Everyone needs a monthly budget, even if you make plenty of money! Budgets lead to feeling confident about your finances, and this confidence will lead to less stress and put you on the path to financial independence.
Long gone are the times of check registers and paper tracking of your budget. We want digital solutions, and we know some good ones to share with you. First, you need to understand what the essential components of a monthly budget are.
When you are starting to create a monthly budget, most apps and spreadsheet templates ask you to write down your net monthly income. Net income is what you get from your paycheck after taxes, insurance, and savings are taken out. This is the money you will have access to on a daily basis.
Income can come from other places besides a job. For example, you would consider benefits you collect from disability insurance or social security income. You would also consider payments from any investments like rental income, royalties, or dividends as a type of income as well. If your investment income is reinvested or stays in your brokerage account when it is earned, you would not include this as income. The income that you have access to and that flows into your pocket each month should be used in a budget.
Each source of income should be listed and tracked for any changes each month. Income is then totaled and thought of like a pool of money that then is used to pay all monthly expenses. If the pool runs dry, the expenses have to change…or you need a bigger pool!
Most budgeters like to break down their monthly expenses into two or three groups. The first group we like to call mandatory or must have expenses. The second group we call flexible or discretionary expenses. The third group could be expenses related to your goals. There is a final group of expenses if you hold various forms of debt.
Let’s break down each type of expense category.
These are expenses that are typically fixed costs or have a long-term commitment tied to them. If something were to happen where you lost your income, these expenses are those that must be paid no matter what. Here are some examples, you should add any others that apply to you:
- Rent or mortgage payment
- Car loan
- Utilities like trash, water, electric
- Minimum groceries
- Gas for your car
- Healthcare or Insurance costs like auto and life (don’t include those already taken from your paycheck)
- Cable, phone, and internet
- Minimum credit card payments
- Other Minimum loan payments
Your budget should total the must-have expenses as a separate category, and you would aim to build an emergency savings fund that equals at least three times this amount. Three times the amount would help you get through at least three months of living costs should an unexpected event happen. After a budget is established and accurate, a six-month emergency fund is ideal.
Emergency funds keep you from turning to debt when unexpected expenses arise. There are lots of easy ways to grow your emergency fund. Most banks now have a rounding feature so that with every purchase on your debit card the cost rounds up to the nearest dollar and the change goes automatically into a savings account. Acorns.com is a company that allows you to take that same idea but use the change to make automatic investments into an account for your goals. You can set up and decide which investments are right for you online. Read the details to know about any fees associated with this type of account, but it's definitely a great idea.
Discretionary or flexible expenses can be trimmed if you need. Ask yourself: If you lost your income can you go without it? Those items go here. Here are some examples:
- Dining out
- Personal care – nails, hair, massage
- Gyms or kid’s extra activities
- Gifts / Shopping
- Home care – lawn or maid
These expenses are also flexible and could be given up in the event of an emergency, but this is the section where your savings or extra payments on your debts will be listed. Only include savings that you pay for after your paycheck. For example, a 401(k) contribution would not go here; it automatically comes out of your paycheck before you receive it. Here are common goal expenses:
- Additional $200 towards your car loan or credit card
- Summer vacation travel savings
- College savings for the kids
- Additional retirement savings
When you have expenses that are related to eliminating debt, it is important to have a strategy to help get rid of debt as quickly as possible. There are a couple different strategies you can use.
The snowball method is a debt elimination strategy where the smallest debt is paid off first. Contribute any extra money you can to the smallest debt and make the minimum payments to other debts. Once the smallest debt is paid off the entire monthly payment goes to the second smallest debt. Once that debt is paid the entire payment you were making goes to the third debt. This creates what is known as a debt snowball, where the payment size builds and builds. Many people like this strategy because you can quickly see progress of eliminating debts. There is a psychological benefit to eliminating the smallest debts first.
A second method of eliminating debt is called the avalanche method. The avalanche method focuses on paying off the highest interest debt first regardless of what you owe. A lot of money can be saved when you can focus on eliminating high interest payments first. Many people who are more analytical like this method of debt elimination because they do not feel like they are wasting money on interest.
Before guessing at an amount each month for your goals consider using a system to help define your goals in more detail. Many are already familiar with the SMART system. Here’s how it works:
Write down your goal, how you will get there and what you will give up to achieve it. Rank the goal’s importance to you.
Let's use as an example saving for a family vacation 1 year from today. My S would be something like: traveling to the Mexican Riviera with a family of 5 in March of next year. I am going to give up lunches out everyday to save for this trip. My savings will go into my savings account. On a scale of 1-10, 10 being the highest priority, I give this goal an 8.
Define the amount of money you need. Define when and what to review to check your progress. If you are saving for a travel goal, you’ll need to have thought through the travel plans, so you know when you will have saved enough. Ask yourself how you will know when you have reached the goal.
My M for the Mexican Riviera vacation is measured by the fact that airfare currently costs $550 per seat, the all-inclusive hotel costs $150 per night per guest, I need to board my dog at $35 per night, I plan to spend an extra $100 per day for special day trips and shopping, and I plan to be gone 4 nights. My goal is measured to cost about $6,400. This means I need to save $533 per month to reach my goal.
Don’t be overzealous — it is important that you don’t set yourself up for failure. Setting up milestones or defining small tasks to accomplish will help you get to the finish line and keep you motivated.
Looking at my Mexican Riviera goal, I am not going to be able to save $533 per month just by eliminating lunches alone, that would only save me about $200. I need to also give up something else if my family is going to be able to go on this trip. I need to eliminate our movie outings and 2 family dinner outings per month if we are going on this trip.
Review your timeframe and reason for the goal on a regular basis. The goal is important if you have spent time dreaming about it. Work out the details of the dream, so you know what to aim for and work out any unknown variables. Ask yourself if there are too many items that can get in your way and are they out of your control?
My R would be to think that even though I would love to take my family on vacation I only will earn 5 days of vacation time at work for the year and one of my children may have a special band trip next year. It isn't realistic to take all my vacation at once and why would I plan a vacation when my child has a different opportunity that also may cost a lot of money. Maybe a vacation in 12 months isn't likely to happen, maybe 24 months is a better idea.
Set a deadline for your goal. Be careful to avoid changing this too often, but if something derails you, don’t give up. Determine if the goal has flexibility.
My T is that I may begin planning for a Mexican Riviera vacation in 12 months, but I will schedule a review of the goal in 4 months from the start. By then, I will know more about the likelihood of having more vacation time and my child's band plans. If the vacation doesn't work in 12 months I can push it out to 24 month and then the savings need decreases to $267 per month.
Additional ways to make goals achievable is to write them down. Have cheerleaders on your side to talk to when you feel discouraged, and you need a boost to stay motivated. Here is a graphic that you can print to help you define your goals in detail.
Budgeting tools are coming out of the woodworks these days, that just proves how important a budget is! While some people still like the paper or spreadsheet method using the above categories, most are starting to rely on budgeting apps for their phone. Key features may include:
- A link or bank download of a debit or credit card spending
- Quick ways to see what is left for a budget at any point in time
- Bill pay
- Ability to see expenses in categories or groups
- Alerts of upcoming bills
- Real people who can help if questions arise
- Tracking and viewing of savings and investment accounts
- Graphical representations of the numbers for ease of understanding
- Savings calculators
- Two-factor authentication for security or device registration
- Credit score monitoring
Well-liked apps include: EveryDollar, Mint, Pocketguard, and Personal Finance. There are free versions you can try on your phone or desktop. Decide what is most important to you to be able to stay true to the budget you created. You may not need all the above features, but you need to be able to see progress, and an app does this simply.
The first step to a successful budget is monitoring. It is essential when first creating a budget that you review it each month for accuracy, at least for the first three months. There may be items you need to add or expenses you can change because you’ve trimmed them. Once you know the numbers are accurate and realistic then push the review to every six months.
The money you have left over every month after you pay all expenses is called your discretionary income or excess income. Have a place where you can write down your excess income each month and watch if it is increasing or decreasing. This will help you catch a downward spiral before it gets out of control. If it is increasing, GREAT, start accomplishing those goals you already have defined!
If you find yourself in a time when your income just not enough, it is important to be honest and assess your income and expenses thoroughly. Be sure to review every expense you have. Here are a few places where you can trim easily:
- Auto and homeowners insurance — many of us find we are over insured. Talk to your agent and ask questions about why your current coverage is what it is. Shop around and compare costs with other agencies. When the policy expires consider a lower cost provider.
- Cable and cell phones — these are negotiable. If you do not have a contract on these services, call up your service providers and negotiate a new package. Tell them exactly what you want and the amount you want to spend. They want to keep your business and will work with you to find a happy solution.
- Mortgage refinance — this can save you hundreds of dollars per month. At the time of this article, interest rates remain very low. Reviewing your current mortgage with your bank and discussing the opportunity to refinance is a great way to save money. Shop around for lenders too, you are not obligated to keep the same lender with a refinance.
- Coupons and frequent customer cards — these have savings that add up. Give coupons a try. Many stores now have coupons via an app so you don't have to carry paper coupons around. It has become much easier to save a few dollars every time you go to the store.
We all can play mind games with ourselves about what we really need. Be true to yourself or you will find unnecessary money stress will creep into your life.
Your income is everything. If you are trying to live a lifestyle you can’t afford, tough choices need to be made. Give up something or find ways to make some more money. It sounds so easy, but it is important to try and push yourself for a better situation. Part-time side jobs help tremendously, and many can be found online. Make the commitment to find the best solution for you.
Financial freedom doesn’t mean being wealthy with fancy cars and houses — it means living life without worry. A budget is your answer to being financially free. When you get lost and start to feel out of control go back to the budget, adjust as needed, and stop the worry.