me, I turned it into a game. I started calculating the percentage of my budget each expense category was. I figured out how my expenses were against the targets and played with the targets some more. I created “Zero-Spend” days (as in $0) where I didn’t spend any money whatsoever and tried to maximize the number of Zero-Spend days I had in a month. I created Sub-$5 days and Sub-$10 days and No-Restaurant Weeks and all sorts of crazy metrics as a competition for myself. It became a game and the game helped me save.

Adjust Your Budget

This is sort of step 2.1 of budgeting, not really a third step but not really part of tracking, and it refers to how you should be looking at your budget as an evolving entity. As we progress through the year, your expenses will change slightly. Your electricity bills tend to be lower in the temperate months of Spring and Fall, compared to the extremes of Summer and Winter. You may drive more in the Summer so your car expenses will increase in those months. Regardless of the reason, each month you should adjust the budget as you need to and account for changes. You can still play the statistic games (if you’re into that!), the underlying numbers will just be different.

In the end, whatever you decide to do, by starting a budget and sticking to it, you’ll have a better idea of your spending and a better chance at boosting your savings. :)

What are your favorite budget tips and tricks?

(Photo: bikesontransit)

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17 Responses to “How to Budget”

  1. Jim,
    Great post to kick of Financial Literacy week. My favor part is hearing about how you created “Zero-Spend” days, No-Restaurant Weeks, etc… For my wife and I these types of things are absolutely essential to our success. We are big fans of “board game weekends” instead of expensive movies or dinners. We’ve also committed to drinking only water (healthy & cheaper) at restaurants, drive-thrus, and even at home now.
    It’s these little games and challenges that keep us more motivated than anything. Really enjoyed the post!

  2. Sarah says:

    It seems the most important part for us was the “adjust your budget as you go along part”. Most catagories we set either too high or too low and it took us months to adjust them where we felt comfortable. Or maybe it just took us months of being on a budget to get used to the boundries! Either way, we are now at a very good spot, saving a lot and spending wisely. I love budgeting!!

    • Jim says:

      Adjusting your budget is absolutely crucial, I was like you too. When you set your budget tends to skew it towards certain categories, I set mine in the summer so certain bills were lower. As we went into winter, I saw different expenses rise while others fell. Sometimes I think that a spending limit “range” may be more effective but I haven’t figured out how to make that work yet.

  3. Miranda says:

    I agree that some flexibility is needed in budgeting. It’s all about finding something that works for you — and that you can stick to! So many people create impossible budgets only to fail. I like the idea of creating something that you can keep with long term. Of course, for a budget to be effective you still have to live within your means.

    • Jim says:

      I think that when you’re sitting at a computer or at a desk, you have the best intentions in mind. You say you’ll budget to the penny, you set restrictive spending limits, and you tell yourself you’ll save 30% because 30% is a really nice figure in your mind (it is a great percentage to save). However, you have to temper that enthusiasm and good intention with a dose of realism and adjust that budget so that you arrive at something that you can achieve without hurting yourself too badly. If you eat out 7 nights a week, it might be a good idea to channel your inner Emeril and try cooking one night. If you’re bad at cooking, trying to cook one night a week is a good thing. It’d be entirely unreasonable to expect you to go from 7 nights of restaurants to 0 nights, so being realistic is crucial.

  4. In The Money says:

    This is a great post. I particularly like that you create statistics and make saving money into a game. I totally agree with making saving a line item instead of passively saving whatever is left over from your budget. It is important to pay yourself first.

    • Jim says:

      Making it a game helps motivate you to do certain things. The only bad thing I’d say about “No spend days” is that you often just shift your spending, rather than cut it out. It’s like when the Presidential candidates suggested a day where the gasoline tax would be waived, all it does is shift the purchase of gas to that day, causing headaches and wasted time for everyone (look at Dennys and they were just giving away a breakfast!).

  5. Tina Fortune says:

    Great article!I am going to try the zero spending day.I’ve been budgeting for years and it works!

  6. Neal Frankle says:

    Yes. Fantastic way to kick the month off. Budgeting and tracking are the keys to financial success so it only makes sense to start off on this topic.

    Great tools and really well presented.

    Thanks

  7. Yana says:

    I’ve done accounting for years with a Day-Timer system, and account for every penny. I don’t consider restaurants “Food” either. I call that a Miscellaneous expense because it is a luxury, in my view. Also, Gas has its own category, while CRIM (car repairs, insurance, maintenance) is separate.

    The goal is to have complete control/mastery over our money. However, the best one can do is *almost* complete, because we don’t decide exactly how much we are going to be charged for things. We can’t say no to rent or utilities, and we can only say no to certain grocery items when they are outrageously priced.

    The way we do things, we are forced to save. Some people are incapable of doing that, and instead get tax refunds. Any expense that can be paid annually vs monthly, we pay annually, like car insurance. We pay no interest on anything. We don’t get tax refunds, and consequently have full control of our income. It belongs to us, not the government, and we don’t have to count on them to have our own money to give back to us. What seems weird to me is that some people getting refunds don’t seem to realize that it is their money in the first place. They get the refund and think it is “free” money or a bonus. LOL And for some reason, they sometimes seem not to respect that money, and they spend it away asap.

    • Jim says:

      What’s the Day-Timer system? Does that just refer to using the scheduling booklet? I think putting restaurants into entertainment is a solid idea too.

  8. Bill says:

    This is one of the most balanced treatments of personal budgeting that I have read, especially your examination of guesstimating versus tracking expenses.

    There can be no better way to start Financial Literacy Month than by focusing on the starting point for those wishing to increase their financial literacy, creating a financial plan, AKA “a budget”.

    Great job!

  9. Yana says:

    Day-Timers (daytimer.com) are a planner system, and the one I’ve been ordering comes with a box of small file folders, booklets and add-on sheets to track expenses. In the folders, I keep receipts, and on the inside of the folders which are lined, I write down income, expenses and track things that there isn’t a receipt for. With the category, such as (m) or (n) after the expense. Miscellaneous and necessity/non-food grocery are (m) and (n). Restaurants are (m), using pay laundry machines are (n).

    After the year is up, I save everything in the box and store it. The trouble is that I keep things too long, and several years ago, I had years worth of Day-Timers, including every credit card bill. I don’t have a shredder, but there was just too much there to rip up. So I enlisted the help of a friend and her fireplace. LOL Good thing she is 100% trustworthy ;)

  10. Jackson says:

    I’m curious how you handle multi-month expenses that are paid up front but don’t have a fixed time frame.

    For example, stuff like toilet paper, soap, cleaning products, etc…

    I tend to stock up if there’s a sale since I figure I’ll always need to use it, but that does mess up my budget sometimes.

    I know I’m probably over-thinking it, but I’m also a stat junkie and I get a weird joy knowing exactly where my money goes :)

  11. Master Allan says:

    I’m a master saver and a stats junkie like yourself having created an Excel spreadsheet and using the “tracking by the penny” model. Like your budget there’s always small adjustments to my budget calculator that can be applied. Any possibility we can see some screenshots of your tracking system? You described it quite well and it would be extra helpful to work with it a little and maybe pick up a few ideas.

  12. otipoby says:

    I am a firm believer is financial software – I use Quicken (longtime MS Money user :( . I also track my expenses down to the penny. I have every CC / bank transaction since 1995. I actually enjoy tracking my expenses.

    I find the “what category should restaurants be in” topic interesting. I have “groceries” and “restaurants” as sub-categories of “food”. If I spend more than usual on groceries, that may not be a bad thing if it is more than offset by less spending on restaurants. That just means I am making more dinners at home. The total should go down.

    Another checkpoint I use that is helpful is I pick a day in a month and take a snapshot of all liquid assets (checking and savings) and all liabilities (CC, car loans, minus mortgage) to see how my emergency fund is changing. For me, that day is the 12th of every month since most of my accounts close around that time and I am already reconciling them. I am also a statistics junkie and love to see my savings rate over a full year.

    • While I use a spreadsheet that I customized instead of Quicken, and I do not keep my transactions or statements, I think we look at budgets very similarly.

      I do look at the “food” category and sub categorize groceries and restaurants. The sum of the two stays pretty constant from month to month. Like you said, if one goes up, it usually means the other goes down.

      I also do a snapshot of my liquid assets/liabilities on a given day each month. It is so exciting to watch the net (my EF) grow from month to month. :)


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