Setting a Budget – Tips and Best Practices
In most cases, a budget (your cash flows) forms the bedrock of your financial plans. A budget is one of the most effective ways to begin tackling your financial life. Unfortunately, there are some negative connotations to the idea of budgeting. You might imagine a friend saying “I can’t go out to eat, I’m on a budget.” Your instant impression might be that they don’t have any money.
In reality, budgeting simply means that you are aware of your spending. Your budget could be large or small, but regardless of your income or nest egg, it is an important tool you can use to become financially stable and happy.
In order to establish a budget and have it work, there are some basic fundamentals you need to be aware of.
Define Your Goals
For a budget to work, you need to have an idea about what your budget is trying to accomplish. Are you saving for retirement, a down payment on a house, aggressively paying off debt, or are you just struggling to spend less than you make?
Whatever your reason for wanting to organize your cash flows, you need to be clear with yourself (or your spouse) what that reason is. If you do not define your goals, it’s unlikely that you will have the discipline to follow through on your budget.
If you’ve taken any sort of business class in your life, I’m sure you’ve seen the “SMART Goals” acronym. I roll my eyes when I see it, too, but with budgeting it’s actually pretty helpful. The acronym stands for: specific, measurable, achievable, relevant, and time-based. So, let’s see what that looks like when applied to the goal of paying off debt:
Specific – I am going to pay down an extra $500 of my debt per month, beyond my regular payment.
Measurable – As long as I contribute $500 extra per month, I’ve met my goal.
Achievable – $500 extra is a reasonable amount for me at this time in my life.
Relevant – I’m doing this because if I just make the minimum payments, I will be in debt for another ten years and it’s inefficient to keep paying money towards interest.
Time-Based – If I pay down at least $500 extra, I will pay off my debt in two years.
If you can’t define one or more of these categories, then your goal needs an adjustment.
Organizing Cash Flows
Once you’re clear on what you’re budgeting for, you need to organize your resources. There are plenty of ways to keep track of your cash flow. Personally, I use the spreadsheet we provide clients when doing their financial plans, but you can find something similar online or even create your own. Software and apps such as Mint or Mvelopes can automatically link your accounts to track your spending, though you will need to be diligent about ensuring that it is categorizing your expenses correctly.
I generally recommend getting as granular as possible with your spending categories. It doesn’t do you any good to have 40% of your expenses as unclassified or miscellaneous. Even having a general category like ‘Food’ doesn’t allow us to tell what you’re spending on groceries versus eating out at restaurants or fast food places.
It will probably take at least a couple of months to get a good idea of what you’re consistently spending. Once you have good estimates of what’s going out monthly for your various needs, you can begin to identify areas that may need addressing.
Take your monthly income, compare it to your expenses, and determine how much free cash flow you have now and how much more you need to accomplish your goals. With this in mind, set a spending target for each category.
In almost all cases, your reason for having a budget is to limit your spending on the things you don’t need. Take a look at your cash flow and be honest with yourself about where you can realistically cut back. It does you no good to acknowledge that you don’t need the Starbucks you spend $5 on per day and set a target of $0. You’re just setting yourself up for failure. Start small and try to ween yourself off the luxuries.
Following Your Budget
The hard part.
Identifying your goals and organizing your expenses may be necessary and time-consuming, but it really doesn’t ask all that much from you. Putting your budget into action is much more difficult.
As you begin monitoring your budget, pay attention to the areas where you know you might be weak. Get rid of the temptations in your life that cause you to spend on your weaknesses. If your spending vice is clothing, unsubscribe to those email ads and ‘sales’. If you don’t see these prompts and triggers, you’re less likely to go out and buy things you don’t need.
Once you have a handle on your budget, don’t stop keeping up with your expense tracking and always keep your goals in mind. It’s easy to become comfortable after a few months of successful budgeting. Don’t relent.
Budgeting is going to require commitment and discipline on your part. Importantly, though, realize you will blow it every once and a while. Don’t get discouraged when this happens or give up. Instead, make an extra effort next month to stay within your targets.