The basic concept of budgeting is this: Dividing your estimated earnings into assigned categories for spending. If you are on a fixed salary this process is fairly simple. I’ll cover some basics, and then talk about some more difficult cases. I am addressing this primarily to people who are not in dire financial need or poverty. People in those situations need to seek out local resources for help in finding solutions which are tailored to their particular situation. This post focuses on budgeting on particular. I’ve got a more general post about financial management that might be helpful to read first. Onward we go.
The mechanics of budgeting can be as simple or as complex as you wish to make it. If you never overspend and always have money waiting for emergency expenses, then the system you’re using is working for you. Stick with it. If otherwise, here are some places to start in putting together a budget.
Pick some categories and assign dollar amounts to them, making sure that the totals don’t add up to more than your salary income. We have categories for groceries, gas/electric, water/garbage, auto insurance, life insurance, medical, auto repair, auto fuel, clothing, dining, entertainment, savings, and assorted other categories which are more particular to us. What you name your categories is not as important as making sure that you have one to cover every way in which you spend money. I use a lot of categories because my financial program (Quicken) makes them easy to track, and then I can run reports to tell me exactly how much we spent on comics in the last year. If you’re new to budgeting, fewer categories might feel less overwhelming. However it is best to make sure that your fixed expenses, like utility bills, are not in the same category as discretionary expenses like eating out at restaurants. One of the most important things that a budget can do for you is to make sure that you don’t spend your rent money on going out to see a movie, but it can only do so if rent and movies are not in the same category.
A useful way to visualize budgeting: When I’m teaching my kids about budgeting, I use the envelope method to help them visualize. They divide their allowance into several envelopes or jars. This lets them plan ahead for how much they want to spend on the various things in their lives. If the Candy envelope becomes empty, the only way to spend more money on candy is to borrow from another envelope, or wait for a new influx of income. The kids borrow money from envelope to envelope all the time, but the act of pulling it from another envelope helps the kids see that if they spend all their money on candy, then they will not have any left for books or for what ever cool toy they’ve been coveting. In my budget, I loan money across my discretionary categories all the time. I do not pull money from the fixed expense categories like Mortgage Payment.
Pick a tracking method. We keep all our money in one checking account and just track the categories in our financial program. When money is really tight, I keep a little tally in a notepad that I carry with me. Then I can refer to it at a moment’s notice when making buying decisions. If I buy socks I subtract it from the Clothing category on my tally. I know a friend who issues himself a cash allowance for fun spending, essentially applying the envelope method for everything except bills. What ever method you choose for tracking, always refer to your budget tracking method before spending money. If you don’t have money in an appropriate budget category for those lovely new curtains, don’t buy them. Not even if they are on sale.
Knowing how much to put in each budget category can be tricky if you have never done a budget before. Start by looking at bank statements, bills, and receipts from the last few months. This can teach you a lot about where your money is going. Add up the amounts you spent in the various categories. I’m usually shocked by some category of spending that I did not realize was adding up to so much. Use whatever information you have to make some guesses and then get started. It is more important to start training your brain to think about how you spend, and whether you should spend, than it is to get the numbers right. The numbers are your measurement tools, not something which will be graded by others. You will goof up. That’s okay, learn something from it and do things differently next time.
Some good practices for budgeting:
- Pay your bills first, as soon as you can. That way you’re less likely to use the money for something else.
- Don’t use your checking account balance or your credit card balance as a measure for whether you can afford something. Use your budget.
- Build savings into your budget. Keep an “in case of emergencies” fund. But also, pick something you want and save for it. It can be anything: college, retirement, a trip, a car, being debt free. It needs to be something you’re willing to sacrifice for. Put that money aside until you have enough to pay cash for your dream. This fund will probably be raided in times of emergency, but then you’ve made your emergency less financially catastrophic.
- Pay down your debts as fast as you can. Debts weigh on you and limit your financial possibilities. The interest you pay on debt does not add anything to your life except stress.
Be extremely cautious about acquiring debt. See above.
Some questions and answers about difficult cases:
What if your income is irregular? Not everyone has a bi-weekly paycheck, which can make budgeting seem difficult. However most bills are on a monthly billing cycle. If you set up your budget on a monthly basis, then having a budget can help even out the bumps. Average out your expected income over the course of four months, then divide that by four. I would recommend low-balling your estimated income per month. Some months you will have more than this, others less. Sticking to your budget in times of financial plenty will help you fill in the times when money is scarce. If your income is irregular, stashing money into savings is crucial.
What if money is always scarce? If the total of your estimated expenses by budget category is greater than your estimate income, you are in financial crisis mode. It is time to sit down and seriously look at all all your financial commitments to see what can be eliminated. Being able to eat is more important than having 300 channels. Find every way you can to reduce expenses: cancel subscriptions, pick less expensive foods, sell a car. There are a lot more than you might think. I recommend reading books like The Complete Tightwad Gazette many of the methods inside won’t apply, but the mindset of “I can do this cheaper” is important when money is tight. If you can’t bring yourself out of financial crisis mode within a couple of months, look up local debt management resources. There are often free resources out there to help people get control of their finances.
What if you get hit by an unexpected expense? This happens all the time. Medical bills and car repairs are the biggest culprits. In a solid budget there is some planning ahead for these things. Create a budget category for “in case of emergency” and stick money into it each month. This is what savings accounts are for. Planning ahead means that the unexpected expense is merely annoying instead of an emergency.
What if you have an expense which is not monthly? My auto insurance comes due twice per year. Property taxes on our house are due once per year. I take the amount I’ll need to spend on these bills and divide it by the number of months between payments. Then I put that amount aside each month. To use some made up numbers: if $100 per month is allotted to Car Insurance, then when the $600 bill comes due I have money waiting. If the $600 insurance bill was an annual bill, I would only need to set aside $50 per month. Put this set aside money where you can not accidentally spend it. I routinely put this into my savings account and then transfer it back out when time comes to pay the bill.
What if I goof up and forget to track my budgeting? I do this all the time. This past year I hardly checked my spending against budget categories at all. I was too busy and distracted. The result is that we over extended a little bit, but not much. The reason we did not over extend is because all the years of practice I’ve had in tracking a budget trained my brain to think about money in ways which kept me in check. The act of tracking your budget is training your brain to be financially responsible. Like any sort of training, it takes practice. Just start up again and keep going if you forget for awhile.
What if it is just too overwhelming and stressful to track all those numbers? Then your budget needs revision. Simplify it. Break down to something that is one step more organized than you were before. Adding little pieces of financial organization to your life can make a huge difference over the years. I revise my budget about once per year to make sure that my categories and tracking methods are still working. Systems fall apart, just use the good pieces from the old system to build a new and better system.
And that is enough for now. There are lots of good books on budgeting and financial management that you can get from your local library for free. Your librarian will be happy to help you find them.
When I get Financial Management for Creative People 102 and 201 written up, I’ll link them here.
Take time to read the comments below. Lots of additional good ideas there.