On Monday we chatted about finding financial freedom with a safety net fund. Yesterday we further chatted about the rules I follow to save over half of what I make (58% to be precise). Today we are going to talk about the foundation that makes both of those things possible. We are going to talk budgets.
Budgets are the very foundation of a strong financial future. They provide each of your dollars with a purpose. You treat your dollars like they are members of your team, and you are the strategist that understands the big picture. You tell your dollars where to go accordingly. Although budgets are the most important tool in a financial tool belt, it is surprising to know how few people actually create one. Fewer still follow their budget. You know better, though, and that’s why you are here. For that reason, here are my favorite tips along with a Budgeting Workbook you can use to build your budget.
The Financial Audit
In order to predict your future it is best that you first understand your past. The best way to understand your financial past is with a financial audit. There are some financial experts out there, not naming any names because we all know Suze Orman can’t help herself, that go way over the top with financial audits. That lady doesn’t play. She suggests that you pull together bank and credit card statements for the past two years so that you get a big, and I mean big, picture of your spending. She recommends that you tally up all of your expenses by category for two full years and then divide each category by 24 to find your monthly budget amount. If you would like to do this exercise yourself, then please, by all means do so. I am guessing that those that go through that process find it therapeutic. You can gain a very honest perspective and correctly budget for expenses that do not occur monthly with great accuracy.
Or…you can hack your way to accuracy using my financial audit technique. Go to the electronic version of all the mediums you use to pay your bills (bank accounts, credit cards, etc.). Now you are going to audit the past three full months of spending (that would be October – December in at time of publication). You can download the Budgeting Workbook to help you along. The audit is on the first tab. Once you have inventoried your spending over the past three months, you will take an inventory of expenses that occur quarterly, semi annually, annually, or sporadically. Examples for me include an annual homeowners insurance policy and gifts that I purchase sporadically. You will notice that the spreadsheet is already formulated to then take an average of your three months of spending, along with your annual sporadic spending divided by 12, to give you insight into how you currently spend your monthly budget.
Once your financial audit is complete you should have a much better understanding of your spending habits. You might already have ideas on how you could improve your spending, but not so fast. We have something else to cover first.
Let’s Talk About Money Shame
By doing a financial audit you are coming face-to-face with your ghost of finance past. This is often a time when money shame starts to set in. Money shame is worse than guilt. It can be paralyzing. If you suddenly feel compelled to put organizing your budget on the back burner, then that is likely money shame ruling your subconscious. Kindly call the money shame monster by name and then use this guide to understand how to handle that shame correctly.
Alright, now on to a brighter future.
Determining How Much Your Life Will Cost
Okay, now let’s create the budget. With the inputs from your financial audit, you have a good understanding of how you have been spending. Now let’s determine what changes you want to make in your budget going forward. You can do so on the Personal Budget tab in the Budgeting Workbook.
A couple of peculiarities about the way I budget that you will notice in the spreadsheet:
- I do not considering dining out to be an entertainment expense. I purposefully treat it in the same category as groceries, and I have a monthly allotted amount I set aside to feed myself. Each time I eat out I do so knowing that I am decreasing the total amount of money I have to feed myself for the month. It puts things in perspective.
- Speaking of entertainment, you will notice I don’t break this category down into categories. That’s because my entertainment outlets are quite diverse. They include everything from girls’ night at the gastro pub to, say, going to the craft store to learn how to crochet. So, I save myself the trouble of subcategorizing these expenses. I did add a line item for babysitting for those of you with children at home.
- I know that in my case I will need to replace my home’s furnace and water heater in the near future. I build things like this into my budget as far enough in advance as possible so that I have time to save for them. It is sometimes hard to predict potential home maintenance catastrophes, but that is why I use my home maintenance checklist during Fall Back and Spring Forward.
- If I have debt, then my vacation budget is zero by default. Vacations are luxuries, and they should be planned and saved for. It is my belief that if you are in debt, then you should not go on vacations. You should also not go into debt in order to fund a vacation.
- I believe that if I cannot afford the cost of my life, then I should be careful about the other lives that depend on my income. This includes children, family members, friends, and pets. Of course, if you already have children and pets then I am not instructing you to put them on Craigs List. However, you should not add more dependants to your income until you can afford to. You know how the flight attendant says put on your own mask before assisting others? That.
- I believe money has karma. The energy you put out into the world comes back to you. Newton wrote a law about it so it must be true. With that being said, I set aside an amount of money each month that is not out of my means but is not insubstantial compared to my overall budget. This money is meant for a charity of my choosing. It’s good fun picking the charity I allocate these funds to on a monthly basis.
The bottom line on budgeting is that, as a marketer, I understand spending is a “goal setting” activity for the average consumer. We spend for where we want to be in life instead of for where we are. Let’s change that around. Let’s not let goal spending get in the way of our actual goals. Let’s save for where we want to be in life instead. To get there it is good to know “spending zone” you should be in now given your current finances. Check out “Fast, Diet, or Maintenance? What spending zone should you be in?” for more details.
Creating an Emergency Budget
As I discussed recently on the topic of creating an emergency fund, your spending will undoubtedly change if an emergency does happen. Use the Emergency Budget tab in the Budgeting Workbook to figure out the minimum dollar amount you can live off of in each budget category if you were to lose a source of income. In my particular case, I currently pay double on my student loans on a regular basis so that I can pay them off early. However, in my emergency budget I itemize the regular monthly payment amount. You may consider requesting a deferment or forbearance in an emergency and make this amount zero. This is really at your discretion because no one knows your life better than you do. To figure out your emergency fund, you would multiply your monthly expenses by 9 and then multiple them again by 1.3. You can see all of the details in “Finding Financial Freedom with an Emergency Fund“.
Developing a Money Practice
You now have your budget. Congratulations! Now it is time to build a money practice to ensure that your budget changes your life in the way you intend. Here I will use a phrase that I use commonly in my day job as a management consultant.
“What gets watched gets done.”
If you want to improve your behavior, then you have to monitor and measure that behavior using a means that is a part of your every day life. I have my phone with me 24/7. I sleep with the darn thing. So, I use my phone to help me monitor my finances primarily by way of my Mint app. Instead of tracking my budget every month in the spreadsheet, I transfer my budget information into the app and then the app categorizes my spending accordingly. If Mint miscategorized a transaction, then I can go to that transaction and pick the right category. Mint is a learning system so the next time I make a similar transaction it will remember what category that the purchase should be in.
As a part of my money practice, at the end of every month I then go to the Budgeting Workbook and add the monthly totals as displayed in my Mint app in the appropriate monthly column. Over time my personal budget becomes populated, and each month adds a chapter to my spending story. I can use this data to see if I need to make any changes to my budget in the future. The best part is that I can see, over time, how the every day choices I have made have helped me save for the future I long for.