It is a brand new year and with that everyone around me is setting goals to become more organized financially and setting up their budgets for the new year. A big question I often get asked though, is where to begin? In my 3 part mini series, How to Start a Budget, I will be talking you through all the ins and outs of starting a budget. If you haven't read my post about this budgeting series, you can find it HERE.
So for today, we are going to be talking about the basics of a budget and where to begin.
There are a few things that I feel everyone should know before starting a budget.
1. What is your income?
2. What are your fixed expenses?
3. What are your variable expenses?
4. What are your other expenses (savings, spending, budgeted expenses)
#1. What is your income
This may sound like a silly question but it is the most important aspect of starting a budget. You can't begin to start a budget if you have no idea how much money you are bringing into the household. So, get out your paychecks and figure out exactly how much money you are bringing in each month. Also add in any extra money that you may bring in (this can be from side jobs, freelance work, etc) Once you have an actual amount that you can put to your income, you can move on to the second most important part of a budget, how much money is going out each month?
Now that you know how much money is coming into your household each month it is important to determine how much money is going out of your household. In an ideal world the amount of money outgoing will be less then the money that is coming in. (We want to be in the positives not negative, when it comes to our money) For example, If you make $800 a month, we want our outgoing money to be $800 or less. If we are bringing in $800 a month but $1000 is outgoing, this means we are in the negative and we have some work to do.
Now that we know how much money is coming in and going out, lets take a look at #2 and #3 and find out exactly what our outgoing money is being spent on.
#2 Fixed Expenses
Fixed expenses are items that you generally pay every month and always stay the same. Your mortgage payment or rent payment generally stay the same each month. Other items such as phone bills, internet and cable also stay the same. Fixed expenses are the easiest expenses to keep track of on a budget. When you have a fixed expense, you always know when it is due and exactly how much you will need. This makes it easy to allocate money for those expenses. For example, if your rent is due on the 1st of every month and is $400, you know that every month you need to allocate $400 of your income for that expense.
Although fixed expenses generally are a set amount, it is important to re-evaluate them a couple times throughout the year. Look at your fixed expenses and see if there is a way to reduce the amount or if it can be cut altogether. For example, contact your phone company and see if you are eligible for a family plan that may help to reduce your monthly cost, or how about switching to basic cable instead of the premier package (or even cut it out altogether and use a service like Netflix or Hulu instead) Once you have exhausted all options in terms of reducing your fixed expenses, you can move on to the variable expenses.
#3 Variable Expenses
Variable expenses are items that again you generally pay every month but the amount always changes. Your electric bill and water bill are two great examples of variable expenses. Variable expenses are a little more difficult to budget since they are always changing however, it can still be done. One way to budget these types of expenses involves tracking past bills. Look at your monthly payment over the past 3-4 months and find the average.For example if during the past 3 months, you paid $30, $35, and $37 you can add the three payments together and divide by 3 in order to find the average amount spent. This will give you a good estimate of how much money you should be setting aside for that expense. You can also use past payments to determine how your bill may change during certain seasons. For example, if in 2013 your average electric bill during the winter was $200 and during the summer it was $70, you know that during the summer months of 2014 your budget for electric will be much lower opposed to the winter. Finally we can move on to #4 and all those extra expenses.
#4 Extra Expenses (Savings, Spending, & Budgeted Expenses)
So now that we started to discuss budgeting expenses that change, lets dive a bit further into that area. It is important to also budget for items such as food and fuel for your car. Some people might assume it is too hard to budget for these items or not realize the importance of doing so. First, lets think about the items we spend every month and how much we want to spend on them. For example, in my household we budget $400 a month for all grocery cost. Yes, sometimes I may spend over that amount but having a budget for those items allows me to put aside that money so it is ONLY allocated for those items. If I did not have some sort of budget in place it is very likely I would tap into that money and instead of having $400 for groceries I may end up with only $300. Without have a place for all your money to go, money can be spent on other things since it is there and has not been assigned a reason. This leads us into the method of zero based budgeting.
Here we have an example of what a zero based budget should look like. Now you may be wondering, what exactly is a zero based budget. A zero based budget is a budget that, essentially, starts with X amount of money and ends up with 0. The intention of this type of budgeting allows for all your income to be accounted for. Every last dime has a reason and a place that it is to be used for. In this example, we start out with an income of $800, we then subtract all of our expenses from that amount. In this example, after all expenses are accounted for, we are left with $200. We now need to determine where that $200 is going to go. We are going to allocate $150 towards savings and $50 for spending. This brings our total down to 0, this means that every single dollar from that $800 income has a purpose and a reason. Without giving your money a purpose or a reason, a budget can be useless. You worked hard for your money so don't let it go to waste. Make sure your money is accounted for and put to the best use for your particular situation.
Now that we have covered the basics of a budget, fixed & variable expenses, budgeted expenses, and what a zero based budget is, you are off to a good start. Just remember, your budget is working for you, not the other way around. If you do not like the budget you currently have, know it is OK to change it. In fact, I encourage it! Look at your budget on a month to month basis opposed to a yearly basis, not only does it make things seems a little less overwhelming but sometimes our needs change and while your budget might work great for 4 or 5 months, month 6 you may have completely difference circumstances (a new addition to your family, a loss of a job, a move, etc). Budgets are't meant to be set 100% in stone, there has to be some wiggle room. If you try to make your budget 100% set in stone, refuse to re-evaluate it and change it, your budget is going to end up working against you instead of for you. You will soon resent having a budget and that just leads to frustration and bad choices.
So remember, make your budget work for you, go over your budget on a monthly basis if needed, and know it is OK to make mistakes at first, everyone does. Just learn from those mistakes and try again. If you are too hard on yourself, you will lose the motivation for having a budget.
With that being said, this is where part 1 of this series ends. Remember to keep an eye out next Sunday for part 2, where we discuss the envelope system and how to get started.
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