It’s the end of the month and, once again, you just don’t know where the money went. Maybe this was finally going to be the month you started saving toward your dream house or paid off that credit card, but it just didn’t happen. Where does the money go?
Many people have a very inaccurate guess of how much money they have coming in and going out each month. As a financial adviser, I was frequently asked for advice on how to create a monthly budget. An accurate budget and the will to follow it are the foundations to meeting your personal financial goals. The actual steps involved are quite simple, but it does take some time and discipline to do it effectively. Here are a few ideas to help you get started.
Step 1: Write down all of your income and expenses for at least three months. Everything you buy, including that coffee from the drive through or the candy bar from the vending machine at work, needs to be accounted for. Those small purchases can really add up over the course of a year. I had a client shocked to find out that she was spending $500 per month just on coffee and daily fast food lunches. To track your expenses, either use a good old fashioned notebook or log them on your phone as you go. However you decide to track them, the important thing is consistency, and if you have a significant other, that both of you are on board.
You’ll want to track your income and expenses for at least three months to create a accurate picture of your monthly finances. Some bills are not monthly, so you need to make sure you are able to capture everything. It also helps to get a better picture of bills that fluctuate month to month. On the income side, maybe your paycheck varies month to month depending on hours or commissions. Your budget is only going to be as good as the data you provide.
Step 2: At the end of the month, add up what you’ve made, what you’ve spent, and figure out how much, if any, is left. An easy way to do this is to create a basic spreadsheet on your computer and simply list all sources of income on the top—your job, interest, and investments, and put all of your expenses underneath with different headings for the things you spend money on such as housing, utilities, food, entertainment, medical costs, and transportation. Then simply subtract your expenses from your income and see how you did.
Step 3: Prioritize your goals and create a working budget. When you have three months of data, average each category and see what a typical month looks like. Are there any expenses that surprise you? Are there any you feel you could trim? This is a great time to have a conversation with your significant other to prioritize and decide on your shared goals. Talk about how much those goals will cost and figure out a timeline to achieve them.
From tracking your income and expenses, you already have the framework for your working budget. Start with your monthly income. This is the starting number you have to achieve your goals and pay your expenses. Start with your fixed expenses that are necessities for living such as utilities, housing, and food. This does not mean your dining out budget. Next, pay yourself. This means, pay yourself the money for your goals before you decide on your discretionary budget. You may not be able to do everything right now, so what is the most important to you? This is where the prioritizing comes in. How much will it take to pay off that debt, retire in 15 years, or buy that dream house? How soon do you want to do it?
Once you have paid yourself, use the remaining amount to figure out your discretionary budget. This is where things like entertainment, cable, dining out, clothes, and gifts go. None of these are as important as your personal financial health and working towards your goals, so if anything has to give, I would suggest that this is the category that gives.
You may wind up with a negative number as you work out your budget the first few attempts. This is very normal; it just gives you the opportunity to decide what are really the most important things to you. This helps you to decide where to cut and feel better about whatever sacrifice that may be, or maybe it makes you seek out ways to make more money. This does not necessarily mean a raise at work or working more hours. Remember, your investment income also counts. Are there any ways to replace spending with investments that will pay you?
Congratulations! You have now taken a big first step toward creating financial success! Keep tracking yourself against your budget and see how you are doing. Trust me, it can actually become fun at the end of the month when you start finding ways to come in ahead of your budget. Maybe you can reach those goals even faster than you imagined!
