The one single word in the glossary of personal finance terms that seems to cause more groans and headache than any other is budget. For better or worse, budgeting seems to be the adult equivalent of a homework assignment or research paper. Most of us tend to procrastinate or altogether neglect putting any sort of system in place to ensure our financial success. The ultimate goal is to implement a practical, easy-to-track framework to use as a benchmark and track progress towards our ultimate objectives.
If we’re being completely honest, making a budget isn’t the hard part; the hard part is resisting the temptations that life throws at us on a daily basis. Spending countless hours tracking every single penny spent and crunching them down into a fancy budget is completely useless if you go out later and spend $100 on dinner and drinks to celebrate that you didn’t plan on! Let’s face it: we’re all human, and life is too short not to be enjoyed. Your own happiness and mental health are a huge part of being financial successful, so let’s discuss how to balance being financial responsible and enjoying the money we spend hours working for.
Just like the fad-diets we all know and hate, there is not magic bullet for physical health just like there is no “trick” or short-cut in being financially fit that will alleviate your money woes. Fortunately, it doesn’t have to be complicated; let’s review the 5-minute guide to budgeting.
Keep it Simple!
For the visual-learners and mathematically inclined among us, the following formula is as complex as budgeting gets:
Income Earned (-) Expenses = +/- Savings
In layman’s terms: a budget quantifies how much of our income we are able to save towards future goals such as: retirement, travel/vacationing, large purchases, emergency fund, etc. As you can see, there are only three variables that are relevant here: the income you earn, total expenses, and the savings that is leftover afterwards. Understanding each one of these and the various nuances involved is definitely a much more involved exercise, but understanding this basic equation with your own personal figures is the most important step in improving your financial health. Without understanding exactly how much your expenses are and how much you are able to put away, it is nearly impossible to be successful.
Your Income
Determining the “Income” piece of the budget equation is generally much easier than the “Spending” portion, and will most likely be more consistent and predictable for most individuals. For the majority of working-age adults, the bulk of income earned will come from a traditional job or position. In certain scenarios there may be additional streams of income to consider, such as: interest income, dividends, alimony/child support payments, or income from a side-business or self-employment. Whatever the source, it is important to note the total amount of income you earn in a given period and understand how to plan for it.
In the event your income is irregular, seasonal, or otherwise less than stable, you may need to think about using an average amount received over the last 6-12 months, or some other method of estimation for budgeting purposes. A sturdy budget is far more important if your income is received in waves, as you will need to make absolute certain that you are able to make these funds last. In either case, the starting point of your budget is how much you earn during a given period.
Spending: do you NEED it or WANT it?
The simplest, most important component of an effective budget is to develop your own personalized spending plan. The beauty of this is that it can be as simple as you want it to be; after all, the plan only needs to work for you! Creating your spending plan is as easy as answering one question: how much do I spend on things that I NEED, and how much do I spend on things that I WANT.
This may seem like a silly oversimplification, but the ability figure out your own answer to this question will highlight the differences between your discretionary and non-discretionary spending (we will dive into the specifics of each in a future post). Many of us remember our parents asking our younger selves “do you really need that?” when we reached for a toy or some other frivolous item; this is the exact same exercise, but in adult terms!
- Non-Discretionary Spending (things we NEED): by definition, non-discretionary spending is termed as “required by a contract or other commitment” and is generally a must-have expense.
- Discretionary Spending (things we WANT): it goes without saying, but discretionary spending is basically all of the money spent on things that can’t be classified as “need” items. The amount spent in each category will obviously vary largely from person to person, but are fairly universal.
While it is more important to understand your TOTAL expenses, you may learn a great deal about where your dollars are being funneled by separating these two categories. It may be true that all money spent has the same impact on your bank account, but where you are spending will shed light on what your areas for improvement lie. We will elaborate on this in future posts, but knowing these figures will make it much easier to decide where you may be spending too much without even realizing it.
Saving your Money
This may not be a revolutionary idea to some of you, but the quickest way to get the most bang for your buck from budgeting (no pun intended) is to target your savings first, then determine how much you are able to spend. Whatever you do, do NOT skip to the end and ignore the previous steps; without a good grasp on your income earned and expenses there is NO WAY you can accurately determine how much your savings target should be.
- Determine your income: what is your average income, and how predictable is it?
- What are your expenses: how much have you spent on average during the past 6 months? 1 year?
- How much should you save: create a savings target that works for you; if you are only able to save 5% of your income without feeling stressed then GREAT! What about 15%? Even better! Remember to make your own goals based on what you are able to commit to.
As you can see, there is not a one-size-fits-all approach to budgeting, and that’s the beauty of it: there is no right or wrong answer. Setting a savings target that is the same or slightly higher than what you are already saving is a great place to start. The idea is that slowly, over time, you will be able to either: increase your income while holding your expenses constant, lower your expenses, or both. There are countless articles, websites, and personalities that push a wide range of appropriate savings targets; rather than blindly following a measuring stick made for someone else, we suggest taking the time to understand your own financial situation before taking aim. Remember, no one cares more about your financial health than you do.
Set your Finances to Auto-Pilot
One point that we at The Healthy Wallet cannot stress the important of enough is setting your financial life to auto-pilot, ESPECIALLY your savings! There are a variety of ways in which we can do this (think about bills on auto-pay, bill-pay services through your bank or credit union, automatic transfers, etc.), but the end goal is to take the leg-work out of sticking to your budget. Once you have successfully created your iron-clad budget take it to the next level by setting up an automatic transfer for your targeted savings, ensuring your bill payments are automatically paid in full every month to avoid any late charges, and to have peace of mind that the funds leftover are free and clear.
This will be a recurring theme for a number of topics we will cover in the future, but trust the thousands of financial professionals and successful savers and set your finances to auto-pilot. This great article by Erin Burt at Kiplinger goes into great detail on a few ways to put this plan into action.
Put Your Plan into Action!
Now that we’ve covered what exactly a budget is and how to arrive at the numbers needed, take a few minutes and fill in the blanks. There are countless apps, software, and other programs that are designed to complete this same task, but nothing is easier and more valuable than arriving at the answer yourself. Just remember that a budget is the single most important financial task you can complete, and every successful businessperson, investor, and entrepreneur goes through the exact same exercise on a regular basis, be it for themselves or their business.
Rest assured that once you are able to get past your first trial-run, it will eventually become second nature to think in these terms. You will be happy you did, and so will your wallet.