How to make a budget

Posted By Paul

In several posts Matt and I talk about creating a budget but we never really explain step by step how to come up with one, so here is what I hope is a set of simple instructions for doing just that:

First we start with:

EXPENSES

Here are some standard ones and I how I deal with them in a budget:

1) Home - this one is usually easy, your monthly rent or mortgage payment (include property taxes, insurance, etc.).

2) Car - also easy, your car loan or lease payment if you have one.

3) Car Insurance - most car insurance policies give you a premium you have to pay every 3 or every 6 months. I just do the math and come up with the monthly payment.

4) Unchanging utilities - the utilities that don't change from month to month (garbage service, cable bills)

5) Subscriptions - this is where you capture things like NetFlix membership, and health club fees. Things that send you a bill every month and it's always the same amount.

6) Automated savings - if you have something set up where money automatically goes into some sort of savings account every month, include it as an expense.

This is usually where I stop with expenses, then I move on to

INCOME:

This is really just any income you have coming in. This is an easy one, for most people it's just your pay for the month (make sure it's your take home pay, don't include stuff like 401k contributions, or income taxes taken out of your paycheck here).

If your income is variable, how do you capture that? Well what I suggest you do is enter your GUARANTEED income for the month. If you have a job that is totally commission based then I suggest you consider your guaranteed income to be zero (since that's essentially the truth). Then you can capture your specific income when you track your money (see the next step).

TRACKING YOUR MONEY:

Okay, so you have your budget set up, now what? Well what I started doing was I actually used this to track my money. Why? Well you'll notice we haven't included things like going to the movies, eating out, buying a latte. We also haven't covered groceries, utilities that vary (like your electric bill), stuff like that. People have different ways of handling this, but here's what I did:

Once you have all of your monthly expenses listed and all of your monthly income listed, if you subtract the expenses from your income the number that's left is your "surplus income".

By the way, if you get to this point and your monthly expenses are MORE than your income, you may have a big problem. Look very hard at things because changes need to happen.

You may have a negative surplus because your income varies a lot (like if you have a commission based job). That just means that you have to work that much harder to make sure that money is coming in faster than it's going out, and you need to accept that or else get a job where your income is more steady.

So let's say after doing the math you discover your surplus income is $300. What I started doing was I gave myself a $300 allowance on the first of each month (I just tracked the amount of my "surplus account" on a piece of paper, but I know some people actually keep the cash in an envelope or something like that), and whenever I spent money on something that wasn't listed in my expenses I deducted the amount from my allowance.

I also did the following:

-If at the end of the month I had any extra then it rolled over to the following month (so if I had $50 left at the end of the month, I'd still get my $300 so my running total would now be $350).

-I rounded all purchases up the nearest dollar and I didn't track anything that I paid for with change. This just simplified things a lot.

-After a while I discovered that many of my utilities varied, but only a little each month (like my phone bill). Once I realized this I included the average amount as an expense in my budget and if my bill was less than the average one month I'd add the extra into my surplus and if it was more I'd subtract it.

-Money was deducted from my surplus when I BOUGHT something, even if I put it on a credit card, this made it easy for me to know that I was never using my credit cards as a way to overspend, and when my credit card bill came I paid the whole balance each month.

-Any unexpected income that came in went into my surplus income total (for me this was rare but could be things like tax refunds, or gifts of cash). For people who have incomes that vary greatly from week to week, you can just add the money as unexpected income.

Here's why this system worked for me:

1) By watching my surplus account I could be certain that money was coming in faster than it was going out.

2) I tracked my spending on a piece of paper so I could tell at a glance what I was spending my money on.

3) If my surplus account total ever got really high I knew I was allowed to splurge a little. If it started to get low, I knew it was time to tighten my belt a little. If it ever went negative then I knew I REALLY needed to scale back immediately because it meant at that moment in time I was living beyond my means.

4) Sometimes I would have money left over and so I'd transfer some money to my savings account and then subtract that amount from my surplus total.

To be honest, now that I'm older I don't track my exact spending down to the dollar like I used to, but that's because I'm a little older and have a few more extra pennies than I did 10 years ago. But when I was fresh out of school and money was SUPER tight this system really worked for me. I never overspent, and the satisfaction of having an extra $40 at the end of the month to put into savings felt great.

Also, when I wanted to buy a big ticket item (like a TV) then I saved by scaling back my spending until my surplus total was high enough that I could buy the TV. Instead of saving first and then buying it, lots of people out there put it on their credit card and then "save" for the purchase "after the fact" by paying off the card. If you are doing this, then you are throwing away money and YOU SHOULD STOP DOING THAT NOW!

I can't stress this enough. I am amazed at how many people carry balances on their credit cards so that banks can charge you tons of interest as you try to pay it off. When you pay credit card finance charges all you're doing is taking money that you could be putting towards your financial future and handing it to a credit card company.

There are lots of ways to make and hold to a budget but this is the one that worked for me. I'd be interested in hearing about systems that worked for other people. Remember that the goal of a budget is to make sure you are living within your means, so watch closely for the signs that you're overspending and deal with it before it becomes a huge problem.

If you've never gone through this exercise before, then congratulations on taking this first step, and hopefully it will really help you get your financial life under control.