The first step of any financial achievement begins with a budget. Until you are in control of your spending, it’s almost impossible to consistently save for retirement, college, or investments.
Budgets are for everyone, whether you have plenty of money and can’t figure out where it’s all going, or if you are never quite sure if you’ll make it to the end of the month without overdrawing. And budgets can still work if your income is irregular!
A good budget allows you to allocate money for savings while still being able to spend on fun items. And it helps you communicate with your spouse about financial priorities and goals.
Before You Start
Before you can make your budget, you need a clear picture of what is happening with your money now. Look back at the past few months–your bank’s transaction record is a good place to start. How much money came in, and where did it go?
The first step is calculating your income. The number you want is your after-tax monthly earnings. If it’s deposited monthly with tax deductions already made, that’s easy. If it’s contract or freelance pay, you should subtract the money that you will need to pay in taxes. And if you earn money weekly, biweekly, or in varying amounts throughout the year, you’ll need to average it out from month to month. Instead of spending whatever is in your bank account each month, you should aim to spend your monthly average and keep excess in the account for lean months.
If you earn a paycheck every other week, you get the special perk of the occasional three-paycheck month. In that case, plan your monthly budget based on two paychecks, and then consider where that bonus third paycheck can go. If there are big tax or insurance bills coming up in a certain month, you can plan to save that third paycheck for it. Otherwise, it could go to savings, to big-ticket purchases, or to pay for Christmas presents.
Next, look at your expenditures for the past few months. What regular bills do you always pay? How much do you spend every month on rent, insurance, internet, and utilities? Then look at your other expenses. Are there a lot of transactions for shopping, a daily coffee or lunch, or music downloads?
Crunch the Numbers
At this point, it helps to use a budgeting app, a spreadsheet, or some graph paper to visualize the data. There are lots of apps, both free and paid, to choose from. But if you want something you can scribble on, get out the colored pencils and make one on paper. There’s no wrong way to organize your budget! Get your spouse, and your financial advisor if you have one, and block out some time to get to work.
The first way to divide the expenditures is by discretionary and necessary purchases. Rent, insurance, loan payments, gas, and groceries are all required every month. Netflix, cable, impulse purchases, and eating out are not. That doesn’t mean you have to stop spending that money! But you have more flexibility in that section of your budget than in the previous section.
Next, divide these by category: housing, transportation, insurance, childcare, food, savings, debt, and so on. What percentage of your money are you spending on each? Does that match your priorities as an individual or as a couple? What are the percentages you want to spend on each?
A good rule of thumb is to spend 20% on savings or getting ahead on debt. If you’re not doing that now, it’s a good idea to look at your discretionary spending and ask what you could cut out. Putting money in savings every month is what stands between you and financial disaster if some emergency comes up: job loss, a broken car or appliance, or illness. And every penny you put toward getting ahead on loans is saving you many more in interest.
While you shift your priorities, though, it’s important to leave some fun spending intact. If you’re trying to cut spending, ask yourself which of your entertainment or luxury purchases mean the most to you. Do you watch Netflix every night? Do you count on Friday night takeout after a hard week? Cut out careless purchases that don’t mean that much to you–overspending on shopping trips, or lunch because you forgot to pack one–to leave room for the fun spending that actually means something to you.
Now is a good time also to plan for charitable giving. If you don’t budget for it, it isn’t very likely to happen. You can set up an autopay to a cause that matters to you, or keep that money in your account in case you see a fundraiser you want to support.
If the numbers aren’t adding up, it’s time to take a hard look at your financial situation. Move on from the discretionary purchases and look at the required items and at your income. It might be time to downsize your home, downgrade your car, or take on a second job. No matter what, running a budget deficit every month can’t be an option. That leads to falling behind on bills, overdrawing your account, or running up credit card debt at punishing interest rates. If you’ve fallen into that hole, put down the shovel. Only once your budget balances out can you start working on paying off those debts.
Once you have a monthly budget you can stick to, you can look at the year ahead and make plans. Are there months with extra expenses, like taxes or insurance? Is there a vacation you want to save for? Using your monthly budget, you can figure out how much you’ll have saved by any given date.
Keep your savings in a savings account. Not only can you earn interest, but you’ll be less tempted to spend it. If you have different goals you are saving for, you can open several savings accounts. Your employer may offer to split your paycheck for you and deposit money into savings automatically.
Now Make It Stick!
You have a beautiful budget now to admire. But it does you no good if you put it in a drawer. Every month, go over your expenditures and see how closely you are sticking to your budget. Are there specific areas where you’re having trouble? If you’re constantly going over budget in the same ways, you should either make a plan for avoiding temptation or adjust your budget to account for that spending. If it’s not realistic for you to stick to your planned $200 per month on groceries, it’s time to raise your grocery budget.
It’s also good to see if there are emergencies that crop up over and over. If there’s always something broken that needs repairing in your house, you should allocate money for home maintenance every month. If you don’t use it, roll it over to the next month, until repairs are needed. Likewise, if doctor visits are adding up, it might be time to either increase your health allocation or consider changing to an insurance plan with a lower deductible and copays.
Every once in a while, revisit your budget together with your spouse. Is the budget working? Are there allocations that need to be adjusted? Are there new expenses coming up that you need to talk about? It’s always better to have these conversations in advance, with your budget in front of you, rather than having an argument when the money is already spent.
Now that you’re ready to start living within a budget, you might want another person on your team. A financial advisor can help with every aspect of the budgeting process. Call before, during, or after you make a budget, for help at every step!