Whether you're flush with cash or not, making a budget and sticking to it is an important tool to your financial security.
Making a personal budget to track where your money goes can save you money in the short and long term, and in these uncertain economic times, creating a budget will tell you exactly where you should trim the financial fat. While creating a budget is a major undertaking in itself, sticking to a budget is another matter altogether--one that requires varying levels of difficulty according to each person. The key is to be objective in your analysis of how you spend money and to be realistic in terms of creating a budget you can stick to.
Financial Planning Software
Commercial software, such as Quicken Intuit, can be a very useful tool in budget planning. Sticking to a budget has never been easier, at least in theory. Budget software can track your income and expenses and does so while placing a premium on ease of use and easy to understand breakdowns of where your money is going.
In the past, the major criticism of such programs was that they focused primarily on checks and credit expenses, but lacked the ability to track cash outlays. The program could tell you that you withdrew $200 from your bank account, but couldn't tell you exactly how you spent that cash. However, the recent versions of these software programs have improved and now feature applications that can track such cash outlays so that you can determine exactly how your money is being spent.
There are also free spreadsheets you can find on the internet that can help you track your money. While they lack the sophistication of commercial software programs, they can be a useful starting point for those who are just beginning to track their spending.
The Old Fashioned Way
While computer software can be enormously useful to enable sticking to a budget, it's not absolutely necessary, and in fact many people prefer to do a budget with pencil and paper so that they can see the entire picture right in front of them. If you're one of these people, you'll need to do more work in keeping your records organized, but if you do so, you'll be fine once you get going.
Whether you decide to use a software program or pencil and paper, you'll need to gather your records and make a comprehensive effort so that you don't forget any income or expenses, and any potential future change to either.
The Essentials
The basics of making a budget are simple. You need to:
This sounds easy, but getting over the mental hurdle of starting a budget and the initial energy it takes to track your money is the hardest part. Once you accept that there are absolutely no disadvantages to creating a budget and doing so will make your financial life easier to manage, maintaining your records becomes second nature.
Total Your Income
Take stock of every source of income that you have. If you have a regular paycheck, tally up your monthly take home pay. If you are self employed, be sure to include any income you generate as well as any outside sources of income. A few examples of extra income include:
If the income is not regular, note the average of that income over a 12 month period. The goal here is to come up with an average monthly income.
Gather Your Records
After you've taken stock of your income, you'll have to spend a significant amount of time and energy into tracking your expenses. You should begin by tracking regular expenses such as mortgage payments, student loans, utilities, car payments, insurance, child support, and any other obligation that you pay each month. These are considered fixed payments, and most likely will not change much over the long term.
The next step is to track your variable expenses for about two months. Variable expenses include groceries, dry cleaning, entertainment, dining, clothing, gasoline, and similar items. You can do a shorter period if you prefer, but to be comprehensive, you'll want to track your expenditures for a longer time to get a better sense of how unexpected or irregular expenses affect your budget.
Whether you use a software program or paper and pencil, you will want to carry a budget sheet to write down your expenses during your evaluation period. You can make a weekly calendar (you'll simply make several of these and swap them out at the end of the week) and jot down every time you spend money. If you withdraw money from the ATM, note it and then be sure to write down exactly where you spend that cash.
Making A Budget
After you've tallied up your total income and total expenses (this process will take you at least one month), you will immediately see whether your expenses outstrip your income and you can begin to make decisions on where to trim the fat.
Your budget isn't a static document--you'll want to project the budget for the next year and then compare your projections to the actual income and expenses. If you have a software program, the software will do this for you and will automatically assign outgoing money to specific types of expenses. For example, if you spend $15 on a hat, the software will assign the value to "clothing" and you'll be able to see how much you're spending on clothes.
If you choose to use pencil and paper, you'll have to write it down on your budget for the month. You'll need 12 sheets of paper, one for each month, and you'll need to be fastidious about keeping track and monitoring changes each month. You'll want to mark down not only how much you're spending, but what types of expenses they are. Each monthly budget sheet should contain your income for the month and fixed expenses at the top and include a list of categories of variable expenses.
Examples of major categories of expenses include:
Within these major headings, you'll have sub-headings and sub-categories. For example, under "Home" you'll include home related expenses such as utilities, cable, rent, telephone, supplies. Under "Food" you'll include groceries, dining out, and snacks. This is not an exhaustive list, so you should modify, add, or delete categories so that they better reflect your circumstances.
The obvious goal here is to make sure that your income is higher than your expenses. But what a budget does is allow you to see exactly where your money is going, so that you can make adjustments and cut down on unnecessary expenses. You'll also know whether you can afford a particular purchase or how much you'll need to save (and where you can cut down) to buy it. Even without a budget you probably know you spend too much on clothing and don't need to buy that $15 hat, but if you have the actual numbers in front of you or in your head, you'll be less likely to buy it.
The amount of difference you want between your income and expenses is a personal choice, but financial experts say you should save at least 10% of your income so you have a healthy cushion in the event of financial trouble.
Sticking to a Budget
Making your budget is time consuming and you may feel as though you're done, but you still have to remain faithful to your budget or your effort will be for nothing. Think of your budget like a diet. You want to stay on it, but if you splurge on one day or in one area it's alright, you'll just have to make up for it in another area.
Your budget is simply a guideline for your fiscal behavior. Go too far off the path, and you'll be in the financial weeds. A budget should give you a sense of where you are financially and what you can afford. Just remember how much time you spent in calculating the budget and how objective you were when you created it. Trust yourself--that you knew what you were doing when you made the budget--and you'll be better off for it.
