Photo (cc) by Rande Archer
Editor’s Note: This post is part of our Resolutions 2011 series. Last week we posted 5 Steps to a Debt Free Life and 5 Steps to Saving More This Year. If you’re looking for a complete financial makeover this year, check them all out.
If you’ve ever resolved to create a budget only to fall off the wagon a few weeks or months down the road (and who hasn’t?) you were probably missing one or more of the steps below. Check them out and see if they won’t help you create a budget you can stick with this year.
Step 1 – Have a goal.
If you’ve already read 5 Steps to a Debt Free Life or 5 Steps to Saving More This Year, you’ve already seen this step. It’s the single most important thing you can do to accomplish anything meaningful in your life. And the lack of a goal is the single biggest reason people fail at virtually anything, including sticking to a budget. Because having a meaningful, specific, and compelling goal is the only thing that will create a change in your behavior. And tracking, studying, and making changes to your expenses is, for most of us, a big change in behavior.
So if the only reason you want to try a budget this year is for some vague reason like “it seems like the right thing to do,” or “I really should see how much I’m spending,” forget about it. You’re wasting your time.
If you want to succeed, try something more specific, like this: “By January 1, 2012, I will have saved $25,000, so I can make a 20 percent down payment on a house that costs $125,000.” If you really want that house, you’ll do what it takes to get it – and one of the things is to track your income and expenses with a budget.
Once you have a compelling goal, it’s time to start building your budget. But before we start, let’s eliminate the word “budget” and substitute a more empowering and more descriptive word: “spending plan.” The word “budget” sounds like the word “diet” – they both imply deprivation. This isn’t about deprivation: It’s about making completely voluntary, conscious decisions about where you’re choosing to spend your money. In other words, it’s a plan, not a diet.
Step 2 – Write it down.
When you decide to start a spending plan, the first thing you’ll need is a place to write it down. You can create your spending plan with a pencil and piece of paper. Use one of the budgeting spreadsheets we offer here, use an online solution like Mint or Bundle, or even buy a program like Quicken. But it doesn’t have to be fancy or cost a dime.
This isn’t rocket science – it’s just recording what you make, what you plan to spend, and what you actually spend. Invest a few minutes by checking out different options, decide what will work best for you, and get started.
Step 3 – What’s your income?
Your spending plan starts with putting down the amount of money you make every month: your monthly income. But what is your income? You know what you make: That’s called your gross income. But before you get paid, you’ve probably spent at least $1 of every $5 you earned.
You sent a lot of it to Washington, some in the form of federal taxes. You invested some in Social Security (which you hope to get back when you retire) and you paid future medical bills by paying into Medicare. You may have paid federal and state unemployment, and depending on where you live, you may also have given to your state or local government.
That’s stuff you have to pay. You might also have stuff you choose to pay, from health insurance to union dues.
What’s left? Net income. The accountant’s term for what’s left after everyone’s upfront cut. What you net is usually at least 20 percent less than what you grossed – sometimes 30 percent less. But since that’s all the income you have to work with, that’s where you need to start your spending plan.
Of course, you could be getting money from other sources: alimony, child support, rent, interest…you could get a bonus or overtime every now and then. Whatever the source, now’s the time to estimate your monthly income as best you can. It doesn’t have to be to the penny, and you can always adjust it later.
Step 4 – Where is your money going?
Now that you know what’s coming in every month, it’s time to see what’s going out.
Money you spend on everything from keeping a roof over your head to transportation to food: It’s a long list. So this part of your plan will take a little more digging, but it’s no biggie. Because much of what you spend you either already know or it’s already written down for you in your checking account and credit card statements. All you have to do with these expenses is transfer them into the appropriate categories of your spending plan.
That only leaves your cash expenses.
These are a little trickier to keep track of, because it’s not always convenient to stop and write stuff down. But that’s exactly what you’re going to do: Otherwise, you’ll have no hope of remembering them. You can use a little notebook, or maybe an app on your smartphone. The key is to record what you spend as soon as possible after spending it so you don’t forget.
This is probably the hardest part of a spending plan – making sure that you’re recording everything you spend, every day. It takes some discipline at first, but after a few weeks it will become automatic. Is it a pain? A little, but it’s not nearly as painful as not achieving your goal.
Step 5 – Fine tune your plan
Once you’ve got an idea of what you’re bringing in and exactly how much is going out, you’re ready to start reallocating money from where it’s going now to your goal.
For example, if you’ve decided to save $25,000 over the next 12 months, that means putting aside $2,083.33 every month. Where will that money come from? Until you started tracking your expenses, there was no way for you to know. But now that it’s all in front of you in black and white, it’s staring you in the face.
If you’re spending $600 every month of groceries, for example, you might try to spend $500 next month and apply the $100 savings to your goal. If you’re spending $75 eating lunch out at work every week, you could try bringing lunch from home and reducing that amount next month. If you’re paying for premium cable channels, you could decide to try going without them until you reach your goal.
As you go through your list of expenses looking for places to save, the key is to focus first on things that won’t reduce your quality of life. Whether this is possible depends entirely on how carefully or carelessly you’re spending now. But doing things like using coupons, buying used, or increasing your insurance deductibles will help you find the money to meet your goals without having a huge negative impact on your life.
There are thousands of tips for spending less on this website alone, and thousands more on others like it. Explore and see if there are ways you can spend less without feeling deprived.
One of the most valuable things about keeping a spending plan is that it enables you to think about the things in life that make you happy – something that’s unique to each of us. In my latest book, Life or Debt 2010, I go into this in much greater detail, but generally, as you go through your list of expenses, think about how much happiness you’re receiving for the money you’re spending. If you’re spending on things that don’t really make you happy, stop. If what you’re spending on measures up on your mental “happiness yardstick,” try to get it for less.
For example, if you have nine movie channels on your cable, does that really make you happy? If not, drop them and allocate that money to your goal. If they do, call the cable company and ask for a break. If you really love books, you don’t have to go to Barnes and Noble – the library has the same ones for free. If you really enjoy eating out with your spouse every Friday, cut the cost in half by eating an appetizer at home and splitting an entree at the restaurant. If you really enjoy clothes, take your old ones to a re-sale shop and use the money you get to buy different ones there.
The point is that a spending plan can do more than help you achieve your goals. It can also help you reconnect with the things that make you happy and eliminate wasting money on those that don’t. If you’re like most people, you’ll probably find that a lot of the money you’re spending now – the money that could be used to help achieve your goals – is being spent on stuff that advertising convinced you that you need, but you really don’t. Ask yourself: “What were the happiest moments of my life?” or “What are the things I’ll be remembering on my death-bed?” These are the things you should be spending on.
Bottom line? Creating a plan that works isn’t easy, but it is simple. It’s not easy because it involves some thought, and if you don’t have the resources to meet your financial goals, maybe some sacrifice. But it’s simple, because it’s the shortest path from where you are now to where you want to go. Try it.