7 easy, low-tech steps to build a spending plan.
July 9, 2016 – By Catey Hill
Everybody needs a budget. You need a budget to save and spend money, and you really need a budget if you need help getting out of debt. If you don’t have a budget, you’ll always wonder where all your money went and it’ll seem like you never have enough. With a simple but realistic budget, you’ll start saying, “Where did all this money come from? Oh, I know. I saved it.”
Despite the fact that creating a budget is fairly straightforward, more than two-thirds of Americans do not have one, according to Gallup. The scary part: By neglecting to create and follow one, they may be putting their families at risk.
“The difference between people who are financially secure and those who aren’t is often times one thing — a budget,” says Scott Carty, president of DC Capital Management in the Detroit area. Indeed, a budget can help you pay down your debt; save for retirement, emergencies and other things; and pay for the things you want and need.
Here’s a simple, step-by-step guide, to creating a budget.
1. Make goals.
“Whether it’s driving or budgeting, it’s hard to get somewhere without knowing where it is you want to be,” says Kevin Gallegos, vice president of Phoenix operations for Freedom Financial Network . That’s why it’s essential to write out, and prioritize, your financial goals.
On a sheet of paper, you will write down your goals, making sure to prioritize these:
- Paying down high-interest debt like credit card debt, as quickly as you can
- Saving for retirement (aim to save 10% or more of your income)
- Building up an emergency fund
Then, think about other things you’d like to get out of life that cost money — taking a vacation, renovating your home, whatever — and add those to the list in order of the importance they have in your life. If you have a spouse or partner, it’s important to include him or her in this discussion, as well as in the budgeting process.
2. Figure out your monthly expenses.
There are two ways to do this (or use a combination of the two), both with the goal of determining everything you spend money on and how much you spend on it in the average month.
First, you can gather all your financial statements from the past few months; these include bills, credit card and debit card statements; checking and loan account statements receipts and anything else showing the expenses of your household. From there, add up your total expenses for the past few months to determine your typical monthly spending.
For some of you, this will be difficult. Maybe you pay cash for a lot of things and don’t keep receipts or maybe you toss bills. In that case, track your spending for a few months by writing it all down in a notebook or by putting it on your smartphone. “Every single dollar that leaves your pocket must be accounted for,” says Mindy Jensen, a financial blogger at BiggerPockets.com. Once again, add up your total monthly expenses using this information.
You should also make a note of any large expenses that aren’t monthly — homeowners or car insurance payments or an annual holiday you take — as these will need to be accounted for. Many experts recommend breaking these costs out into smaller monthly costs so you can easily account for them in your monthly budget going forward. For example, if you have bigger expenses such as tax payments that you need to make annually or every quarter, just divide the annual amount by 12 and add that to your monthly expenses. Then you won’t be caught out when the due date comes around.
Once you know your expenses, divide them into two categories:
- Essentials: These are expenses you have to pay, including housing, food, transportation, utilities, debt and tax obligations.
- Nonessentials: These are things that you can spend your discretionary income on, such as vacations, eating out, entertainment, enrichment.
3. Determine your net monthly income.
To figure out how much you money you take home each month, gather all your pay stubs, interest statements, child support payments and any other information that shows income earned. From those, you’ll want to calculate what’s called your net income, which is the amount your household actually brings home after all deductions have been taken from your paychecks, explains Katie Ross, the education and development manager for debt management firm American Consumer Credit Counseling. These deductions may include taxes, Social Security payments, health insurance premiums, deductions for retirement savings, union dues, life insurance premiums, even wage garnishments and liens.
4. Compare your income to your expenses and make a plan accordingly.
Subtract your monthly expenses from monthly income; you can use a work sheet like this one, from the Federal Trade Commission, to help simplify this process. (This work sheet can be used in future months as well to ensure that you stay on your budget.)
If your expenses are higher than your income, you risk going into debt further, so look to cut costs from your list of nonessential expenses in Step 2. Could you stop going out to dinner, push your vacation until a later year when you have more money, stop getting a latte each morning? Some experts recommend trying to break one of your expensive habits each week (if you try to do too many at once, you might fail) until your spending is under control.
Once you are at a point where you can pay for all of your essentials (debt payments, housing, transportation, health-care costs, etc.), you’ll want to begin paying for the goals you listed in with saving for retirement and an emergency fund at the top of your list. If you’re not sure what these goals will cost you each month, use an online calculator (Bankrate.com has several) to figure that out so you can make room for those costs in your budget.
If you have extra money coming in each month after meeting your expenses, look to bolster your savings and begin funding your secondary goals.
5. Simplify your financial life.
As much as you can, automate your bill pay for everything from your mortgage to your utilities (so you don’t miss payments and get hit with late fees) and savings (so you aren’t tempted to spend the money sitting in your account). Added bonus: Some lenders and utility companies even offer reduced interest rates (or other benefit) for use of their automated payment services.
6. Stay on track.
To ensure you have enough money each month to meet all of your expenses, pay down your debts and save for your goals, you should continue to track your spending every month. Note everything you spend money on each month (don’t forget to add in those bills you have automated) by either writing down your expenses on a sheet or paper you carry with you or in your smartphone notes works too. (If that’s a bit too labor-intensive for you, you can review your bank and credit card statements each week to track spending and insert each item into your budget then.) “It’s very similar to writing down everything you eat when trying to lose weight,” says Gallegos. Review your spending at least weekly to ensure you’re on track.
If you find that you’re still spending too much despite writing down all your spending, start cash — yep, cold hard currency — for everything that you can. Each week, take out the amount of cash you’re allowing yourself to spend and keep the credit cards and debit cards hidden from yourself.
7. Be adaptable.
Changes to both your income and spending will happen, and you may need to restart this process if the changes are significant. Even if they’re not, you may still need to adjust your budget each month to reflect true spending. You may get hit with an unexpected expense, for example, that zaps your emergency fund, so you have to put that goal ahead of say, saying for a trip. Or you may find that your expenses are ticking up, in which case you will need to work on ways to cut costs.