Why a budget?
You can read a bit about debt and why it is bad in an earlier post. One of the easiest ways to get into debt is to spend more money than you have. This is a very common problem for people who have not had any exposure to money management before but now have some money to spend. It's our natural first reaction to see the $100 in our hand and think that we can afford the $100 shoes, the $100 coat, pay the $100 electric bill and still have money left over. What our minds fail to realize is the limited nature of each dollar we hold. That is why we need a budget. Like a grocery list, it helps us organize and visualize and gain better understanding. So, while not managing our money gets us into debt, having a budget is an easy way to get out of debt faster, and hopefully start saving.
What a budget is
A budget is a break down and correlation of two things: the money you take in and the money you send out. It's a plan to be used over time and so works best with predictable amounts in these two categories. Ideally, the money you take in comes from a stable source, like a pay check. This may not always be the case, however. Also, budgets work well helping you to meet your fixed expenses with your stable income. The more predictable your expenses, the easier it is to budget.
I say "easier" but don't take that to mean required. Same goes for your income. You can budget to unpredictable income and variable expenses too - it just takes more foresight and discipline over the course of the year.
What a budget isn't
A budget is like a project plan... or like a grocery list. It's a rope to guide you along the path... not a noose to hang yourself with. Don't expect your first stab at a budget to be perfect. It's not meant to be. You'll go through a few rounds of revisions as you get a handle on what you really spend and the (hopefully) infrequent random expense pops up.
Making a budget
A good place to start is to download a tool. I recommend you take a look at Pear Budget. For most folks, the 30 day trial is going to be enough time for you to figure out a budget. The problem is it takes several months to fine-tune a budget once you have created it. For this reason, and while I am appreciative of the efforts that the folks at Pear Budget have put into things (and hope you can afford their subscription service), I have to recommend their older FREE spreadsheet version. Allow me to explain briefly because I do think we should reward those who do a kindness to us and subscribing to their service would indeed be a kindness. However - my experience has been that when you are trying to get a budget together, you are usually going to quickly realize that you don't have as much income as you do outflow. Adding a monthly expense is not in your best interest in this circumstance. If however, you have room in your budget, of course, use the pay service as it's much more up to date.
That said - you might still be able to find the free version here. If you wind up saving a lot of money using it - from what I've read you will much more enjoy the online version and its ease of use. But this will get you started and is what I use.
Now - did you start using Pear Budget yet? he he. If you don't read another word I say here and start using it right now, mission accomplished. But if you want some tips on creating and living within a budget from someone who has had to do it, read on.
What's coming in?
I hope and pray you have an income. Either you're on a salary, a fixed income like a pension or social security, or you are getting some sort of per diem or hourly pay. Or you may have access to a trust fund and don't want to blow it all at once. Good thinking! In any case, you need to start by tracking what you're taking in. Many people look at their weekly or monthly income and expense when considering a budget. This is fine for fixed income and predictable expenses. But if you own your own business or have a job, like sales, where the pay tends to rise and fall with the season, you'll want to consider your total yearly income. In the case of Pear Budget (spreadsheet) you will want to average this back to a month for the purposes of having a month to month health check on your spending vs budget.
Do this by adding up everything you make in the year and divide by 12 if you want to figure your expenses by the month or divide by 52 if you want to go by weeks. If you want to do it by four week periods, divide by 52 and multiply by 4. It's a tiny bit different than dividing by 12. Pick the method that fits how you will track your expenses. Don't forget to include all of the income that you consider accessible. If you are earning interest on investments and will be using it to pay your bills, don't forget to include it. If you have a part time job or two or more, figure out what you're likely to make on average by counting all of these. You may also be in the position where you are now living on savings due to the loss of a job. You may need to skip ahead, figure your expenses, then figure out how much to draw down each month.
What has to go out?
We all have expenses. If you don't, you don't need a budget. :o) Capturing all of your expenses can take some time and effort. An easy way is to take your bank statements and lay them out in front of you and begin to categorize them. For example, I lump all food retailers into grocery, and all gas stations into auto fuel. Then there's utilities, rent or mortgage payments, spending money and savings and so on. Be thorough! Your budget will be quickly "blown" if you miss something. Magazine subscriptions? Website hosting plans? Memberships? Dues? Starbucks?
It's important that you not go in debt - right? So make sure you are covering all of your mandatory expenses before you set aside "spending money" or savings. You can't do these things if you are racking up debt by not paying your bills. So make sure you add up all your bills and recurring expenses like food first. Like income, it may be necessary to add up several months of data or a year and average. Or just get last months statements and take a stab at it. Getting started is important - being perfect to the penny right out of the gate is not.
Finally getting some control
Now - this is the juncture where you start to have some control over your life. Take your averaged income and subtract your averaged expenses. Do you have something left over? Good! Now you can decide how much to save and how much you can blow each month. A good rule of thumb is tithe 10%, save 10% and play with 10% and do business with the rest. That way you're taking care of God first, your future second, and your sanity now. But - not all of us are going to have a 30% surplus, sadly.
If you subtracted your income from your expenses and you are still not meeting your expenses, it's time to exercise some control. You need to look long and hard at your expenses. I have friends who I love dearly who struggle with money and yet still have cable, expensive cell phones and the $90 plans that go with them and still buy new clothes regularly, and of course still eat out a lot.
It's important to be honest with ourselves about what we really, truly need. We really truly need food and shelter. And if we live a long ways from work and can't walk, ride a bike or catch a train or bus, we need transportation. Everything else is a luxury and you'll need to start seeing it that way before you can convince yourself that it can be cut from your expenses.
I personally recommend, and have done the following:
1. Get rid of the expensive smart phone / iPhone / Android and get an $8 tracfone or similar with pay as you go activation. This move saves me about $600 annually.
2. I also recommend ditching the cable and/or satellite TV. You'll LIVE! Honest! The library now loans DVDs, so get a library card and relax and enjoy the fact that you have made a net-positive contribution to your budget. You can save about $1000 a year on this one.
3. Shop at thrift stores. Seriously. People give nice clothes to thrift stores and if you are careful and make it part of your weekly grocery run, you'll find what you need for 20% retail. If you're diligent and stick to your guns here, you might save several hundred dollars each year depending on your tastes.
4. Drive your car into the ground. I do this now as a matter of course. I'm not saying you should abuse your car. I am saying even a $3000 transmission job is cheaper than a $20,000 car (and a $2000 "beater" is cheaper than a $3000 transmission). Dave Ramsey says: Nobody cares what you drive but you. I agree. My car has 178,000 miles on it and I take care of it so that it takes care of me in the form of NO CAR PAYMENTS. It saves me $3,600 a year if you figure a $300 monthly payment, and in turn I spend about $800 a year on really taking good care of it with regular maintenance and service. I net out $2400 ahead of the game.
Don't let pride keep you from making your budget and your money work for you!
So, this is the tough part. If you are in the red, you're going to either need to reduce your expenses or increase your income. The later is harder than the former for most people. Lots of us are lucky to HAVE a job these days, let alone be picky about what it pays. All of us, though, can sacrifice luxuries to get our money under control. Dave Ramsey has another oft-quoted line: If you're willing to live like no one else right now, you can live like no one else later on. That means if you are willing to have the discipline and do the hard work to get your money under control NOW and include some savings in your budget, you will one day be sitting on top of your money rather than under your bills.
With tools like Pear Budget, you enter your expenses in as you go or at the end of the month. I find it easiest to get my statements together at month end and sit down for 10-15 minutes of data entry. This tells me if I splurged too much or if I didn't budget enough for gas or food or if I estimated way too much for one category and shorted myself somewhere else. Make any needed adjustments at this time but try to be forward looking. If you figured $125 a month for electric based on past expenses but now it's $130 due to a rate increase, try to find out how much your rate is going up in coming months so you can budget for it. Similarly, if you took drastic measures to reduce your electric consumption and now you're going to be predictably below $125 each month, reduce your budgeted amount to a realistic level. Like I said earlier - it doesn't have to be perfect. You can hang onto the rope as tightly or loosely as you like.
For most people, just being ON a budget makes them more cost conscious and you will likely see a net savings over budget by the end of your first month - if you did a good job setting your budget in the first place.
Now that you have a budget, it's time to start structuring your savings for maximum effect. That will be the next topic I cover in an upcoming post.