Keeping a budget isn’t just about controlling your spending but can also help you fix three of the worst financial problems
Budget is the four-letter word of the personal finance world. We all know we should be tracking our spending but how many people actually do it?
The problem is that budgets are for living within your means, planning out your expenses to cut back and be able to meet our income.
So first, people avoid budgets because they don’t want to cut back. We know there are probably places we could save, expenses we could cut, but we’re afraid to look because then we’d have to follow through.
But even people that aren’t struggling to meet their expenses should be putting together a budget. Having enough money to pay the bills is almost as bad as not having enough because you’re never forced to actually look at your spending.
A lot of folks out there are paying the bills every month but have little money left for saving. They aren’t in any immediate financial danger so they don’t worry about it…and then they get to 65 and have nothing saved for retirement.
Everyone needs to create a budget. Whether you’re struggling to pay the bills or have more than you need, you need to create a budget.
You see, a budget isn’t just about living within your means. A good budget will help you solve financial problems you didn’t even know you had.
Let’s look at three of the biggest financial problems that affect nearly everyone and how a budget can pull you from a bleak financial future. I’ll then walk you through how to create a budget that works, one you can actually keep, and some budget tricks you won’t believe.
How to Stick to Your Budget
When we think about our budget, we should not only take into account the price of the item and its quality. We should also think about how it will affect our future. If we buy something that does not last for a long time or that is not worth the money we spent on it, then we are just making a bad investment in the future. It is important to prepare ourselves financially before making any decision and to know what it means if we don’t stick to our budget.
The first thing you can do in order to stick with your budget is to plan ahead and set a budget for yourself. This way you will know what you want to spend and you won’t be tempted by things that do not fit in your plan. Do some research beforehand so that when you see something that looks interesting, it will be easier to resist.
Your budget is a personal decision and should not be dictated by others. It's not a race to see who can spend the most money, it's a time to enjoy the experience.
The key to sticking to your budget is knowing how much you want to spend in advance. That way you can work backwards from your desired monthly or weekly budget, and plan accordingly for the entire month or week.
Don’t forget that there are ways to save money when it comes time to pay for certain services. For example, if you have a cell phone plan with unlimited data, you might be better off switching over to a plan with limited data because of the difference in price. It’s worth considering these options before renewing your contract with your current provider even if it means spending more up front.
Sticking to your budget is one of the toughest things to do. It's important to know how much money you have and what you can spend on. You want to make sure that you are not wasting your money on things you don't need.
There are some ways that might help you stick to your budget:
- Take a look at all the expenses for this month;
- List down only the things that you need;
- Make an estimate of how much it will cost for each item on your list;
- List out what items are most worth it and which ones are not worth spending any money on;
- Put away some money every week, or week and half, into a “savings” account so that when an emergency arises, you will be able to cope with the situation more effectively
How much should you set aside each time?
Every person's situation is different, so there's no one universal answer. The crucial thing is to keep enough money aside so that if you were to face a difficult or uncertain situation, you would have the means to deal with it.
3 Financial Problems You Didn’t Know You Had
One of the biggest financial problems many people face is that they just don’t know where their money is going. They have enough to pay the bills and maybe the family has a few weekly traditions eating out or whatever the case may be.
Not knowing where your money is going leads to what I call leaky faucet finances.
After sitting down with people to create their first budget, they’re amazed at the little things, the drip-drip-drip of spending, on which they spend every month. Their money is just swirling down the drain and they don’t even know it.
We’ll look at some average spending numbers in the next section and some ways people lose money on little things without knowing it.
Another huge financial problem for many people is that they have just enough to pay the bills but not enough for saving. Surveys show that two-in-three households don’t have enough saved to cover a $500 financial emergency.
Those families are just one car repair, just one medical bill away from financial ruin.
And if you’re lucky enough to pay for the occasional financial emergency, there’s no way you’re ready to cover living expenses in retirement. The average American has just $100,000 saved for retirement, enough to provide about $4,000 a year in living expenses.
But if you’re able to cover your monthly expenses, there’s no immediate pressure to budget. You might even be able to put a little away each month even if it’s just a fraction of what you’ll need to meet your future goals. Your income matches your spending, so what’s the problem?
I call this Don’t Worry, Be Happy finances.
Unless you are making so much and saving more than you’ll ever need in retirement, and how many can say that, then a budget will help you maximize your saving. Again, a lot of the people I sit down with to budget and plan how much they need to be saving are shocked at how far they were behind the mark.
Creating that budget shakes them from their financial apathy. Ignorance is definitely not bliss when it leads to your future financial disaster and a budget is your way of changing that future.
Finally, there is such a thing about being too frugal. One of my first financial blunders was working myself too hard and saving too much. I hated my first job and put everything I had into saving for early retirement.
I didn’t think I needed a budget or financial planning because I was saving every penny. I had roommates helping to pay the mortgage. I so graciously accepted every invite to eat with my parents. I followed every money saving tip you could imagine.
Why would I need a budget to tell me I was saving as much as possible?
The problem was that I was getting burned out on frugality and going on spending binges a couple times a year. Every spending spree would set me back months of savings.
I call this the financial equivalent of yo-yo dieting.
One of the most important parts of your budget is going to be paying yourself, budgeting spending on going out to eat and enjoying life. Understanding where your money is going and how much you are able to save will help keep your goals realistic. You’ll be able to balance saving and spending, enjoying the now while still planning for the future.
Whether you see yourself in one or more of these financial problems, a budget can help you get back on track. Now, the only thing left is to create a budget you can actually keep.
Budget Strategies that Work
People drop budgets like they drop their keys. They do it so often that it feels like it’s no big deal.
There are two problems with budgets that make them completely unworkable for most people. First, we have no idea how much we should be spending. We’ve lived so long with some expenses that we just take them for granted. It’s how much we spend and that’s how it is.
The second problem is that 99% of budgets are so far off that failure is guaranteed. Between missing little expenses and infrequent bills, budgets miss what we’re actually spending by hundreds a month.
What happens is that people come up short even when sticking to their widely inaccurate budgets. What’s the use if you stick to your budget and still can’t save money, right? So people give up.
We’re going to tackle these two problems in reverse so let’s first look at creating an accurate budget that will give you a detailed picture of your spending.
Putting together an accurate account of your current spending isn’t going to be something you do in a couple of minutes. You need to really think through everything you spend money on including infrequent and occasional expenses.
You see, it’s these infrequent expenses that throw people’s budget off and make them impossible to follow. It’s easy to list out the monthly bills like utilities, mortgage and groceries. People forget to add in expenses like annual memberships, vacations and common repairs.
When these infrequent expenses come up, they smash your savings goals and discourage you from staying on budget. The solution is to include every-single-expense in your budget, the monthly expenses and a monthly amount for everything else.
Before you try putting together you list of expenses, print out your bank and credit card statements for the last year. Don’t just guess at your bills, actually print out your statements so you have something to work from.
Start by making a list of all your expenses:
- Utilities and waste – these can fluctuate so make sure you take an average of both winter and summer months.
- Cable, internet, car and health insurance, childcare, mortgage and other fixed loan payments are expenses that usually don’t change month-to-month.
- Gasoline is a very commonly underestimated expense. It helps to use a credit card for all your gas over a few months. That way you can get an average spent each month, just remember to always pay your card off at the end of the month.
- Groceries is another expense you’ll want to track over a few months to get an average estimate. This doesn’t include eating out for lunch or dinner, only the money you spend at the supermarket for food. If you commonly shop for non-food stuff while grocery shopping, save your receipts and subtract the non-food purchases to put them in other categories.
- Most people spend more on clothing during specific times of year like holidays and when the new school year begins. This makes it super important to track your spending in those months as well as others.
- You’ll be able to budget for some car and home repairs. If the furnace is 15 years old and has been acting up, you know it’s going to need replaced soon. Unfortunately, it isn’t always so easy to budget for the unexpected. The convention is to budget about 1.5% of your car and home’s worth each year for repairs. So if together your home and car are worth $300,000 then you multiply that by .015 for an estimate of $4,500 in annual expenses. Then divide that number by 12 for your monthly budget.
- Separate out as many miscellaneous expenses as possible into their own line in your budget. Don’t just lump eating out, entertainment, household products and beauty/grooming in one line. You need as much detail as possible so you can get the most accurate picture and cut if necessary.
- Other infrequent expenses you need to budget for include property taxes, car registrations, subscriptions, professional dues, oil changes, copayments on dental and medical checkups, and extracurricular activities for the kids. All of these need to be divided by 12 to get a monthly amount to save in your budget.
- Budgeting for saving? I didn’t forget it but you really need to get an idea for how much you need to save so you can put that at the top of your budget. I’ll explain why having saving at the top of your budget is important pretty soon and how to calculate how much you need to save in this article about getting started investing.
So you’ve got estimates for how much you spend in each category every month. The problem is that some expenses are going to be higher or lower in different months. You averaged your annual clothing spending to an average monthly expense but you’re still going to be spending most of your clothes budget in a few months. The same with your utility bills, especially for those further north where winter heating can cost double or triple the summer bills.
It's a problem for which there really isn’t a perfect solution. In the months where your bill in a certain category (i.e. utilities) is lower than estimated, put the extra in savings. Remember that there are going to be months where the bill is more than the average. In categories like clothing where it’s up to you how much you spend, remember that you need to underspend in some months to afford the months when you might need new uniforms or holiday gifts.
For other categories of spending that come around infrequently but on which you have no control; so I’m thinking of things like vacations, repairs and annual subscriptions, you need to sweep your monthly budget for these into savings so you can pay the bill when it comes due.
This is where a little financial discipline comes in handy. You’re going to see your savings account start creeping higher. It’s going to be a great feeling and take a lot of financial stress off your shoulders. You’ve got to remember that this money isn’t really a financial cushion or an excuse to splurge a little. This is money you know you have to spend within the next few months or a year. It’s not extra money, just money for which the bill hasn’t come due yet.
The income part of your budget is the easy part. A lot of experts will tell you to include all forms of income here including expected bonuses, dividends and interest income on investments. Unless you’re living off your investments then dividends and interest should stay in your investment account, helping you to reach your financial goals. You also don’t want to be relying on an annual bonus or salary increase to make ends meet.
I would recommend just using your normal salary for estimating income. If you earn commissions as a regular part of your income, add up the commissions over a six- or twelve-month period to find an average monthly estimate.
Remember, this is all just to get an idea of your spending and average out your total expenses for a monthly budget. We’ll look at working with your budget to increase savings and some budget tricks in the next section.
Now back to that first budget problem, not knowing how much you should be spending or what expenses are truly wants versus needs. Growing up, having cable TV was a luxury. We might get cable hooked up for a few months each year but it wasn’t something we expected. Now we hardly think twice about paying for cable TV, at least the basic package.
I like to start with the Department of Labor’s Consumer Expenditure Survey. It’s a regular survey of consumers about their spending and can help to see if some of the expenses on your budget are way out of line or about average. The information is available for lots of different groups including by age, region of the country, city size so you can use the overall data or really get an idea of what other households similar to yours are spending.
Looking at the spending survey, you see that the average household spends about $4,000 a year on groceries. Obviously, your spending on food is going to depend on how many are in your family. This survey estimate is just something to use as a reality check on your expenses. If the average household spends $2,661 eating out each year or about $220 a month but I’m spending $400 then maybe I need to rethink my budget for that category.
Another way to get an idea for how much you should be spending on different categories is one of the many Cost of Living calculators on the internet. These are most commonly used when people move cities and want to compare costs but they can also be used to find how much people are spending on living expenses in your city. Again, it’s not an absolute rule for how much you should be spending but just a check on your current budget.
How to Keep Your Budget
With this initial look at your budget, you can attack the three financial problems head on and with all the information you need.
- You know exactly where your money is going, for better or worse.
- You’ll find places to save money to plan for your future
- You can relax a little in your budget, paying yourself where you need to and saving where you can
For some, looking at a real budget is going to mean cutting some expenses. Even some people that thought they were making ends meet before may find that once they include absolutely everything, they are coming up short.
Believe it or not, this is a good thing.
Just because you weren’t budgeting for those other expenses or didn’t budget in saving for things that only need paid a few times a year doesn’t mean they weren’t going to happen. By not budgeting, you were just setting yourself up to be surprised when the bill came due.
It’s one of the biggest traps in personal finance. People think they’re doing great and then get slammed with a few unexpected bills all at once. The furnace breaks, the kids need school clothes and the property taxes are due. You scramble for the money, maxing out the credit cards and taking cash advances which send you into a debt trap that you’ll never get out of.
It might suck to realize you need to cut a little from your spending to meet all your infrequent and unexpected expenses but it’s better than getting caught off-guard when they come.
Listing out your expenses, your real expenses instead of how much you ‘think’ you spend on something, is going to open your eyes to overspending. When you see how much you actually spend on fast food or drinks or a lot of the other ‘little things’ we buy every day, you’ll be able to find savings where you thought none were possible before.
Budget Tricks that Rock
Finding extra room in your budget isn’t always so easy. Whether you need to save an extra $50 a month or an extra $500, we get used to our spending habits and it can be very difficult to change them.
That’s why I wanted to close up this section with some great budget tricks, ways to find places in your budget to cut and some ways to save money. Try out just a few of these ideas and you should be able to balance out your budget and get back on the path to saving for your financial goals.
The first budget trick is something I mentioned earlier but wanted to wait to really detail it out. I call it turning your budget upside-down.
You see, the typical budget starts with all your expenses, taking everything out of income. At the bottom of the list, if anything is leftover then that’s the money that goes into savings. Ok, if any money is left over it’s usually split between having fun and a little for savings, right?
This leaves absolutely no room for saving. Seriously, how many people have much money left after budgeting out all their expenses? Most don’t have enough and have to start cutting expenses just to get back to even, not including savings.
Turning your budget upside-down means taking out savings first, before your expenses. Plan on taking out a fixed amount, however much you need to reach your retirement goals, or a percentage of your income. I’d recommend starting at least 10% of your income but you really should plan it according to how much you need to invest regularly to meet your financial goals.
Only after this amount for savings has been taken out, then you list out your expenses. This forces you to cut spending instead of cutting savings.
Another great budgeting trick to use if you’re having trouble finding where to cut is called budget bucketing.
This is where you separate out your budget into categories, for example:
- Necessities are expenses you can’t go without like rent and utilities.
- Must haves are things that you need but maybe could cut spending a little like groceries and clothes.
- Really wants are things that you spend a lot of time using and enjoying. They may not be necessary to life but they are well worth the cost.
- Finally you might have a fourth bucket of things you spend money on that, if push came to shove, you could do without.
Budget bucketing just helps you break down your list of expenses to focus on smaller chunks at a time.
Sometimes I’ll even list out expenses without the dollar amount. Just write out your budget without the amount you spend on each item. Then put the list from most to least important or necessary.
The problem is that there are usually things in your budget, expenses you’re paying for that really aren’t that important but they don’t cost much each month. You look at a traditional budget with the amount spent next to each item and you say to yourself, “Well, I really don’t need that choco-mocha-latte every morning but it’s only $30 a month so I’ll keep it.”
All those little expenses add up and the things you could easily do without end up crushing your budget.
Looking at your budget without the spending amount lets you just start chopping away at those little expenses.
Spending challenges are becoming a popular way to change habits.
Habits are super-difficult to break. Research at the Duke University Medical Center shows that some habits even cause chemical changes in our brains so that breaking a habit can be as difficult as kicking an addiction to drugs or alcohol.
Spending challenges are a kind of cold-turkey way to kick bad spending habits.
I’ve seen spending challenges done in two ways, each with a time frame of a month or two.
- Cut spending in everything by a percentage. Any spending that can be cut gets reduced, maybe by 25% or half. Obviously you’re not going to be able to cut your rent but eating out, gifts, clothes, everything else gets cut.
- Cut spending completely in one item. I like this method because it can really show you how much you don’t need some of the stuff on your budget. When the cable TV contract is up, cut the cord for a month or two and see if you can live without TV. Cut out buying coffee outside the house for a month. There are a lot of little things you can just cut completely and most of the time, it affects your happiness way less than you imagined.
Research shows that it takes about eight to twelve weeks to form a new habit so this is the length of time you should be aiming for with your spending challenges. Even if you don’t reach all your goals, you’ll still create some new spending habits and will be better off for it.
Don’t let budgeting be one of those things you do for a week as a New Year’s Resolution. If you really take the time to put together a detailed budget and track your spending, you’ll find all kinds of money you didn’t know you had before. Knowing where your money is going is the first critical step in your personal financial planning and it’s going to make all the difference.
Read the Entire Budgeting Series
- Holiday Budgeting Tips: How to Do It Right?
- 6 Budgeting Hacks to Beat Your Savings Goals
- The Un-Budgeting System that Makes Budgeting Easy
- Top 10 Questions on Budgeting and How to Save Money
- Budgeting Help and Tips I Used to Save $54K in Interest
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.