I have proposed four New Year’s resolutions that are achievable and will improve your financial future. I have included strategies and tips to help you follow thru with them past your first month so they become part of your personal financial foundation for life. Now let’s discuss a tool that will make it even easier to follow thru with two of the principles: “living within your means” and “saving towards your goals by paying yourself first with auto-pay”. That all important tool is commonly called a budget, but let’s call it your “money management plan” so I don’t frighten people off before we even get started. I will show you how to make budgeting easy.
Many people shy away from budgets as too much work or from too little knowledge, so why go to all that trouble? Because a money management analysis or budget gives you the hard data you need to live within your means, identify areas for potential savings, match what you should do with what you currently do, make hard choices about how to meet priorities, find areas to economize, determine how much you should be able to save in key areas, identify “wants” and “needs”, and figure out whether you can afford that next big expense. Would you start a new trip without a map or GPS? Well a budget gives us a similar tool to help ensure our financial journey will go well, too.
How to budget
Here are the easiest steps to develop a money management plan:
- Determine how much money you have coming in and going out (called cash flow).
- Specify a goal to help control your cash flow (pay off debt, save for a new car, retire early, etc.)
- Create a spending plan to balance your money going in and out (Yes, this is the budget part, but it is vital.)
- Periodically review your spending plan and adjust where necessary. (Life happens and sometimes your budget needs to adapt to it.)
1. Determine your cash flow
First, determine your current “cash flow”, the “before” picture of where your money is currently going. Identify and list where your money is going each month. Choose the method that is easiest for you: spreadsheet, paper, or online. I like using a spreadsheet so it can do the math for me and is simple to change. A spreadsheet is just an easy to use grid of boxes so you can line up, change, and calculate categories and numbers. Your PC probably came with a spreadsheet (Microsoft Works or Excel) or there are several free ones on the web including Google Docs.
You can start a simple budget from scratch or select a free, ready-made template. You can download my simple version here.
See more choices here: http://www.budgetsaresexy.com/2009/07/free-budget-templates-sites/. Another choice is to use a financial website that offers budget applications along with other money management tools. One of the most popular is www.mint.com. Smartphone users may value the growing list of money management apps such as “Mint”, “Quicken Money Management”, CoinKeeper, or “Pageonce”. Of course, sometimes nothing beats just a blank sheet of paper, sharp pencil, and trusty calculator.
Once you have picked your tool, let’s get started. First, list and total your monthly, net income. If it varies by month, then average it (total for a year and divide by 12 months). This is the amount of money that your saving and spending must be less than to live within your means. Some people tell you to list your gross income and then make you list all your deductions, but we are doing this the easy way with the net after all deductions, since that is what you really care about. If your income is from commissions or other variable sources, then use your worst recent year’s income. Learning to live on that frees up anything above it to devote to paying debts and savings goals.
Now list and total your monthly expenses.
- Start with the easy, fixed ones: housing, car, insurance, telephone, internet, cable, student loans, etc. Include savings like college funds that are not already deducted from your paychecks such as your retirement 401(k)s.
- Calculate a monthly average for the ones that change each month like utilities, gasoline, groceries, etc.
- Turn annual and quarterly expenses into monthly averages like insurance, vacations, and subscriptions.
- End with the ones that are harder to pin down such as eating out, clothes, tunes, gadgets, entertainment, etc. Include credit card interest, but not purchases that should be totaled under appropriate categories.
Many amounts can probably come from your checking and credit cards statements, but you may need to dig out bills or hunt them down on the web. Especially, categorize credit and debit card statements, because they likely will reveal the most secrets about just where your money is disappearing every month. Don’t worry about exact numbers; rounding and estimating are fine. Do NOT have a category called “ATM withdrawals”; estimate where all that cash is going or better yet, jot down your cash spending for a week or two and then enter it in your appropriate budget category. There are even a growing number of smartphone apps that make it easy to enter and track your daily expenses as you make them, such as “Toshl” for Android and IPhone.
Download my budget spreadsheet to get started or see some categories you may consider for your own budget. There is practically no end to the list of expenses, but when you have entered yours, add them all up, and don’t faint. If you have income left over, this is the amount you can save, increase debt pay offs, and spend. If your expenses exceed your income, then you have work to do so your debt level and financial security don’t worsen.
2. Set a goal
After seeing whether you have money left over or are overspending, think about your financial goals and discuss with your partner. Set a goal of why you would like to improve your cash flow. For example, live within your means, buy a car, save for a down payment for a house, get ready for the baby, pay off credit cards, go to Hawaii, become a millionaire by age 55, etc. There is always something to pay off or save for. Focusing on your next goal helps you keep on track and develop good financial habits, security, and peace of mind.
3. Create a balanced budget
Many people think a budget may be hard to start, harder to do, and hardest to keep. People may think budgets keep us from doing something we want to do, like spend, but they may also be the best tool to enable us to do something we do want to do like one of our goals. It did take a little work to get to this stage, but now comes the payoff to budgeting.
Review your cash flow spreadsheet or paper list and be surprised about just where and how fast your money is disappearing. Don’t let get you down, but use budgeting as the best tool to ensure your financial future.
1. See how much you have left over each month or are overspending. If you are overspending or not saving enough, now you have data to see how big the problem is.
2. Calculate how much you have left over to save towards your goals. We have repeatedly discussed “saving” even when you have multiple demands on your money. Now you can use this cash flow analysis to determine how much you can save and where you can free up more money to better save.
3. Review which categories you can reduce to live within your means and boost savings and debt pay offs.
See which spending categories could be reduced the easiest. For example, think whether eating out this often is more important than whatever your stated goal is. Zero in on both the big items like insurance and the little items like your “latte spending” on many little indulgences. Spending less doesn’t necessarily mean depriving yourself; it could also mean spending more wisely. See the blog posts on “Spending Wisely” for a wealth of ideas that should make this task easier.
Now take the same spending categories in your cash flow list and assign new amounts to them. In my sample spreadsheet, complete column three “Goals”. Total and revise the spending and savings amounts until the amount of good cash flow enables you to meet your goals. Of course, there are plenty of circumstances where this is easier said than done, so keep following the Financial Guide to Life for more tips on how to better accomplish this along life’s journey.
4. Review and revise your budget
At the minimum, you should repeat this cash flow and adjustment analysis whenever your income, expenses, or goals change. However, you can get even more benefits, when you periodically review your budget to see how well you are doing and revise it where needed. Decide how often is “periodically”: monthly, quarterly, annually. In my sample budget, use the “Monthly” columns to periodically review how well you are keeping your own balanced budget. Keep it simple, so you are more likely to follow it. Focus on your goals and successes more than your failures. Reward your successes. Even when we don’t follow our budget religiously, just creating one usually is an eye-opener as to just where our money goes, and in which areas can we most easily economize.
This is an absolutely vital step towards living within your means, reducing your debts, increasing your wealth, and meeting your goals. You must know what your income, essential expenses, and savings goals are in order to know how much is left over for “wants”, debt payments, wealth building, and your goals.