In my last post, I talked about how budgeting is viewed with disdain by virtually everyone. I also mentioned that before attempting to work out a budget, it’s important (if not essential) to begin by tracking your expenses for at least one month so you see how you’re really spending your money. Today, let’s take the next step towards creating a budget by showing you a simple and relatively painless way to gain control of your spending.
One reason budgets often derail is because people set up their monthly expenses assuming that every month should be the same. They plug in their numbers only to find that by month 2 or 3 something’s way out of whack.
Think about your average year. Are your expenses the same each month? Some things like a mortgage or rent payment usually are. Utilities like your cable bill can be consistent (if you’re not paying for “on demand” services), but other expenses aren’t identical every month. Energy bills will fluctuate with the weather. Clothing costs may vary with the seasons. There are periodic costs like school fees, annual taxes and insurance. You no doubt have incidentals like birthdays, holidays, and other gift-giving events. Lastly, there’s always surprises — flat tires, parking tickets, your dog needing an emergency vet visit, or the water heater blowing up.
How the heck does a person budget for all of these things properly?
Like most things in life, there’s no one right answer. There are different ways you can map out your spending. If you’d like a traditional type of budget spreadsheet to work with, try using the template I provided a while back in a post on assessing your net worth and cash flow. The cash flow template is essentially a monthly outline of your income and various expenses and can be used as a starting point for your budget. You can expand it onto your own spreadsheet to make a month by month budget.
If you’re comfortable trying new technology, there’s plenty of good budgeting apps, some of which are free or minimal cost. If you’re using online banking, your bank’s website probably has budgeting tools. You may have to try several apps before you find one you like to work with.
“One number” budgeting
Another easy approach to budgeting is called “the one number budget”. Here’s how it works.
Assuming you tracked your expenses for at least a month, take that info and divide your spending into four categories:
Fixed, Regular, Non-discretionary Expenses — In this category, write down the bills that you have little or no choice in paying. This includes your mortgage/rent, phone bill, utilities, loan payments, and such. For bills that vary significantly through the year (heating for example) tally up the past 12 months and use the average. Set up automatic payments for as many as possible to make it easier to stay on top of these expenses.
Personal Savings/Goals — Most important, don’t forget to account for your personal goals. Retirement savings, setting aside money for major purchases, extra payments on debt (over and above the required monthly payments which would be in the first category), putting money aside for your emergency fund, and so on. Set up automatic transfers from your checking account to various savings accounts (you may have more than one) for anything in this category. This way, money goes to your goals before you have time to spend it.
Periodic Expenses — This group of incidentals includes things like annual insurance premiums, birthday and holiday gifts (set limits on these), auto registration, school fees, children’s programs and others. Add up what you spend each year on all of these and divide the total by 12. This is the amount to put aside each month to cover these incidental expenses. When it comes time to pay for these incidentals, you’ll have cash ready.
Flexible/discretionary Spending (“Flex Spending”) — the last category is the money you spend each month that fluctuates and is either somewhat discretionary or completely discretionary. Things like take out food, entertainment, recreation, any vices you have, “fun shopping”, and so on.
When you’re categorizing your numbers, keep in mind that it’s possible some expenses you’ve lumped together in your previous budgets might be split into two different categories when you try this “one number” system. With transportation expenses for example, using this system a person who takes transit to get to and from work each month, may put their transit pass in the fixed, regular, non-discretionary category. If they only drive their car for pleasure, they could put their fuel expenses in the flex spending category.
After you’ve finished categorizing your expenses, you do some easy number crunching. Start with your take home pay for the month. If you’re retired, start with your pensions or other monthly income sources. From that number, subtract the fixed expenses, your personal savings and goals, and your periodic expenses. The number you’re left with is the amount you can spend each month on your flex spending.
Now that you know the how much you can use for flex spending, you really only have to focus on that one number (hence the name). Divide the flex spending number by 4.3 and you’ll have the approximate amount you can freely spend each week. Divide your flex number by the days in the month, and you know how much you can spend per day without blowing your budget.
Here’s an example (please note: these numbers are totally fictitious and for informational purposes only). Let’s say you’re take home pay is $3000, your fixed expenses are $1500, your personal savings/goals is $400, and your periodic expenses come out to a monthly number of $800. The calculation then looks like this:
Take home pay/monthly income: $3000
Less:
Fixed expenses $1500
Personal savings $400
Periodic expenses $800
Equals: $300 left per month for “Flex Spending”.
Divide $300 by 4.3 and you can spend $69.77 per week at your discretion, or about $10/day. If you spend more than that one day, you should spend less on another day to make up for it. If you’re constantly spending more than that, you know you’re going outside of your budget. Do that for too long and you’ll see the results with larger credit card statements, late payments on your bills and other nasty consequences.
The one number system is the simplest method of budgeting that I’m aware of. It does take a little work on your part to put it together, but it won’t take long and you’ll see your spending habits improve. Chances are in the first few months you’ll have to do some fine tuning, which is okay. Just refine your numbers, and keep working towards staying within your one number budget.
If you’re struggling financially you need to take the steps of first tracking your spending and then using some form of budgeting system to regain control of your money. It’s like when you take steps to get into better physical shape; it requires measuring things regularly (like your weight), and putting a control system into place (watching your calories) and reintroducing healthy activity into your lifestyle. Similarly, to get into better “fiscal” shape, you need to measure things regularly (tracking your spending, cash flow, and net worth), put a control system in place (budgeting, disciplined spending) and reintroduce healthy financial activity (setting up an emergency fund, saving in advance for major purchases and saving for retirement).
By the way, if you use a budgeting system that you think works well and is easy to use, feel free to let me know at [email protected]. I’d be happy to hear about what works for other people.
