Budgeting is never the most exciting topic, but it’s something everyone needs to consider because the way we spend money is the baseline for everything in our financial lives. The amount of money you spend is directly related to figuring out other important aspects of a financial plan, like how much to have in an emergency fund or the amount needed to fund a successful retirement. Some people take budgeting to the extreme and account for how every penny is used, while others don’t do anything and aren’t even sure if they spend more than they make. Even if you don’t stick to a strict budget in the long term it can be very beneficial to get a better idea of your current spending to see where you stand. Before beginning to start on a budgeting plan there are some easy steps to take to prepare.
1. Where is your money going?
This seems obvious, but it’s the first step to understand where you are currently and plan for where you want to go. Most people have a general picture of what they spend and a hazy idea of the different categories. In order to really understand the detailed picture it’s helpful to have some sort of tool or system that will help track and categorize expenses. Start out with the things that are usually the largest expenses and have a set payment schedule such as mortgage/rent payments, any loan or debts payments, car expenses and insurance premiums. Don’t forget to take into account anything that is paid infrequently, like car registrations, and if you own your home it makes sense to factor in an expected amount for maintenance and repairs. Once all the big items are accounted for it’s time to start looking at the granular expenses that can vary throughout the year. This includes things like groceries and restaurants, clothing, vacations and other smaller transactions. Since most people pay these expenses with a credit or debit card there are some good apps that can help automate this process to aggregate and categorize expenses with minimal intervention. Some of the bigger names in this area are Mint, Personal Capital and YNAB (You Need A Budget), which make the process pretty simple once you link your accounts. Tracking spending over a 6-month span can allow the ups and downs to even out and start to give a clearer picture about where everything stands.
2. Does your spending align with what you value?
After getting a good handle on current spending, the next step is to think about your values and matching those up to your spending. We all need a place to live and food to eat, but people place very different values on the qualities of those things. The key is figuring out the things that really bring happiness and value to your life, and spending money efficiently there, while cutting back on things that don’t matter as much. If a car is just something you need to reliably get you from point A to B, then opting for a quality used car can save significant money. Before buying a new house consider that bigger houses cost more time and money to clean and maintain. If you cut back on eating out, but miss the social value of the time with friends and family, add more back in. I’m focusing on the big three categories of housing, transportation and food because that’s often where budgets succeed or fail. If those categories are well thought out it’s easier for everything else to fall into place. Everything is a balance, but spending money with intention can really increase the amount of satisfaction with your choices.
3. Choose a budgeting framework that you can commit to
Finally, after figuring out current spending and giving some thought to money values it’s time to pick out a framework for budgeting. The single most important factor here is finding the one that work for you. No matter how good a particular style or framework for budgeting might look on the surface, it doesn’t matter if you can’t stick to it over time. There are a few different options that have proven successful for many people in the past, depending on your habits.
- If you want to be extremely detailed and meticulous with a budget, then zero-based budgeting is a good option. It’s probably the strictest and most detailed form of budgeting, but it allows you to be extremely intentional with every dollar and deciding how to spend. Basically, you start with your total monthly income and allocate all of it into separate category buckets that represent how you want to spend. The trick to this is staying on top of monitoring to ensure the budget is being followed and updated over time. The YNAB app I mentioned earlier is a great tool for following this sort of budget.
- A more simplistic option is also a commonly repeated message: “pay yourself first”. With this style there isn’t much tracking, instead you decide how much you want to save and stick to that no matter what. The savings gets taken out first and whatever is left can be spent without regard to any specific categories, which reduces the ongoing work of tracking expenses. The trick is just making sure the savings goal isn’t too aggressive and you find yourself with consistent deficits at the end of the month. The other thing to keep in mind, is that this can lead to lifestyle inflation over time. To combat this, revisit and adjust your savings goals whenever income increases, or an unexpected windfall shows up.
- Another popular budget style that falls more in the middle of the previous two is called the 50-30-20 budget. With this one you again start with your monthly income and then divide it so 50% is for necessities, 30% is for wants and 20% is for saving. I personally like this one because it has a good balance of structure and simplicity, and also allows for some flexibility in how it is structured. I plan to cover this in depth in the future, to be continued…
Budgeting doesn’t have to be painful, so hopefully this post gives some ideas about easy ways to get started. If you would like to start a conversation about where your budgeting stands currently, schedule a complimentary call to see how we can plan for this area of your life.