Budgeting is a hugely important step in getting financially integrated. A good budget helps you work out how much you have to invest and grow your money. Without a basic budget you’re flying blind in terms of trying to achieve your financial goals. So where do you begin?
Work out your average income over a 3 month period.
This should hopefully be pretty straightforward if you work a fixed number of hours at a fixed rate every week. If you have a less routine schedule, try and work out an average income over a 6 month period, or take the month thats closest to what you’d typically work.
Start with a review of your spending and expenses
If you’re spending has been fairly consistent over a 3 month period, thats a good enough set of numbers to use . If however you’re spending is very different from month to month across these three months, then its better to go back a little longer (and I’d also see if you can determine why you’re spending was so different over the 3 month period if you don’t already know why!). The danger with using just a 1 mth time frame is you won’t have a good enough measure to know if you’re spending is typical, above average or below average.
If you have a credit card that you put most of your spending on, you’re already off to a good start in terms of getting the data. Just remember to add back any spending that you know wouldn’t be on the statements (rent, mortgage payments etc).
There are some tools out there that can do a lot of the heavy lifting for you. Mint.com is one that I have looked in the past. It does a great job of pulling in expenses from a variety of sources to give you a consolidated view of your expenses (and also other things like your total debt position and net worth (if you are interested). Its also a free service. Otherwise, a basic spreadsheet can help with tracking your expenses and putting them into different categories.
What’s essential and whats discretionary ?
Try and estimate what’s “essential” spending versus “discretionary” spending. Essential spending is spending on items that are, well, essential. This includes things like your rent/mortgage payment, gas bill, electricity, internet, phone bill, food (exclude restaraunt spending here for the month), car loan payments, gas etc. Whatever is left over becomes your discretionary spending.
Subtract your average income from your “essential spending”.
What you have left over is what I call your “savings opportunity”. It’s what you could save, not necessarily what you should save or may want to save. If your average income doesn’t exceed your essential spending, that’s a big problem, which likely has you in some measure of debt. You then need to aggressively revisit the essential spending to see if there are any opportunities there to save (ie increasing income through shift work, or possibly share accomodation to reduce some expenses.
Review the items in your discretionary spending bucket
Look long and hard at whether there are things in here that you can’t do without. The idea here is to add back to the essential spending bucket those items from the discretionary bucket that you know you can’t do without. Lets call this bucket the “Needed Spending”. Increase your “Needed Spending” by 5% to cover yourself for unexpected increases. Be honest with yourself here, the budget won’t work if you don’t properly account for these items. If you know you will need that daily coffee, or those new pair of shoes once a month, add them in here. Otherwise you may get frustrated at your inability to meet your budget, which only make you think that budgeting was a stupid idea!.
Review your overall budget.
Average Monthly Income- Monthly Essential Spending – Monthly Needed spending = Monthly Savings Target
Track your performance!
The last, but probably most important part of the budgeting process is to review your performance against the budget!. A budget is no good if you dont compare it regularly to how you actually did. Hopefully you find that you are pretty close to what you estimated you could save, but if you are not, take some time to review your actual spending and see where you are off, and understand why you are off. If its some one off expenses that won’t repeat, its not such a big problem, but if its not, you may need to take the time to review your budget and make some tweaks.
I’ve outlined a framework above which should provide most of the basics for putting a budget together. Like any framework, it can always be modified and adapted to suit your needs. However, if you can get a budgeting process put in place you’re well on your way to getting the basics of being “financially integrated”. Budgeting takes some work and its sometimes boring, but its helpful to understand what you spend and what your potential is to save an earn a return on that saving. There may be further opportunities to more aggressively save and you can work out if these are right for you.
I’d love to hear if any of you have different ways that you pull your budgets together or if you think there is anything I’ve missed. Happy budgeting!