Before your eyes glaze over at the thought of doing a budget, let me share with you the magic that can happen with your finances when you actually sit down to look at your money situation and plan your spending.
A budget brings awareness and confidence to your financial life. When you’re aware of what your made of, financial speaking, you can take your finances by the reigns and begin to make positive changes.
A budget also helps you live the life you want by allowing you to funnel your spending into areas that will bring the most joy to you. A budget doesn’t limit you, it simply prioritizes your spending into the things that matter.
When you think of a budget in these terms, it can actually be very empowering.
Budgets come in all shapes and sizes, but the basics are the same: pick a time period and list your expected income and your expected expenses.
Then compare the two numbers. Hopefully the difference is not a negative one.
Calculating Your Income
Let’s first calculate our income. For purposes of a budget, income is basically any expected inflow of money into your life.
To estimate your total income, write down all of your income sources for the current time period (let’s use a month throughout this example).
Examples of income include earnings from a job or a business, a stipend, alimony and child support, and gifts.
If your job income fluctuates, review your last six months’ worth of pay stubs. Throw out the highest month, total the remaining five, and divide by five to get your average.
Use that number going forward in your budget. If you’re just starting with a new job, take your expected annual salary, reduce it by 20% (for taxes) and divide by twelve.
If you’re a commissioned based employee, ask more experience coworkers what to expect, and use the most conservative income you can handle in your budget. But don’t forget to also have a plan if that extra money does come in.
When in doubt, underestimate your income. Don’t fret too much on getting this absolutely right the first month.
The beauty of a budget is that it can be adjusted from month to month based on actual results and your changing life situation.
In fact, if you drop these numbers into the Mint budgeting tool, you’ll have an easier time with this because you can automatically import your checking account data.
Deciding on Expenses
Now that we’ve got our income down, it’s time to decide how we’re going to spend that money. Let’s make another list.
This time we’re going to list out all of the expected outflows. Examples include savings, charity, taxes (if you didn’t take this from income already), living expenses, and, of course, fun money.
A good rule of thumb to use here is to budget 10% to 20% of your income to savings (pay yourself first!), another 10% to charity, and then fill in your standard monthly bills – like rent/mortgage, utilities, loan payments, insurance, and other services you must use each month.
Finally, list out all of your optional expenses – like dining out, entertainment, and travel.
To find good estimates for each of your spending categories, review your prior spending. Again, using a service like Mint can be very practical here, as you’ll be able to import your previous months’ data. When in doubt, overestimate your expenses.
Positive or Negative?
Now for the big reveal. Compare your total expected income and total expected expenses.
If you find that your total expenses exceed your income, then you’ll obviously need to reduce some of your expenses to make it to the end of the month.
Start with the items you have the most control over, but don’t be afraid to hack away at larger items.
If you find that you have extra money in your budget, then allocate it to whichever spending category you like.
Want to save more? Increase your saving percentage. Want to travel more? Increase that category. The beauty of the budget is that it helps you decide how you want to live your life.
Be sure to review your budget against actual numbers at the end of the month to see how you did.
You’ll find that you spent more in some places and not as much as you thought you would in others. Make the proper adjustments for next month and move on.
Sticking to It
Sticking to a budget is hard. Some people love crunching the data from month to month, but frankly, some people will never want to do this.
Online tools like Mint certainly help to make the process easier for you, but it’s still a tedious process to categorize last month’s items and make projections for the next month.
If you find it hard to stick with it each month, switch to a quarterly or bi-annual review.
What I’ve found to be of utmost importance throughout the years is just to make sure that I automatically take care of the important things in our budget first.
For me, saving and giving are the top priority. We make sure we automatically save and give as soon as our income hits our checking account.
What happens with the rest of our budget isn’t as important, as long as we’re spending within our means (i.e. not going into debt to support our spending).
So take some time to determine what the important things are in your life. Then create the budget to help you spend your money on those things.