People are constantly harping on the importance of a budget. A simple google search can produce hundreds if not thousands of different versions. Some are simple and easy to use, while others do advanced calculations to track your net worth. The bottom line is that a budget is critical to reaching our financial goals
for most of us.
To effectively reach your goals, you must be able to account for your money. How much is coming in, and how much is going out. Only by knowing that can you begin to take steps to reach your dreams. What’s excellent about budgets is they’re for every income level, and it doesn’t matter what your goals are. Maybe you’re saving for a car, a house, a child’s college fund, or just for retirement. A comprehensive budget can be simple but always a handy tool.
With gas prices setting record highs and inflation running rampant, everyone is experiencing higher costs in their daily lives. This likely means your savings four months ago have decreased, and you must account for those significant changes. Too many people over the years have told me they don’t know where the money goes each month or each year and don’t understand how they have so much debt. During these times of higher costs, there isn’t a better time to either update your budget or get one started. In the below steps, I will walk you through establishing your monthly budget.
Step one: Identify all income for you and your household. This is typically easy as you can pull it from your paystub or the amount directly deposited into your account. If you work in the service industry, I recommend taking an average of your tips each week or month and using that amount, but remember your pay can fluctuate at times. This will be important when we look at expenses and money left over. If you have a side hustle, such as babysitting or working as a handyman, I would also average this income. If your hustle income is not consistent, it may be best to leave it off the budget for now.
Step Two, Part A: This part can be a little more complicated depending on your lifestyle and the depth of your expenses. In this step, you want to calculate all your reoccurring expenses throughout the month. This includes things like mortgages, rent, car payments, cell phone, cable/internet, and insurance. Many missed costs include streaming services, XM radio, child support, and student loan payments. Most of these expenses are fixed and will not change from month to month. A good starting point is to view your bank account and credit card statements to see what costs you have.
Step Two, Part B: We then move into variable expenses. These expenses can include groceries, gas, and utilities. Money spent on food can fluctuate each week depending on what you’re buying. Still, I recommend taking a weekly average to determine an overall monthly expense. Don’t include eating out in this section as well cover that in Part C. While gas prices are through the roof currently, you should be able to estimate your monthly gas costs based on your driving habits. Utilities can vary by month, especially where you’re located and what season you’re in. For this budget, you can take an average for the year or go back later and update your monthly utility costs based on the season. Your internet costs will be fixed for many, but water, gas, and electricity will fluctuate. Again, take an average for a starting point.
Step Two, Part C: In this part, I want you to list out your miscellaneous expenses or discretionary expenses. Do you grab a Starbucks coffee on your way to work every Friday? Do you have date night every other week or a girl’s night once a month? Take a hard look throughout a typical month and see what expenses you make and account for those. I always feel it’s better to overestimate an expense than underestimate when budgeting. This section tends to be a little less exact, but the goal is to account for 99.9% of your monthly expenses.
A good tip for tracking expenses is to pull bank statements, debit card transactions, and credit card statements. Looking at these will give you a great starting point to identify all your expenses. You may even find out you’re paying for something you didn’t know, like an Amazon music subscription.
Step Three: Now that we’ve listed out all our incomes and expenses, we can now start to look at the numbers hard. What’s good about breaking out all the costs is seeing how much one specific expense fits with the rest. Does that car payment makeup 50% of your costs, or maybe it’s your house. Many lenders have different standards regarding the ideal mortgage to income ratio. Still, I recommend that your mortgage not exceed 25% of your income, and the lower, the better. You can now understand what you’re spending every month by breaking out these expenses. Some people I talk with are surprised by how much their daily coffee purchase is and how much it costs to go out with friends multiple times a week. For some, seeing the math written down makes it so much more real for them.
Step Four: Now that we see clearly what money is coming in and where it’s being spent, we can now apply the budget to our goals. At the end of each month, the goal is you’re in the “green” or that you have money left over after all your expenses. Once there’s money left over, you can begin to direct it to your goals. Moreover, by knowing exactly how much is available, you can effectively budget to increase your financial standing and get out of debt.
Going Forward: Before spending your leftover money, ensure you have a rainy-day fund. This fund is what you’ll use if your car breaks down, you have an unexpected medical bill, or you need a sudden house repair. I promise you that these unexcepted expenses will happen at some point, and you won’t know when or how much it’ll be, so you need to be ready. For some, this could be $500 right now cause that’s all you can afford, and that’s fine. You want to position yourself not to go into debt or rely on credit cards to get by. The long-term goal for most should be to save up roughly six months of expenses into a saving account which is only touched when an emergency happens. Your risk tolerance comes into play, and you may be comfortable with only three months, and others may want nine months. The overall goal is to have money set aside for unexcepted expenses or loss of income, such as getting laid off. Establishing a rainy-day fund doesn’t happen overnight but may take months or years to obtain fully, and that’s ok. Once completed, it can provide some peace of mind along your financial journey.
So your budget is complete, and all your money is accounted for. Now it’s time to give your money a purpose in line with your goals. Let’s say you have $1,000 leftover each month after your expenses. You now need to look where that money is best spent and then allocate it. For example, if you don’t have an emergency fund, you’d want to establish that first and start building that up. Then you can start looking at what debt you currently have; maybe it’s a credit card balance or a car loan. Knowing you have $1,000 leftover, you could allocate an extra $250 or $500 to the remaining balance on that credit card to pay it down sooner, especially if you’re only paying the minimum payment. This is also a great time to see what expenses you could cut or reduce, which would allow you to allocate more money to other things such as saving for retirement or saving up for a down payment on a house.
Lastly, I want to highlight the importance of not only doing a budget but also physically writing down your goals. Studies have shown that people who write down their goals are more likely to succeed in achieving them. While writing out your budget is essential, so is writing down your financial goals. As I’ve mentioned thus far, these goals can range widely from getting out of debt, buying a boat, or maybe just getting $500 into a rainy-day fund. Whatever your goal may be, get it down on paper and start working towards your goal. Just remember that to reach your financial goals, you must first know the comings and goings of your money.
Now go out there and start that budget!