Creating a Budget that Works

by Neal Frankle, CFP ®

Lots of people name “getting out of debt” as their top priority for the coming year. Well, if you are one of those people, the most important first step you should take is to become a master at budgeting. The good news is that you can make a budget that works even if you’ve tried and failed in the past. Here’s how:

1. Get Religion

Your budget is the building block of your financial future. It doesn’t matter how much or little you have or earn. If you earn $100,000 a year but spend $150,000 annually, how much financial security do you have? None. Lots of people run after earning more, and that’s fine. But that step alone, without being crystal clear on how much you spend, puts you on a never-ending paper chase. In order to really have a budget that works, you need to fundamentally understand that you need a budget even if you don’t have any debt. You have to want a budget as if your financial life depends on it – because it does.

2. Get “Webstered”

To have a budget that works, you have to understand what a budget is. And it’s not complicated. For our purposes, we’re not going to need a dictionary. Your budget includes four elements. The first part involves tracking what you spend – everything. The second part is forecasting what you will spend during a month. That forecast includes everything you will spend. The third part is to compare what you thought you’d spend against what you actually spent. And the fourth and final part of this process is to change your behavior (or budget) to reflect the reality of what you spend and what you can afford. We’ll get to this shortly.

3. Get Family

In order to successfully stick to your budget you have to get “buy in” from your family. Without everyone being on board it will be very difficult to stick to your budget. You’ll work at cross purposes and waste energy in disagreements over your spending. The best way to get everyone in your family on the same page with you is to explain what you’re doing and why. Explain why you think your family needs a budget and what’s going to change.

4. Get Tracking

You can track your spending in many different ways, but the key here is to do it such a way that is simple and fun. You need a system or you will stop tracking your expenses and all the previous steps will have been for nothing. There are different levels of tracking. One very easy and simple tracking method is to just look at your bank statement. It tells you what your total withdrawals are for the month. That, in effect, tells you how much you’ve spent. So one very easy way to track your spending is to just keep a tally of your total withdrawals on a month-by-month basis.

This is a great strategy but you may need more details if you want to make better spending decisions. In other words you might figure, by following your total withdrawals from your bank account, you spend $7,000 on average each month. But until you know how that $7,000 is being spent every month, it’s tough to know how to change your spending behavior. And in order to have that information, you need to either write down what you spend or use tracking software.

I personally like to use budgeting software because the idea of writing down what I spend and transferring that data to my computer gives me nausea. I’m just not that ambitious. It’s too much work, and as a result I won’t do it. If that describes you, get a budgeting tracking package.

There are a variety of programs available. Some are free and some aren’t. My favorite is YNAB (You Need a Budget) because it handles all four phases I mentioned above. It helps you forecast your spending, compare the forecast to the actual and then determine what you need to change to get on track.There are other options as well. No matter what you choose, just make sure you get a program that allows you to download the data from your bank and credit cards. This way, you can update your budget in a less than 30 minutes a month. And because it’s so easy, there is a greater chance that you’ll stick to it.

5. Get Forecasting

After you track your spending for a few months you’ll be able to estimate what you’re going to spend in the months ahead. You won’t do it perfectly but that’s fine. You’ll be blindsided by non-recurring expenses like annual insurance premiums and unexpected repair bills once in a while. That’s OK. This isn’t pass/fail. You get to fine-tune your forecasts over time. You’ll see that by continuing this process, you‘ll get closer and closer to the real number that represents what you spend on a monthly basis.

At this point, especially if you use a budget tracking software package, you’ll know where you have problems with forecasting. In other words, there will be some unavoidable expenses that you’ll forget about. These are typically the annual or semi-annual expenses and/or the unforeseeable but completely predictable repair bills. Don’t assume just because you didn’t forecast an expense that you’re overspending.

However, there will also be areas where you are overspending. When you look at your actual numbers versus your forecasted numbers, you’ll know exactly where those problems are. The question is, are you willing to change your financial behavior? If not, why not? And if not, you must change your forecast budget to reflect higher spending.

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