The very first thing I learned about long term financial planning was that I needed a budget. Now don’t freak out on me just yet. A budget isn’t an instrument of torture, I promise.
Provided you are honest about how you spend your money, a budget becomes a powerful planning tool. It not only diagnoses your current financial health, it tells you how close (or far) you are to reaching your goals, be they early retirement, funding your child’s education, or just a relaxing vacation next summer.
I created a budget using the following steps:
1. Track your expenses. I recommend doing this for at least 30 days, but the longer you do it the better your budget will be. The idea is to come up with a spending plan that works with your actual lifestyle, not some idealized lifestyle. To figure out your actual spending habits, it’s important to track them for a period of time before you sit down and develop a budget. Write/type/dictate any and everything that involves money. Bill payments, loan payments, credit card payment, and your regular every day expenditures.
2. Categorize your spending. At the end of 30 days (or however long you decide to track spending), come up with some categories. These can be very broad or very specific, but should encompass everything on which you spent money. Some examples of categories are: housing, food, auto, insurance, debt, entertainment, clothing, savings, medical, etc. Place all your expenses into the appropriate categories and add them up.
Ok. Deep Breath. Here comes some complex math!
3. Figure Out Income – Expenses.Write down your total income per month (if you have a variable income, estimate what you make in a year and divide by 12) or per pay period. Subtract taxes. Write down the after tax amount. Write down your categories and what you spent in each of them. Then, subtract all you spend from your after tax income. If the final number is $0 or positive (for instance, you made $1000 and spent $999), then you’re doing pretty good. If the number is negative (for instance, you made $1000 and spent $1500), perhaps you would be interested in the following steps.
4. Calculate percentages. For each category, divide how much you spent by your after tax income. For instance, say you make $1000 after taxes, and you spend $70 of that on groceries. 70/1000=.07, or 7%. Write down the percentage next to each category.
5. Compare Your Spending To Recommended Averages. On this website, scroll down and click on the percentage guide that fits your situation. Compare their recommendations with how much you actually spend in each category.
6. Make some decisions. Are some of your percentages higher or lower than the recommendations? Maybe you could adjust these categories. Again, the budget needs to work within your lifestyle, it has to be practical for you. But, it also should come out close to $0 at the end of the month, or you’ll continue to go into debt. Adjust the categories accordingly, but base these adjustments on what you value and think you can live with.
7. Create a budget. Set spending limits in each category. Continue tracking what you spend, so that you can make sure you are sticking with the budget.
8. Realize a good budget takes time to develop. It does! It took about 4 months before my budget settled into what it is today, and I still adjust it every so often. Don’t get discouraged if you can’t stick to some of your spending limits at first. In fact, you most likely won’t for the first 3 months. The important thing is to continue tracking what you spend money on, and adjust your budget accordingly until you come up with something that works.
