I'm several months into this personal finance and career advice blog. I've talked about emergency savings, spending during COVID-19, and alluded to having a budget in several other posts. Yet, I've neglected to actually talk about a personal finance budget! Shame on me. Well, let's change that. I'm going to dedicate this week's post to creating and maintaining your budget. But, honestly, you need more. A budget is really just a tool to manage your spending against income to ensure you are living within your means. To have a complete picture of your financial health, you also need a long-term financial plan to make sure you are on track for your future plans! This week, I will cover some of the essentials for a solid budget. Next week, I will help identify how to build a sound financial plan. Last, I will show you how to put the budget and financial plan to work to help you achieve your financial and life goals!
Someone was gnawing that pencil pretty good before this photo shoot.
Where To Start?
The hardest part about doing a personal finance budget is getting started. Many don't do this simply because it seems like a daunting task, or perhaps even fear what they will find out! Unfortunately, putting our heads in the sand does not make money trouble go away. In fact, it often exacerbates the problems (e.g. compounding interest) and makes it harder to deal with when we inevitably have to fix it. Your first task is capturing your income and your expenses as they exist today, which will give perspective on what, if any, changes you need to make in your life.
Income
So let's get into what you'll need before preparing a budget. First, let's start with the fun part - income! For a personal budget, I only count what's actually going into your bank account. Any retirement savings, like a 401(k), should be excluded as they shouldn't factor into your income as you're working. Taxes, health insurance, or other deductions should also be accounted for; if they are not deducted from your paycheck, make sure to count them towards your expenses.
Should you count any at-risk pay, like bonuses/commission/overtime? I would exclude these from a budget and plan to live off of your baseline pay. If your pay is 100% at-risk (commission-only sales, own a small business, etc.), you should set the income in your budget very conservatively. Perhaps use your worst monthly income from the previous year as a baseline, or perhaps only count a percentage of total income as certain for budgeting purposes.
Expenses
In my research preparing for this blog, I've seen several of ways to break down expenses. Many require you to track your spending down to the nth degree. How much do you spend on Diet Dr. Pepper per week? Really? I'm convinced so many people are too intimidated to start a budget - let alone maintain one - because of the micro-managed approach. Who wants to consume hours of their lives with tracking minuscule costs. Instead, I think there's a much easier way to budget!
The way I do my budget is focusing on the big picture - large buckets vs. dozens of line items to update. If you can get these buckets relatively close, it becomes so much easier to create and update as time goes on. Here are main categories I use:
House
If you own a home, this would be your basic expenses like mortgage, insurance,
taxes, HOA dues, etc. You could also roll utilities into this cost, or track separately, up
to you. If you rent, it would just be your rent plus any utilities you're responsible for.
Child Expenses
If you have young children, you know what a large expense childcare can be!
Then, throw in dance lessons, sports, etc. and you're spending a substantial amount of
money on your offspring! I keep this as a separate line item to track as costs can vary
over time.
Credit/Debit/ATM
This may seem really generic, but it works for me! Because we have rewards credit
cards, I aggregate our "other" spending into a single category. This captures our food
costs (dining out and groceries), car expenses (gas, oil changes, repairs, etc.) any
entertainment expenses (streaming services, date nights, vacations, etc.), and any
other expenditures you may have along the way. To come up with a budget number, I
use a rolling 12-month average of our credit card statements (and add about 10% to
be safe). Now, if you choose this method, you have to watch your total expenditures
closely and be able to drill down to specific expenses if you get off course. You should
also have a good emergency fund built up to pad against any fluctuations.
Emergency Fund
If you don't have an emergency fund yet, add an expense for building that up. Most
people advise 3-6 month's worth of expenses, but this varies greatly on your lifestyle,
family size, etc. Personally, my wife and I have saved enough to have at least a year's
worth of expenses readily available (i.e. not in a retirement account) in case we have a
major medical expense or a job loss.
If you have any other categories where you have expenses not captured in the above buckets, make sure to count those. Now, this isn't to say you can't break these expenses out into greater detail! If you want to track your entertainment expenses as a separate line item, go for it! The key is making this a realistic reflection of expenses that you can easily track over time.
Frequency
Is a budget a one-time effort? Absolutely not. A budget needs to be monitored and updated over time. Expenses and income change, and even seemingly minor changes add up. So how often should you be tracking your balances?
In my humble opinion, at least monthly. This will ensure you are seeing monthly credit card statements, mortgage balances, etc. If you use a method similar to what I proposed above, it should only take a few minutes to update.
Crunching The Numbers
So you have your income and your expenses, now it's time to put them together. I highly recommend using a spreadsheet to do this - not only will you be able to track the numbers more easily as time goes on, but you can set up formulas to calculate everything for you! Make sure you label these properly so you know what everything is going forward.
Now, how do you get the numbers? Well, hopefully you're utilizing online resources for banking, credit cards, and other sources to track spending and income. With these numbers in hand, you can populate a spreadsheet accordingly. Below would be an example of a basic budget using the categories mentioned above:
How about that emergency fund contribution?!?!? Great work, you two!
In the example above, you'll notice a pretty solid balance left over each month. Should John and Sally spend it on high-end peanut butter whiskey (yes, this is a thing)? No, of course not. Having a little left over each month is how you build wealth.
Next week, I'll get into what to do with this extra money. In the meantime, put your budget together. Hopefully, you're flush with extra money. If not, feel free to reach out in the Ask Me! section and I will be glad to provide some advice - free of charge. Just remember, personal finance is a Journey. Don't stop... believin'!
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