This is probably the most requested topic that I receive, normally after someone gets a large unexpected expense, or they start thinking about retirement and realize that they have saved a woefully inadequate amount of money. How do I budget?
I recommend using a monthly time frame to look at your cash inflows and outflows because most bills are monthly, and four weeks is a short planning period that most people can manage. The first thing to do is determine your monthly after-tax income. Usually, this is the amount of money from your paycheck that gets deposited into your checking account. If your income is variable, use an average of the last three months or preferably the last six months. (Any savings account interest income would be a bonus.) Next, list your fixed monthly expenses, such as rent, mortgage, car payment, phone, the electric bill, etc. These numbers can be changed in the long term, but first, you need to determine a baseline budget of where you are right now. Some fixed expense bills will provide you the last twelve months’ statements online, where you can derive an accurate monthly average from using.
Ensure you include all of your utilities; some are only paid quarterly or annually, like car insurance, the water bill, or an association fee. Take these expenses and calculate what they would be monthly. For example, if your water bill comes quarterly, divide it by three. If you have semi-annual car insurance, then divide it by six. This is the same process used on fixed monthly expenses that vary from month to month.
So now you have your fixed monthly income and your fixed monthly expenses. Deduct one from the other, and you have the variable amount of money that you are free to spend any way you want for the remainder of the month. From this remaining amount of money, start listing out your main categories of variable spending: groceries, entertainment, medical expenses, clothing, dry cleaning, personal care (haircut, nails, etc.), and gifts. Take each of these variable expenses and put an amount next to them that you think represents your average monthly spending for that category. In this scenario, you carry no variable expenses such as credit card payments as we are not carrying a balance from month to mo0nth and pay the card off in full monthly. These charges are thereby covered in your variable spending budget. You can get our Excel budget spreadsheet for a nominal fee by visiting https://kgmeyerpc.com/product/braving-budgets-and-printable-budget-book/.
Make as many subcategories as you need to make an accurate estimate. The more precise it is for your spending habits, the more effective it will be for you. For example, food can be broken down by grocery store/fast food/dining out/work lunch/etc. Then go through the last few months of your checkbook and credit card statement looking for any spending that hasn’t been covered so far that you need to include for your situation.
You should have a total number for your monthly income, total monthly fixed expenses, and total monthly variable expenses. The moment of truth is when you deduct the two expenses from your income to see anything left over. Don’t panic if it is a negative number – it is far better to discover this out now than build up credit card debt later. Most people comment somewhere along this process, “Oh, so that is where my money is going. I had no idea I spent so much on that!”
Seeing all the numbers in black and white can help you prioritize (and negotiate with all the other spenders in the family). From this beginning budget, you can start to set monthly targets for spending categories. You can focus on reducing the largest expenses and find areas where you should start doing some price-comparison shopping. And did I mention that saving 5-15% of your income should be an additional fixed expense? Yes, you always need to pay yourself first!
Having a budget is the critical first tool in managing your money and finances as a whole. Wielding this tool allows you to finally start making financial decisions based on the facts instead of fiction. You can plan for expenses instead of being caught by surprise. And most importantly, figure out how to move forward with goals like a big vacation, a new car, or investing for education and your retirement.
For help with your budget and how to get it under control, consult a fee-only Registered Financial Consultant. Based in Nashville, Tennessee, KG Meyer, PC can help you no matter where you are.
