I know that there are many other topics that are far more interesting than creating a budget, but let me tell you why it is so important. Your goal, when it comes to personal finance, is to manage your money to achieve your life goals. So much of your well-being, and the well-being of your family, is influenced by how you plan around money matters. If you do not know how much money is coming in, where it is going, how your plan is progressing, then you are operating in the dark.
First, and most importantly, you need to be aware of your money. If you do not have an awareness of income and spending, you cannot control your money. Let me repeat that in a different way. To control a thing, you must be able to measure that thing. Your financial life should be what we call a closed loop system, otherwise known as a feedback loop.
Second, a budget allows you to set goals and measure your progress as you achieve those goals. It may be first getting out of debt, building an emergency fund, reaching your FIRE number. Whatever you want to achieve, first you must measure.
Third, having control over your money and seeing that YOU CAN reach the goals you set for yourself will give you peace of mind. I remember when my personal financial situation was out of control, I was indeed losing sleep. I had feelings of hopelessness and frustration. When I did the work, planned, and began to achieve my goals, I had a huge leap in my feelings of well-being. As I get closer to retirement, I’m grateful to my younger self for planning and sacrificing for me.
What is a budget?
A budget is a financial plan that outlines and tracks your expected income and expenses. Simple! As I mentioned earlier, your financial plan should be a closed loop feedback system. The budget is your way of providing that feedback.
There are many ways to approach budgeting, but no matter how you choose to do it you must do it. My personal style is a little more informal. You may choose to track your money more accurately. What is important is that you do it. So, what are the key points of a budget?
First, identify and define your financial goals. This should include things like, getting out of debt, saving for retirement, saving for your child’s college tuition, or saving for a house, for a few. These are your why’s.
Second, gather financial information. Collect all your income, salary, side gigs, gifts, all of it. There are many tools you can use but the simplest is a spreadsheet. If you do not have Excel, use the excellent free Google Docs. You can even use the notes app on your phone. Heck, write it down in a notebook. (The spreadsheet makes it easier to manage and maintain this information). There is a really useful free spreadsheet template in Google Docs called, Monthly Budget. There is a similar template available if you have Office 365. Both will do what you need and allow you to, at a glance, see where your money is going.
The other half of this equation is recording all your expenses. Rent, car loan, your weekly refill on the Starbucks card… ALL OF IT. This is where you may benefit from carrying around a small notebook or your notes app on your phone, and every time you buy something write it down. Once you get it rolling you may choose to relax on this a bit, but in the beginning, you need to know where all your money is going.
Third, categorize your expenses. You will have fixed and variable categories. Fixed like your rent, car loan, etc. Variable like food, dining out, that kind of thing. This is important, because by tracking and organizing your spending you will get a clear picture of where, and when, your money is leaving you. Again, the budget templates I mention above will allow you to see by category what you are spending on.
Once you have done this analysis, you need to be really honest with yourself. You’ll likely be shocked at how much money is being wasted on things that don’t contribute to your goals. There likely will be a moment of clarity when you realize how much of your income is going to pay down debt. Are you saving anything? Do you have an emergency fund? Can you really afford the car you are driving, the house you are living in, all the meals you have out?
Now that you have a clearer picture of what you have coming in, you need to set some priorities and apply some discipline, to where it is going. Think about Dave Ramsey’s 7 Baby Steps for example. Dave provides some excellent guidance on how to get out of debt and what actions you should take to control your money and not have your money control you. Here are the baby steps:
1 Save $1000 to start your emergency fund
2 Pay off all debt, except your house
3 Save 3 to 6 months of expenses for your full emergency fund
4 Invest 15% of your income
5 Save for your childs college fund
6 Pay off your home early
7 Charity
There are important details regarding each of these steps. Read about it HERE. This is not the only way to gain control of your money, but everything I’ve come across is similar in principle. People in the FIRE movement would tell you to save more than 15% for example. Regardless of the specifics, you need to track your money, limit your expenses, eliminate your debt, and save and invest for the long term.
The budget technique I use is more like the 50/30/20 rule. I use techniques like automatic saving and investing, and keep an eye on my spending to not go into debt. My 401k balance has grown to an impressive level and I’m on track for retirement using this automatic approach.
A parting comment on budgeting. I opened this post by acknowledging that it’s not a sexy topic, but it’s very important. Find a method that works for you. The important thing is that you start and set some goals. The details about where to invest your money, which are the topics that attract more clicks, are great but until you’re out of debt and have an emergency fund it’s not the most important thing. Above all else, keep educating yourself by reading blogs like this, books on the topic, and any other sources of sound financial information you can find.