I realize not everyone shares my enthusiasm.
The majority of people that go without a budget do so because they feel that budgeting is boring. Others avoid budgeting because they consider budgeting a restrictive process or because they have failed at budgeting in the past. You may be able to relate to one of these common reasons for budget avoidance. But even if you are not excited about budgeting you still NEED a budget. You need a budget..even if you don’t feel as if you have much money to budget. A budget is at the core of any successful journey to financial freedom. I don’t believe it possible to have one without the other.
Creating the budget is the easy part.
The hardest part of budgeting is the follow through.
Cash Flow: Where are you keeping your money?
The Budgeting Cycle: 5 Phases
This typically happens at the beginning of each month. This is where you decide how much you are going to spend, save, and/or invest in the coming month and breakdown your spending into categories.
We spend throughout the month so having a plan is very important to successful budgeting.
Do periodic check ins to ensure that you are staying within the spending boundaries that you set up at the beginning of the month.
This part of the budgeting cycle normally occurs at the end of the month. This is where you compare your actual spending to the projected budget that you set up at the start of the month. If you have been doing a good job of tracking then there should be too many surprises during this step.
The revision phase is where you have an opportunity to identify what went well and what didn’t go so well in the prior month. Did you overestimate how much you would spend in a category, did you underestimate it? Did you leave a category out? Is there an irregular expense coming up that needs to be accounted for so that it doesn’t wreck your budget in upcoming months? During this phase there is an opportunity to make adjustments for the upcoming month. Then repeat the budgeting cycle for next month. It does get easier as you move forward.
5 Common Budgeting Mistakes:
1. It’s too lax.
Having a budget that includes EVERYTHING that your heart desires kinds defeats the purpose of budgeting.
2. It’s too restrictive.
If the budget is too restrictive then the budgeting process will be miserable and you will eventually quit.
3. Create it and forget it.
Putting the budget on paper or on a spreadsheet is the EASY part. Living the budget is the hard part.
4. Failing to pay yourself.
Warren buffet says…”Don’t save what is left after spending; instead spend what is left after saving. At a minimum you should be saving 10% of your income. If you are not there, don’t worry…you’ll get there with constantly budgeting and intentionality. 10% is the minimum…if you have other financial goals like buying a home, retiring early, saving for the kids for college…then the savings rate has to be higher….but first things first.
The budgeting process is going to help you identify where you money is going so that you can regain control. It helps if you set your savings on auto-pilot…Designate a specific amount that you can comfortably save per paycheck and then have that amount auto drafted into an online savings account every time you get paid.
5. Not accounting for emergencies and irregular expenses.
These expenses can wreck your budget if there is not plan to handle them. This is where your emergency fund and sinking funds come into play. Sinking funds are a way to put money aside incrementally for short term savings goals.
Let’s break down Budgeting (Phase 1) even further:
How to Budget (The Details):
1st: Add up all of your monthly income.
If you are married and both you and your spouse work (and share finances) include both incomes. Most budgets are created based on take home pay (net income) after all deductions for expenses such as taxes, health benefits, retirement contributions etc. In most instances your budget should be created on a monthly basis before the beginning of the new month.
A quick word on irregular pay…If you are not a salaried employee and your paychecks are variable based on hours worked or commissions, it is recommended that you budget based on your lowest month of income from the previous year. It is much better to be conservative with your income estimates if you have irregular pay to ensure that you are not caught by surprise.
- Salary 1 (Mr. Smith): $2,500 (after-tax)
- Salary 2 (Mrs. Smith): $2,100 (after-tax)
- Total Monthly Household Income: $4,600 ($55,200 Annual Household Income after-taxes)
2nd. Create your spending plan based on priorities(50/30/20 rule).
Budgeting is NOT about deprivation…rather it is about prioritization.
It really is that simple!!
Determining the priorities:
I would recommend that you prioritize your budgeting in the following order:
1. Must Haves (roughly 50% of your income).
These expenses are necessary and cannot reasonably eliminated from your budget.
Must Haves include expenses such as:
- Housing (Mortgage or rent)
- Transportation costs
- Food (groceries- not food cooked in 5-star restaurants..or even 3-star restaurants for that matter)
- Basic clothing
- Medical expenses
- Minimum payments on debts
2. Savings/Investing/Accelerated Debt Payoff (roughly 20% of your income).
Some of you might be gasping at the thought of saving 20%. Traditional financial advice suggests that we aim for a 10% savings rate. This advice is probably based on the fact that the average American saves a lowly 5% of their take home pay. If 5% is the norm, then 10% is great!
Uh, not really. We are aiming for exceptional, not normal or average. Saving a minimum of 20% will allow us to comfortably set money aside for emergencies, save for retirement and other financial goals, and make extra payments towards any outstanding debts we owe (credit cards, car payments etc.).
3. Wants (roughly 30% of your income).
Wants are the things that are just for fun! If you don’t have room in your budget for fun you may grow frustrated with budgeting because you are constantly in the mode of deprivation.
Wants may include things such as:
- Monthly manicures
- Dining out
- Your occasional Starbucks fix
- Music lessons for the kids
- Vacation and Travel
- New shoes (the adorable ones that you don’t really need)
The good news is that you get to enjoy some fun as long as you keep the spending in balance. The bad news is that these expenses will be the first to get cut if the budget is not balanced or if money becomes tight.
50/30/20 Rule (Balanced money formula in action):
If the fictitious Smith family have a total monthly household income of $4600 they should ideally allocate the following amounts:
- Must-Haves(50%): (Total household income of $4,600 x .50)=$2,300
- Wants (30%): (Total household income of $4,600 x .30)=$1,380
- Savings, Investing, and extra debt payments (20%): (Total household income of $4,600 x .20)= $920
The percentages can vary…based on your individual situation.
The type of budget that you choose is totally up to you and will vary depending on your individual circumstances. But I like the balance money for beginners because you will quickly be able to determine if you monthly spending is out of balance.
Imbalanced spending is a very common problem, particularly if you have never budgeted regularly. When your money is in balance, you always have enough to pay your bills, have some fun, and save for your dreams. In essence this style of budgeting ensures that you are living well within your means, leaving enough room to enjoy life today and build wealth for the future.
Feel free to adjust your percentages, within reason, to suit your lifestyle. There may be some phases in your life when spending 30% on wants is not a priority for you. You may want to accelerate debt payoff dramatically and are willing to sacrifice fun in the short-term for long-term comfort with a life free of debt.
You may also be interested in retiring early and achieving financial independence, so instead you may choose to prioritize saving above spending on wants. I am all for that! But don’t make yourself miserable. Remember to enjoy and experience life. Allocate some money for things that you want so that you can enjoy the view along the way to financial freedom.
Types of budgets:
What should you do if you have more expenses than money?
If you are consistently in the red at the end of each month you will need to determine if you have an expense problem or an income problem.
To determine if you have an expense problem, check your budget percentages to ensure that you are not overspending in a particular area.
Penny pinching and clipping coupons is not going to help this situation. Hard choices need to be made. You may need to get ruthless with your budget cuts. First get rid of some of the discretionary spending. You may not be able to afford monthly manicures and pedicures, daily coffees at your favorite coffee shop, and the expensive cable package. This is where prioritization comes in. All of your expenses can’t have equal importance.
Also, take a close look at your food budget. This is an area that is easy to overspend in. This is an area that I refer to as low-hanging fruit. Your food budget is an category that you can make some minor changes and see immediate savings within the first month.
Eventually you may need to cut where it hurts!
You might be saying…what do you mean? I’m already hurting..I already had to give up my expensive coffee! Cutting where it hurts means to closely scrutinize your large expenditures (housing, transportation) to see if some drastic surgery is needed! You may be paying too much for your apartment and a move may be in order when your lease is up. You may need to sell your car. This are the decisions that most people like to avoid. It’s easier to penny pinch and clip coupons to save a few bucks, but much more difficult to make a lifestyle change that causes some discomfort and disruption to the way you have been doing things.
If you have cut all that you can then it’s time to do some deeper evaluation.
If your budget is bare bones and you still can’t make ends meet you most likely have an income problem and it’s time to figure out ways to earn more money.
Multiple streams of income! Work towards getting to the place where you have income flowing in from more that one source. This will lessen your dependence on your employer and provide you with additional income to pay off debt, save, invest, and advance your financial future.
Writing your budget down is the easy part. Living that budget on a daily basis is much more difficult. It is important to track your spending to ensure that you stay within the budget estimates that you wrote down at the beginning of the month. That is the true essence of budgeting. It goes beyond writing it down. You have to live it!
I don’t like keeping track of a ton of receipts so I prefer to use cash envelope budgeting for the bulk of my everyday household spending. With cash envelope budgeting there is no need for complicate spending records or stacks of receipts. The cash is logged on my Excel spreadsheet one time and I simply put my cash in envelopes and stop spending when the envelopes are empty.
Now, repeat each month. Easy right? Well, the math is easy. Changing the behavior is the difficult part.
Now it’s time to do the work of creating your budget and sticking to it!
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