“Don’t tell me what you value, show me your budget and I’ll tell you what you value” -Joe Biden
Once you’ve started tracking expenses, you’re in an excellent position to master your money by making a budget!
In this step, you’ll:
Learn about budgets and go through an example
Clear up common myths about budgets
Create your own budget!
Set up a plan to regularly check progress
What is a budget?
A budget helps you specify where you want your money to go. It guides you to 1) spend on what actually matters to you and 2) save enough to build towards a happier life.
Here’s an example of what a budget looks like:
Take home pay from primary job: $2,600
Take home pay from tutoring after work: $400
Total Income: $3,000
Debt Payment and Savings
Credit Card Debt Payment: $200
Total Savings: $500
Total Expenses: $2,500
Now that you’ve seen an example, it’s almost time to create your own budget! But first, let’s address some common myths about budgeting that can make people uncomfortable about creating one.
Often people have negative associations with the word “budget.” It’s possible you’ve put off making one because you think of it as unpleasant. In reality, budgeting is a wonderful process, which will make you happier and more confident. Let’s quickly bust two of the top myths about budgeting.
Myth #1: Budgeting = Deprivation Many assume budgeting means you have to deprive yourself from happiness. This is simply not true. Often once you create a budget you end up spending more on things you value and increasing your happiness! How is this possible? Once you start budgeting, you’ll likely identify areas where you’re spending a lot (usually without realizing it) but receiving minimal happiness in return.
You then reduce spending in that area and split the surplus between 1) spending on something which makes you happier and 2) increasing your savings. A true win-win! Here’s an example:
A few years ago, Stephanie (then my fiancee, now my wife) and I sat down to adjust our budget. We realized we were spending a lot on restaurants and fast food. We also knew eating out didn’t make us much happier than less expensive options like cooking, packing a lunch, or buying pre-made food from a grocery store. We made and acted on a plan to creatively reduce our spending on eating out.
We then moved part of the surplus budget into savings and part into travel (an expense we value more). As a result, we were happier and able to save more!! Without a budget, we wouldn’t have truly known how much we were spending on eating out, and wouldn’t have made this wonderful change.
Myth #2: You must never go over budget Some people shy away from budgeting due to fear of going over their budget once they set it. Here’s the simple fact: If you create a good budget, you will sometimes go over. Each month, you’ll likely have certain categories where you spend more than you planned. And that’s a good thing! If you never went over budget, it would mean you’re setting unrealistically conservative targets.
You’ll want to ensure you’re generally staying within your total spending, but there will be months where you go over due to large or unexpected expenses. If you consistently go over, then it’s time to start creatively thinking about how to reduce spending.
Similarly, for each spending category what matters is monitoring trends over time. If you go over your entertainment budget several months in a row, you’ll want to think about whether to creatively decrease entertainment spending or move more budget from elsewhere.
Alright! Now we’ve knocked out pesky myths about budgeting, let’s finally move onto creating your budget.
Creating Your Budget
Use the same tool you chose to track your spending to create your budget. As a reminder, that tool was either pen/paper, a spreadsheet, or a smartphone app.
Following the above budget example, estimate your income, specify your savings, then set target expenses by category. Before you get started, remember to keep the below guidelines in mind:
Income must equal Savings + Expenses. Keep adjusting your planned expenses until the equation balances while maintaining a healthy savings goal.
For estimating income:
If you have a job which pays you regular income, only count the take-home pay, you receive. Doing this will exclude taxes, benefits, and retirement contributions. Don’t count bonuses or extra income that you “could” earn.
If you’re an entrepreneur, have fluctuating income, or work in a commission-oriented role (i.e. sales) do your best to predict typical take-home pay over the next few months. When in doubt use a more conservative (lower) estimate of your income.
It’s time! Go ahead and create that budget. As with other challenges in the Path, actually do it now!
Once you’ve created your budget, it’s time to create your plan for regularly reviewing and adjusting your budget.
Reviewing Your Budget
A budget only provides value if it’s used regularly. Your next step is to plan and commit to regular budget reviews to ensure your success.
I highly recommend starting with reviews once per week, as you get into the habit of checking in on your budget. Once you’ve been successfully budgeting for a couple of months, you can move to a monthly schedule.
During these budget reviews, you’ll go through the following steps:
Scan through every expense you’ve logged since the last review. Ensure everything looks correct and you haven’t missed any spending.
If you’re using pen/paper or a spreadsheet to track your expenses, add up expenses by category type. If you’re using an app, this will be done automatically for you.
Evaluate how your expenses compare to your budget. If you’re way over budget in any areas, dig deeper to understand why.
Calculate your total savings (income minus expenses) since the last review. If you hit your goal, celebrate!! Revel in the fact that you’re moving closer to financial freedom. If you didn’t hit your goal, make sure you understand why, and re-commit to saving more going forward.
Consider re-adjusting your budget if something in your life has changed or you want to be more ambitious about lowering spending in a particular area. In general, I recommend adjusting your budget every 3 months, as you want some month-to-month consistency in your targets.
Determine your net worth (assets minus debt) and write it down. Calculate how much your net worth has changed since last review, and be sure you understand why. Most months, you should expect to see strong growth!
If you’re married or share finances with someone, do the budget review together. Households that manage their finances together tend to have more success.
Whether you’re on the weekly schedule or have graduated to the monthly schedule, choose a specific day/time when you’ll review your budget. For example, every Monday at 5pm or the first Saturday of every month at 10am.
Over time, these budget reviews will become one of your favorite habits. Personally, I absolutely love our monthly budget reviews. I see them as a check-in on our continual progress towards financial freedom. I’m confident you’ll feel the same.
If you’ve made it this far and completed each challenge, congratulations!! You’ve learned and implemented the fundamentals of personal finance!
You’ve understood your why, determined your starting point, setup regular savings, tracked your expenses, created a budget, and planned your follow-through.
This is the end...of the beginning. You’ve now joined a select group of people who are committed to building savings for a happier life. From here, you’ll continue your journey, pay off debt, and build wealth.
More advanced techniques now await you. To learn more, be sure to check out our blog, where we regularly post money tips which can accelerate your Path to Financial Freedom.