Why Budget
Why you are budgeting.
If you’re developing a budget just because someone says it’s a good idea, it probably won’t help very much. Similarly, if you’re just following the steps in a personal finance workbook because it suggests this is a great way to move towards financial success, budgeting won’t help much at all.
The reason for budgeting is to help you spend less than you earn. It shows you where your spending weaknesses are and provides the structure for you to get stronger in those areas.
2. Have a specific, concrete long term goal in mind.
For many people, it’s debt freedom. For others, it might be saving for a house or for the ability to make a career change. Whatever it is, having a big long term goal in mind, particularly something that would have a big impact on your life, is useful when planning a budget.
Why? An effective budget is likely going to involve a few difficult choices. You’ll likely be agreeing to cut your entertainment spending and probably planning to do a few other things that on the surface seem like they’ll reduce the quality of your life a little. Knowing that these little choices are in fact adding up to something specific and tangible – and something that you really want – makes the process much more palatable.
3. Know how much you actually make.
The correct answer here is not just your annual salary, nor is it dividing your annual salary into twelve parts for a monthly budget. Instead, you should be basing your budget on your take-home pay per month.
If you make $48,000 a year as a salary, you’re likely knocking off somewhere around $8,000 in income taxes, and likely much more than that when you look at other work benefits and costs you’re paying up front for them, like health insurance. Because of that, using $4,000 a month as the basis for your budget simply isn’t correct – the correct number is likely much closer to $3,000, and possibly below that.
Make sure you know exactly what you’re bringing home as a paycheck, because that’s the number you’ll use as the framework when you budget.
4. Have some accurate data when it comes to your spending, both monthly and irregularly.
Similarly, when you go to plan a budget, it works best if you plan it based on real numbers. This means pulling out your bills and your receipts for the last month or two – all of them – and figuring out what you’re actually spending. Your first “budget” shouldn’t actually be a budget at all – it should instead reflect your spending in an average month.
Don’t forget the irregular bills, either, like homeowners’ insurance, car licenses, auto insurance, property taxes, and so on. These bills shouldn’t be “unexpected surprises” – instead, you should be planning for them throughout the year by socking away a little each month for them.
5. Have checking and savings accounts that have useful budgeting tools incorporated by default.
Does your bank offer automatic transfers from your checking account to your savings account ? Does your bank offer online bill pay? The answer to both of these should be yes.
Now, does your bank charge you maintenance fees on your account? Do you have to pay a lot of ATM fees? The answer should be no.
In short, if your bank is doing these things, they’re actively working against you in terms of making a successful budget work. Many banks offer these features – online bill pay, automatic transfers, no ATM fees, no maintenance fees, and often a nice interest rate to boot.
6. Have a simple budgeting tool that you understand how to use – start with pencil and paper if you have to.
If you’re starting off by sitting down with Quicken or Microsoft Money and you’re quickly overwhelmed by the complexity of the software and the huge number of options available, it’s going to be a lot harder to convince yourself to keep going with this. Your first budget should be incredibly easy to use and manage – and you should understand it from the inside out.
That’s why the best bet is usually to use pencil and paper for your first budget.
That’s not to say that Quicken or Microsoft Money aren’t great options – they are. The problem is that they offer so many options that it can often overwhelm the new user, and if you’re overwhelmed, you’re quite likely to just give up because “budgeting is too complicated.” Don’t let that happen – start with simple tools, then move to more complex ones if you feel a need.
7. Be realistic.
Budgeting is like diet planning – it’s not going to work if you make huge, unrealistic assumptions right off the bat. If you’re trying to diet, moving to a lettuce and tofu diet might work for a few days, but eventually you’ll crack. A much better solution is to be realistic – instead of drinking a sugar and fat-heavy coffee in the morning, cut down to a low fat version, and instead of eating a double cheeseburger for lunch, bring your own cold cut sandwich. Small steps work; big steps result in failure.
The same rule applies to budgeting. Don’t pledge to reduce your entertainment spending by 80% – it won’t work over the long haul. Instead, just average out what you’ve spent on entertainment for the last few months, and pledge to a cap of just 5 or 10% below that average. Then, after some time and some success, trim it a bit more. Going whole hog right off the bat will almost always end in failure over the long run.
