How to Make a Budget That Works

Part 3 in my series, Baby Steps to Financial Freedom

 A brief recap: What does money management have to do with your health and well-being? Here’s my reasoning…

• Stress weakens your immune system, increasing your risk of illness.
• Money (or a lack thereof, whether real or perceived) is a top stressor.
• Responsible money management greatly reduces stress, thus reducing risk of illness.
• Like other areas of conscious living, personal finance is about 20% head knowledge and 80% behavior.

Why Budget?
“Suppose you want to build a tower. Will you not first sit down and estimate how much it will cost to see if you have the money to actually build it? Because if you lay the foundation and then run out of money, everyone who sees it will ridicule you, saying, ‘This guy started to build and ran out of money!’” Luke 14:28-30, paraphrased

10-year-old unfinished shopping mall in St. Lucia

While on our honeymoon in St. Lucia, my husband and I saw this unfinished shopping mall situated along the island’s major thoroughfare. Its owner ran out of money before completing it, and, as I recall, it has sat there for ten years or more, speaking every day to the owner’s poor planning.

“A budget is simply telling your money what to do instead of wondering where it went,” says Dave Ramsey. In the US in 2007, the median household income was $50,233. If you wanted to build a $200,000 house, you’d sit down with your builder and plan every detail of the house ahead of time. But you don’t know where the next four years of your income is going?

You hear it on the news: The housing bust and resulting economic downturn happened largely–not exclusively, but largely–because people made irresponsible choices in their personal finances. They failed to “first sit down and estimate how much it will cost to see if they actually had the money.”

A year ago I got laid off from a part-time job which was my main source of income at the time, and my most steady and reliable. But because I live within my means, know exactly how much money I have, and how much I need to live on, I didn’t panic. I don’t mean to sound self-righteous; I just want my experience to convince you, if it can, of the peace budgeting provides.

There it is again: the “B” word. We don’t typically like the word “budget” because it conjures up images of living on beans and rice and never getting what we want. We equate it with deprivation. Maybe someone’s used a budget to abuse or control you, or you’re afraid of what you’ll find if you sit down and look at your real financial situation. (Been there!) But “you’ve got to learn to manage your money, or the lack of it will always manage you.” (another Ramsey-ism.) Budgeting is a way of living on purpose.

Maybe you’ve tried budgeting before, like I had, and it never worked, like mine didn’t. Reasons for this could be

• You left things out of your budget
• You made your budget too complicated
• You didn’t write your budget down
• You made a budget, but didn’t actually follow it 

If agreed upon by both partners and actually followed, a budget eliminates many of the money fights so common in marriage. A budget also removes the guilt or fear associated with some purchases; ever written a check at the grocery store and had a nagging fear that it might bounce?

I’ll assume you’re convinced and move on to the how-to’s. 

 
Track Your Spending
First write down everything you spend for a month, or at least two weeks. This will give you an idea of how much you spend on different things and enable you to make a much more accurate budget. The following chart is based on Dave Ramsey’s detailed budgeting worksheets, which helped me see where I’d left things out of my past budgeting attempts. Your spending might fall into any of these categories:

If you need to, add your own categories. Be as thorough as possible. This exercise can be surprising! What you spend your money on reveals what you value.

 
List Your Income
List all your sources of income. Besides your regular salary, do you expect a bonus? Have a side business? Receive interest or dividends on a regular basis? Receive rent, alimony or child support? Unemployment or social security? A pension payment? Disability income? Money from a trust fund? Add up how much money you expect to receive this month. (I know, my income is irregular too; I’ll talk about that in a few paragraphs.)

Now use what’s called a zero-based budget to “spend” every dollar on paper before you get it. Use your month of tracking what you spent to create a personalized budget using the same kind of worksheet you tracked your spending with. Add up what you plan to spend in each category, subtract your total household income, and it should equal zero.

If it doesn’t, you have some recalculating to do. Is it a negative amount? You’ve spent more than you earn. Is it a positive amount? You have more to spend. Don’t just leave this extra—plan how to use it.

  
Lump Sum Payments
Some items you don’t pay for every single month, like real estate taxes, homeowners or renters insurance, maybe car insurance, certainly car repairs (unless you have a clunker), probably vacations… Estimate how much you spend on each of these items per year, then divide that number by 12 to determine how much to budget for them each month.

How to Keep Track
Now you need a tracking method for how much of the money in your bank account belongs to each category. Quicken is a popular one, but I just use a plain old Excel spreadsheet. Whether you use handwritten notes, a spreadsheet or something more technologically advanced, find a method that works for you and that you can stick with.

Whatever you use, be sure to balance your checkbook regularly and reconcile it with your bank statement. Fail to do this and you’ll inevitably end up with less money in the bank than you thought you had. (Been there!) Occasionally you find more in the bank than you thought you had. (Been there too! It’s much more fun than the former scenario…)

  
Recommended Percentages
You’ll notice the column on the far right says “Percent of Income.” The following recommended percentages work for most budgets.

• Charitable Gifts 10-15%
• Saving                   5-10%
• Housing                25-35%
• Utilities                 5-10%
• Food                      5-15%
• Transportation  10-15%
• Clothing               2-7%
• Medical/Health 5-10%
• Personal              5-10%
• Recreation          5-10%
• Debts                    5-10%

These are just generalizations. If your income is low, a higher percentage goes toward necessities. If your income is high, put a higher percentage in savings.

 
The Envelope System
Studies show that people spend more—in one study, 47% more!—when using credit cards; it “hurts” less than watching the cash in your wallet dwindle. To counteract this, try using the envelope system. Each time you get paid, withdraw the budgeted amount of cash for say, groceries, and put it in an envelope marked “Groceries.” Whenever you shop for groceries, only pay for them out of that envelope. Consider using the envelope system for the categories marked with an asterisk, since it’s easy to overspend on these.

 
Budgeting to Blow
Notice the category called Blow. This money serves four purposes:

1. You will have an unexpected expense that may not qualify as a full-blown emergency.
2. You will overspend.
3. You will make mistakes in your calculations.
4. At the end of the month, if you haven’t had any unexpecteds, overspent or made any mistakes, use this money to blow on something fun and reward yourself for your discipline!

How I Budget On an Irregular Income
As a self-employed massage therapist, wellness coach, freelance writer, and now blogger, I’ve probably never earned the same amount of money per month. Here’s the system I developed that has worked for four and a half years.

I can pretty well predict a baseline of how much I expect to earn in a given month. (It helps that I’ve paid attention for the last four and a half years!) I use that baseline to create my zero-based budget, and then I plan how to spend any extra money that comes in. (A debt snowball, my emergency fund, a trip, a big-ticket item I want, a category I overspent on the month before…) Naturally, it’s more helpful to underestimate than to be overly optimistic.

Next, I divide the amount I plan to spend in each category by my baseline expected income to get a percentage. For example, say my baseline expected income is $3000 and I plan to spend $500 on groceries.

Each time I get money, I plug in those percentages to determine how much to put towards each category. To continue my example, say I earn $1200 at one time out of my expected $3000 for the month.

I have $200.40 to spend on groceries until the next time I get money. I repeat this step for every category in my budget.

Here’s another example: I spend $10 every three months on a prescription for thyroid medication. It’s only ten bucks, right? It’s tempting to just budget for it once every three months, but I’ve found it easier just to budget for it all along. So,

I round it up to $4, and the third month I’ll only need to budget $2.

Continuing the $1200 example from above,

As I write this out it sounds pretty nerdy. But hey, it works, and it’s gotten me to where I am today, so nerdy it is!

There are advantages to budgeting as a self-employed person on an irregular income. When I make a budget and I see that I’m going to need or want more money that month, I’m motivated to try to get more clients or sell another article. On the flipside, I can see how little I can get away with working and still meet my financial goals.

I’ll add here that I’ve used the same budgeting technique on my business finances, and for four and a half years my business has remained debt-free and built up a small emergency fund.

 
Conclusion
It sounds like a lot of work, doesn’t it? I read recently that a space shuttle uses 67% of its total fuel in the first 2 minutes and 12 seconds after launch. This principle carries over to nearly every area of life: Far more energy is required to get something going than to maintain it. It will take time to get your personal finances going, but think of it as an investment. At this point, I only need to spend about an hour each week maintaining ours.

In the first few months, your budget will not be perfect! You’ll forget things. You’ll underestimate. Don’t worry about it, you’ll get better. I still underestimate sometimes, but I’ve stuck with it for four and a half years and it somehow works out.

My earnest desire is for you to find that “freedom to fly” by exercising discipline!

Questions or comments about this article? Contact me.

Other posts in this series:

• My Journey Towards Financial Freedom
• Dave Ramsey’s Seven Baby Steps

 
Stay tuned over the next few weeks for upcoming posts in this series:

• How to Do a Debt Snowball
• Myths About Debt: Why It’s Not a Wealth-Building Tool
• The Necessary Components of Every Financial Plan
• How to Calculate Your Net Worth
• Extra Wealth: This is What It’s All About!