Building Your First Budget
Achieving a healthier financial standing doesn’t start with sporadic spending and ignoring each item on your statement as you pay it month to month. By building and following a budget, you are able to be the one in control and have a strong understanding of what goes in and out of your pocket every month.
Having an understanding of the different components to a budget as well as following some helpful organizational tips can set you up to make meaningful strides to getting rid of debts. These steps will set up a solid foundation to prepare for life before and after retirement.
Outlining Income
Before anyone can spend money, you have to earn it. Writing down or adding in your monthly income to a spreadsheet will help you visualize the size of the ‘pie’ you have to work with. Even if you know this number, it will helpful to have it written down to compare to the expenses and discretionary spending as you go along.
Acknowledging Debts
No matter how much you try to forget and sweep debts and loans under the rug, they aren’t going anywhere. Writing these down in black and white give you a clear goal of where you are headed. By preparing a budget with these values included, you will have a direct, positive impact in getting them under control as quickly as possible.
List Your Essential Expenses
On a piece of paper or in a spreadsheet, list out all of the essential items that you have to pay for every month. I’ve created a sample sheet below, we’ll revisit the bolded items a little later. Take a look through to see the types of items I’ve included:
There are 4 main categories that you should consider: housing, food, transportation, and general/miscellaneous spending. Housing is typically a person’s biggest expense followed by food or transportation as 2 & 3.
What Does ‘Essential’ Mean?
We need to be realistic about what we say we need to spend money on. If your monthly estimated food expenses are north of $450 for a single person, daily trips to Starbucks as you head into work might have to be reevaluated. A mode of personal transportation is necessary who doesn’t live in a city that has a robust public transit system. That being said, a lease on a brand new car may not be in line with your income. I’ll be going more into detail about cars and how to calculate what you can afford in another post – but for now, it’s important to be pragmatic and remember that our goal is to save money.
Cutting Costs
There are number of areas that are typical culprits for high, unnecessary spending. I’ll outline a few here with some tips on reducing these costs to make for a healthier budget.
Food
We’ve already brought this up, but it is very common that this is an out-of-control category for most people. Constantly going out for coffee in the morning, out for lunch, and late night drinks at the bar – will easily suck up all of your hard earned money and will put your future-self in a compromised position.
Tip: Focus on bringing more of your meals ‘in-house’. Grocery shopping and cooking/prepping meals at home is significantly cheaper that eating out. While a single lunch may be $12, you can likely prep that same meal at home for $2-3.
This doesn’t mean you should never go out to restaurants or bars. It can be a nice treat for yourself and a social event in meeting with friends, but it’s important to realize the inflated costs and to try to make most of your meals at home.
Transportation
I also mentioned this one above, but driving around a fancy car that you can’t afford will only lead to stress and less money in your pocket down the road. I’m not just referring to luxury brands – ‘reasonable’ brands like Honda and Toyota can average around $30,000 for a decently spec’d sedan or crossover. $30k at a 3% interest rate for a 5 year loan is ~$540/month. That is a lot of your money getting used up, especially for something that is constantly depreciating in value.
Tip: Buying the same model you were looking at on the lot, but as a used car 2-3 years old will allow someone else to take on the initial hit of depreciation to the car giving you a significant discount for a slightly used vehicle.
Maintenance is also something that can be a big financial burden as a car gets older. Keep this in mind while picking out a car. The big brands like Honda, Toyota, and Hyundai have a great record of reliability compared to the luxury European competitors.
Housing
This one can be a bit more difficult to cut down on depending on your area and what is available at the moment. If you are in a situation where you have a spare room or are in a larger place that you don’t need, either renting out that spare room or moving into a more appropriately-sized apartment/home can give you a few extra hundred dollars in your pocket a month
Subscriptions
As subscriptions to digital services (video, shopping, games) are becoming more popular, we can easily ignore how quickly they build up. Combining accounts with family or getting rid of services that you rarely use can make a meaningful impact in decreasing the amount of money flowing out every month.
After the Essentials, Focus on Savings
Now that we’ve gone through how to evaluate our ‘essential’ items, I’ve updated a couple of my items with better decisions:
In this scenario, let’s say my monthly income after tax is $2,850. With my new adjusted expenses of $2,245, I have $605/month that is not account for…yet.
There are a few questions that we need to ask ourselves to move forward with how to apply this money:
Do I have outstanding, high-interest debt? If yes, apply all that you can of your remaining money to pay this down.
No debts? Do I have a proper emergency fund? Not sure? Check out my post – What’s an Emergency Fund? If you don’t, it’s best if you put this money directly into a savings account.
No debts? Have an emergency fund? Now it’s time to invest for retirement.
It is good to create a number that you must save every month. Treat this amount just as you would a bill. For my budget, I will choose to save $500 of my $605 into my emergency fund. I am getting close to reaching my 6-month mark and will plan to switch to retirement investments next.
Lastly, Spend the Difference
Now, I’ve left myself $105 of discretionary money to spend on shopping, travel, or a concert. How this money is spent is totally up to you and should be for something fun! You should feel good knowing that you have properly organized your spending and are allocating a good amount to savings. As you expenses change over time and your income increases, be sure to increase your savings rate proportionally. If you have $1,000+ of leftover money down the road, you won’t want to only be saving the original $500. Be sure to revisit and rebalance your budget as your financial situation changes.
IMPORTANT, Keep With It!
Track, track, track! Like a diet, a budget is only as effective as the person following it. Going back to sitting on the couch instead of spending an hour at the gym can undo months of hard work and discipline.
There are several apps out there that help with tracking your expenses and breaking down the different categories. I will be writing a post on a few of these options, stay tuned! Alternatively, you can always use a simple spreadsheet or pen & paper. Any method to ensure that you stay on top of every penny that goes in and out is all that counts.
Tip: Set up recurring monthly/bi-monthly reminders in your phone to keep up with your budget. If it is more helpful, get your friend or partner to be the friendly reminder to check in on yourself. Finding someone that is also creating and following a budget can create mutual accountability.
Wrapping Up
This is a good starting point for evaluating where you stand. I will be writing more on the subject in the future about using different apps to track, moving from cash savings to investment allocation, and tips on cutting back when things can get out of hand.
Comment and let me know if this is your first budget and how things go. Are there any topics from this post that you want me to explain in more detail?
Talk to you soon!