To start off February’s topic of budgeting, I thought I would spend a little time going over some of the questions that I have gotten over the years about budgeting. At the end of the article are some additional references on how to do a budget and common budgeting myths on my website.
What is a budget?
A budget is a best guess estimate of your income and expenses for the year. A budget lets you understand how to get the most out of your money and helps you solve future problems. Many people do not know when they are about to get into financial trouble until it is too late because they do not have a financial plan to know where they are now. A budget maps out where the money is coming from and going to so that it can be used an indicator when trouble first appears (e.g., an unexpected expense or a decline in income). With a budget, a person better understands how an unexpected event will affect his finances and has a blueprint on what can be done when problems do occur. People think of a budget as a spending plan, yet it is actually a prosperity plan because it helps you plan for a prosperous future.
How do I set up a budget?
This is probably the most common question asked. The basics of a budget are relatively simple and can be done in several different ways. Many people delay doing a budget thinking that they do not know how to do it correctly. Yet, waiting is the worst course of action. A budget is never going to be perfect (just your best estimate of your income and expenses), so do not worry if it is not perfect. A budget is about being empowered over your finances and serves as process to get there. So take the first step and do not let needing to a budget perfectly get in the way. The best thing about a budget is that you can update it along the way.
Is a budget for a month or for a year?
I suggest doing it for the year initially because there are expenses that only happen once or twice a year like insurance premiums and holiday gifts. Other expenses are larger in certain months (like electricity for air conditioning in the summer and natural gas or heating oil in the winter). Thus, factor these expenses in for the whole year, so you can save up for these costs through out the year. This way your January paycheck is not going all to utilities and credit card bills without any money saved for groceries. After creating the budget for the year, you can break it down by month so you know how much you should be spending versus savings to have enough saved for the months when larger expenses occur (such as for January’s utilities, property taxes and credit card bills).
What about those who say that a budget is not needed?
Some people say do not worry about creating a budget because a budget is never accurate due to unexpected expenses and because people hate doing it anyway. Using this logic, I guess I can ignore cleaning my house and eating my vegetables. There are things that we do not like to do, yet are important. So, if you are tired of having money problems and stress around money, the budget process can be very enlightening on where your money is going.
Should I save automatically first and then spend the rest?
I know that many people love this philosophy and it has worked for some. In my opinion, the premise is based on the belief that people can not control what they spend their money on. Thus, this method says to put money automatically into a special account that you do not touch unless there is an emergency. I personally do not like this because it keeps people powerless over their money by saying they will never be able to control their spending so do not worry about it by saving automatically. Saving automatically is good when you are in control of your spending by setting up a budget to know how you are spending the rest of your money. Otherwise, you may find yourself duct taping your broken furniture or car bumper to make them last until your next paycheck comes in because you did not plan on having a maintenance fund available for the times when the rest of your paycheck has already been spent for the month.
I never had a budget and never got into trouble, so do I need a budget?
A budget is about becoming more aware of what you are doing with your money. If you have never gotten into trouble before, you may already be aware of your income versus expenses. Yet, if you want to get a little bit more out of what you are spending, looking at where you are spending your money may give you some clues. It is like wanting desert, yet giving it up because you do not want to gain weight. If you look at your diet (eat habits), you may be able to trim some fat from the meat you are eating to be able to indulge in an occasional desert. Looking at your budget (spending habits) may show you places where you can save some money to have that vacation that you have not been able to take due to not having enough money. You may never have been in trouble by not having a budget, yet you may not have maximized what you could have had either.
What if my income or expense fluctuates?
A budget is your best estimate of what may happen. If your income varies year to year, you may want to be a little conservative just in case there is an economic slow down which causes your income is less than normal. The budget process is not perfect yet more of an initial blueprint for your money plans. When you do a budget, you understand where you can cut back if your income is short of expectations or your expenses increase for unexpected items like medical emergency because you have your spending process though out and on paper. Things will never work out exactly. Yet, if you do not know where your money is going, you do not know how to adjust it when you need to. The worst thing to do in an emergency is to panic (rush to create a budget or search to find money to pay bills) because the stress will distract you from where you want to go. Thus, it is better to have your financial map (budget) already created so that you just need to refer back to it in times of emergencies to see where you need to go.
What if I am not good with numbers?
With computers these days, you really do not need to be good with numbers. This is just a resistance to taking control of your budget.
Will a budget give me more money?
No, it will make you feel more empowered over what you spend. And, you may spend less when you are aware of your spending decisions letting you keep more of the money that you already have.
What happens if I cut back all I can and a medical emergency comes up thus the budget goes out the window because there is nothing left to cut?
A budget still can be very useful in this situation because it is a negotiating point with creditors and medical offices. If you show them that you are doing everything that you can to control your spending, you may be able to work out a repayment plan of some kind. Yet, if you do not have a budget, there is no way for them to know if you have extra money to repaying them. Thus, they will expect you to work out repaying them on time on your own. This is no guarantee that they will work with you. However, those that are willing to help their clients will see that you have taken the first step towards working to pay them back which goes a long way in their decision to help you.
What if I do not have the time due to working too much?
A budget only takes a few hours a month to set up and monitor. Taking a few hours may be able to free up money so you do not have to work as much overtime. So make money work for you instead of you always working for money.
What happens if too many things happen that are unexpected where I can not plan where my money goes?
Part of the issue is that not planning for semi-reoccurring items such as maintenance and repairs will cause people to scramble to find money. Your appliances and car will break down, so plan on it. If you have a budget that is so tight that there is nothing left for a maintenance fund, you will constantly be wondering how you can get enough money which distracts you from working (either overtime or for a promotion) to get extra money. The time to plan is when you are doing a budget to make sure your fixed expenses (such as mortgage, utilities – e.g. cell phones, car payments, etc.) do not get too large that you have nothing left for anything else.
Do I need to track everything to the penny?
The tighter your budget is the more likely you will need to do this because there is no room for error. I have set my budget up to have some flexibility because I do not like spending extra time to track things that accurately. However, I am also aware of what I spend my money on. I know if I got out for dinner once month and spend $50 or so per dinner, my eating out fund is about $600. If I am of $20 or so, it is no big deal because I have some flexibility in the budget and I am probably $15 to $25 of somewhere else that help even things out. If I am $200 off, that is a different story which I need to be aware of so that I can adjust for it.
Can tracking you spending in a notebook be beneficial?
People say that you will be amazed when you see how much you spend on the morning coffee by writing it down in a notebook. Yet, there are other methods to become more aware of my spending that have worked better for me. For example, if I get a cup of coffee 3 times a week for $5, it is $750 a year (50 weeks factoring 2 weeks for vacation X 3 X $5 = $750). If I am mindful of what I spent, I could determine this relatively easily without a notebook. For me, I found thinking about my spending (instead of writing it down) helped me start the process of becoming aware of what I am doing in the moment making me better able to catch myself in the act of spending to ensure it is more thoughtful spending rather than impulsive spending. While tracking my spending in a notebook would not work for me because I would go crazy doing it, my wife tracks her spending with a notebook because she is more detailed oriented than I am. Either method can work. Personally, I find my method allows me see the bigger picture easier instead of being bogged down in details so that I can have an easier time adjusting my budget for when things do not go as planned.
For other articles on budgeting see