You probably know that you need a budget in order to help you reach your financial goals.
For many people “budget” is a six-letter dirty word, but it doesn’t have to be. You probably know that you need a budget to help you reach your financial goals, but many people don’t know where to start to create an effective budget. A budget is one of the most critical financial tools for anyone. Everyone can benefit from having a defined budget, no matter the age or income.
According to a 2013 Gallup report, only one in three people creates an extensive budget (and less actually stick to it), which means that two-thirds of all Americans have no idea where their money is going. Not keeping track of your money is one of the most dangerous financial mistakes you can make.
Some sort of plan for your money can help you keep on track — and help you avoid the pitfalls related to spending more than you earn. So why is everyone not using a budget? However, creating a budget can be a bit of a challenge, but it’s easier than most people think.
1. Know what you have right now
The first step in creating a budget is understanding where you’re at right now. Look at all of your banking accounts, credit cards, debts, buried jars of money in the backyard, and any sources of income. You should also spend at least one month tracking all of your spending and see where you money is going. You can get a better idea of larger trends, though, if you follow your money for two or three months. You can use a ledger or notebook to record income and expenses, but it might be easier if you use personal finance software, or sign up for a free budget application. Assign each expense to a category. Be sure to track the cash you spend, as well as purchases made with debit and credit cards.
If you have a smartphone (and who doesn’t?) tracking your spending has never been easier. Apps like Mint and Personal Capital make budgeting as easy as looking at your phone. The apps will connect with your bank accounts and credit cards and automatically separate your spending into different categories. They will display your spending habits in and easy to read graphs.
2. Review Your Spending and Income
After you have taken the time to track your income and your expenses, it’s time to review how your money is moving through your bank account. Look at the categories where you are spending the most, you might be surprised to see where a lot of your money is going. Recognize that you might be spending more than you earn each month, don’t worry if you are, it’s a common problem. This will identify areas of concern before you make your budget, as well as help you realistically allocate where your money should go each month. If you are spending more than you earn, a review will help you see where you need to cut back as you make a budget and will get you back in the black.
Many people are surprised to see how much money they are spending in certain areas. Just knowing how much your spending in certain areas can have a huge impact on your finances and give you the ability to rein in some overspending habits you might not have known about. Paul Moyer, founder of Savingfreak.com one of the leading resources on money saving techniques says, “The two most common areas of overspending are food and entertainment like going to the movies.”
3. Identify Your Needs and Financial Goals
Next, you need to determine what your needs are. These are items that you can’t live without (a new TV doesn’t fall into the “needs” category). You should make sure that your budget first covers items like food, shelter and clothing, as well as transportation to work. Also, recognize your obligations and bills. Make sure debt payments are made, as well as utility payments and other important obligations.
You should also designate some financial goals. If you want to build your emergency fund or save more for retirement, it is important that you incorporate these things into your budget. Each person will have a different set of financial goals depending on their financial situation and their desires. Figure out what you want to do with your money so that you can incorporate these items into your plan. Your will be more likely to stick with a budget that helps you reach your financial goals.
4. Start from the top
When creating a budget, it becomes obvious that you need to make choices. Before you budget in for wants like entertainment, you need to make sure that needs and financial goals are covered. List all of your needs and wants in order of importance. Your food, clothing, gas money, etc. will all be at the top, and things like buying a pool will be at the bottom. It is also important to be realistic about what “needs” are. Yes, you need food. However, what you need are healthy foods. Junk food is not a need. Getting takeout twice a week is not a need. You can reduce your grocery bill by planning healthy meals and cooking at home. There are a number of other “needs” that are actually wants. Be honest about where your money is going, and be realistic about your adjustments. It is not always fun to do this, but it is necessary.
Some financial experts say that you waste as much as 15% of your income each month (did you really need to buy a cup of coffee every morning?). The money is probably there, and a budget can help you put it to better use, providing you with a solid foundation for a better financial future.
5. Make Changes
The good news is, you’ve created a budget. The bad news is, it’s probably going to be wrong. More than likely you have overestimated in some spending areas and underestimated in other areas, but don’t worry, the longer you stick with the budget, the better you will become and guessing how much you’ll spend in all the categories.
After you have created your budget, it’s should not be set in stone. Think of your budget as a fluid, living creature. Every month of your life is not identical; each month will bring different financial needs and wants. Some months you may have to budget for new tires or to replace an appliance. You should continue to review and adapt your budget as your life changes.
6. Go Automatic
If you have trouble saving money, the best way to ensure that you stick to your saving category on your budget is to make your saving automatic. With just about every bank account you can create an electronic money transfer that will take money from one account to add to a savings account. This is an excellent way to prevent you from spending the money that you should be saving.
You can schedule these transfers to happen at any time, but it’s best to do shortly after your regular paycheck will be deposited. The sooner your money is put into savings, the less likely you are to spend it on a non-budgeted item. If you never see the money, you can’t spend it.
7. Stick with it (and what to do if you’re not)
Don’t create your budget and then forget it. Creating a budget is important, but using it is more important. Put your budget in a place that you will see it every day. Print it out and tape it to the fridge or your front door. You don’t have to review it every day, but knowing it’s there is important.
It isn’t always going to be easy to stick to your budget, but it can have excellent rewards. If you become frustrated with sticking to your budget or begin to feel deprived of enjoying certain things, remind yourself of the financial goals you’ve set. If you’re saving for a new car, put a picture of the care to encourage you to stick with the budget.
If you’re having problems sticking to your spending limits, it’s time to start “cash envelopes” With the cash envelope system, all you’ll need is several large envelopes to put money in. Designate each envelope as a different expense, i.e. a gas envelope, groceries envelope, entertainment envelope, etc. the money that you put in each envelope is the allotted amount you are allowed to spend on that category for the month. Once the money is gone, you have nothing left to spend in that category. Cash envelopes are one the best ways to live within your budget. Moyer states that “any area that you continually overspend should be switched to cash envelopes.”
8. Build an emergency fund
One of the most common problems people face when making a budget is not having an emergency fund built in. Because you can’t see into the future, it’s impossible to budget for all of your expenses every month. You never know when a pipe is going to bust, your car will need repairs or a heater will go out. Having an emergency fund can provide the extra cash needed to cover any unexpected costs that could arise.
Without having money saved for emergencies, any unexpected expenses can completely derail any good budget. Many financial experts agree that an emergency fund should be around $1,000 to account for any financial surprises. Having a separate account for your emergency fund will help prevent you from spending it on accident (or on purpose).
9. Don’t forget annual or semi-annuals
Budgeting for reoccurring expenses is easy. Things like power bills, gas money, and water bills are hard to forget, you pay them every month, but don’t forget about those expenses that only come around once or twice every year. These expenses could be car insurance payments, health insurance, any membership fees, or much more. If you have anything like this, build these costs into your budget but divide them into monthly payments on your budget. If you pay your car insurance bi-annually, then divide that number by six and start saving for it every month.
10. Learn the power of No
Being on a budget means you will have to say no to a lot of things. You may have to say no to your favorite type of junk food at the store, going to the movies, or going out to lunch with your coworkers. Being disciplined and learning to say no to some of your wants is one of the most important budgeting skills. Having a budget is great, but it’s useless unless you stick to it. This is where many Americans struggle to follow their budget.
11. Allow some fun money
Who said budgets can’t be any fun? Make sure that you include a few bucks at the end of your budget as “blow money” or “fun money”. This is a just a small portion of your income that you can use for anything you like. Having the extra spending money makes sticking to a budget a little easier. Learn to treat yourself from time to time with this extra money (but don’t spend more money than you’ve budgeted).
Budgeting – it isn’t all bad
When people think about living on a budget, they think they will no longer be able to enjoy the things they love, but that’s not true. It does not have to be the end of doing fun thinks like taking vacations or going out on the weekends. You can adhere to a budget and still do all of your favorite things, as long as they’re in the budget.