Myth: Budget is a Four-Letter Word

The Word on the Street

Budgets have gotten a bad rap over the years. The word itself has become a profanity for many people. They are often considered them nuisances that restrict one’s choices, prohibit fun, and make life miserable in general.

The Truth

The truth of budgeting is that a budget is not restrictive in nature, and if you find that your budget is too restrictive, then it is not a good budget and needs to be adjusted.A budget is a tool that people use in order to help analyze where their money comes from and (perhaps more importantly) where it’s going, so that they can reach their financial goals.

Doubt me? Try it. Just follow these easy steps and advice in order to unlock the true power or a budget.

Estimate Your Income

As far as estimating your monthly income, it is generally best to estimate low. That way, you probably will end up having more than you expected (kind of like finding a cool ten bucks in your pants pocket!).

Dust off your old pay stubs (or check them online if possible) and determine your average paycheck size. Then make your estimate a little bit lower than that. Be careful not to estimate too low, or your budget will start feeling like a vice. Be careful not to estimate too high, or you will find it impossible to maintain your budget.

Pay Yourself First

Many financial experts endorse the “pay yourself first” method of saving. Basically, this method is just what it sounds like: put money into savings before you pay for anything else. By far, the easiest way to do this is to establish an automatic deposit from your paycheck. I recommend setting your savings into a separate account from your traditional checking/savings account at your bank. Put it somewhere where you will not see it often, and thus will not be tempted to spend it. Plus, if you can earn a higher interest rate on your money, then why not? The E-trade Complete Savings account is a good example of such a vehicle.

So how much do you save each paycheck? Remember how we said that a budget is a tool to help you manage where your money goes so that you can reach your financial goals?

Well, it stands to reason that you can only reach a goal that exists. This is why it is so important to think about where you want to be financially.

You need to set aside enough money each paycheck to enable you to reach the goal you have set. You can use a financial calculator to find out how much to save, or you can consult with a financial planner, accountant, etc. Don’t worry at this point about whether you can actually save that much each month; that is a question that will be answered by your budget later.

Budget for Fixed Expenses

Fixed expenses don’t change from month to month, like rent, mortgage, or car payments. Since these are constant and must be paid, they should have priority over other things. These are pretty easy to budget for since they are constant.

Budget for Critical Variable Expenses

Once your fixed expenses are subtracted from your monthly income, you should have an idea of how much money you have for all other expenses. Variable expenses can, well, vary from month to month, but can often be somewhat consistent.

Budget in order of most consistent (like utilities), then most important (like groceries), then to the ones you have the most control over (such as dining and entertainment spending). Use your bank statement to get an idea of how much you typically spend each month on your various categories.

Speaking of categories, you can have as many or as few categories as you like. If you want to lump all your utilities into one group, go for it. If you prefer to track water separate from electric and gas, then you can do that if you like.

The point of a budget is to help you learn where your money is going. If you make it too vague, then it will be only vaguely helpful. But if you make it too complex, then you get nothing from it because you don’t want the headache associated with managing it. So pick a level of detail that is useful and manageable.

Make Room for Fun!

I would save the fun budget type stuff for the very very last. That way, you can see how much spending money you have each month above and beyond what you need to live (and save). I would try to budget an amount for fun that is fairly low, but that won’t stifle you. Your budget should fit your lifestyle and help you reach your financial goals. Generally, try to follow your past spending habits when picking how much to budget.

If there is not enough money to accomplish what you want and to save, then you have an option: you can reduce the amount you save or you can try to save money in other areas.

Can you trade in your car for one with a lower payment? Can you install energy saving devices, or try a little harder to make sure the lights are off when you leave? Can you handle going to one less movie a month?

Be careful here; it is very tempting to just save less, but remember, if you save less then you will not reach your goals. But also remember that you need to have some breathing room in your budget. If your budget is too restrictive, then it will fail in the first month or two, and then what good has it done? (of course, you could win the lottery and solve all your budget problems!)

Is It Working?

What? You thought your budget was done? Nope. Your budget will take a few months to settle in. After the first month, analyze it; how did you do? Did you spend way more on gas than you budgeted? On food? Movies? Take note of where your budget differs from your actually spending, but don’t change your budget yet (unless your budget is so far off that it is obvious that a change needs to be made). With patience and only a bit of work, you will soon find that your budget is a useful tool for keeping your finances under your control.

Posted on 5 Dec 2007