Getting Back onto Financial Safe Ground

The Ultimate Budgeting Guide

ultimate-budgeting-guideFinding someone who truly enjoys budgeting – and sticking to it – is a bit like finding someone who truly enjoys eating handfuls of hot chili peppers or jumping into quicksand. There's likely a few folks out there who do enjoy such things, but it's safe to say the clear majority do not.

While budgeting itself can be painful, it can also be very rewarding. Budgets can help not only with saving for a sought-after purchase like a car or home, but also with being prepared for an unexpected expense in life such as a medical bill and corresponding medication costs, or a home or auto repair.

Indeed, the purpose of a budget, plain and simple, is to keep track of what dollars come in and where those dollars go out. Ideally, your budget should allocate your money in a way that not only leaves a bit of breathing room, but also allows for savings that can grow over time.

For many, setting up a budget is the most overwhelming and annoying aspect of budgeting. Not knowing where to begin, what to include, how to calculate, and how to update a budget are common reasons that cause many who start a budget to abandon it.

But like quitting smoking or going on a diet, establishing a plan and sticking to it is the tried and true way of successfully achieving financial goals.

An added benefit of having a budget is the reassurance that comes with it. Knowing how much money you have, where it's going and what you're doing with it will likely help you sleep at night.

Many people don't think to put together a budget until after they've already gotten to a place where their bills and spending exceed their income, but it's never too early to start. Budgeting can be a critical first step to getting back onto financial safe ground. It's also a great tool for effectively achieving your financial goals, whatever they may be.

Examples of common financial goals include: living on your own for the first time, paying down student loans, planning for a wedding or putting aside money for something fun like a vacation or a new gadget. If you are having a child, you should definitely consider setting up a budget because it will help you to understand your costs over time and how best to manage them.

Choosing and maintaining a budget that works for you is a matter of personal preference.

Here are a few examples of different types of budgets:

Model #1: The Envelope Budget

The lesser known envelope budget is for those who do best with physical cash on hand. It's no secret that today's world flat-out encourages us to use as much credit as possible. The envelope budget is the exact opposite: It forces you to use only what's been put in the envelope for your expenses – and nothing more.

Here's how it works:

First, you separate your budget into categories such as Rent/Mortgage, Mobile Phone, Car/Transit, Groceries, Saving, Entertainment, Emergency Fund, and so on.

Next, you assign a reasonable amount for each category. Rent is straightforward as it's typically the same amount each month, but groceries, meals out, laundry, parking, pet bills, and many other expenses may require more thought. You can estimate the cost of feeding the guinea pig or taking public transportation by reviewing your balance sheet and identifying how much you spent in previous months.

Each category of expenses gets its own envelope and you can label each envelop with what it's for in black marker. You can separate your cash into the envelops based on the amount you've allocated for each category. Since few people carry physical cash these days, you can be flexible in terms of how you track and spend what is in each envelope – for rent for example, you can write down the amount on a piece of paper, print out the corresponding debit from your bank account, staple them together and place them in the envelope. Do the same for your car payment or insurance.

The key here is to set a reasonable amount for each category and stick to the plan. So, if your budget includes $20 a month for coffee, when that $20 is gone – no more coffee.

A tip: Track how much you take out of each envelope and what you spent it on by writing it down on the actual envelope. This way you can go back to your envelopes at the end of each month and see how much you spent on coffee, pizza or drinks.

Another tip: Create goal-oriented envelopes. Most financial planners and personal finance writers will say "savings" is the ideal envelope to put any excess cash into, though there is no harm in creating a "vacation" envelope or "new puppy" envelope.

Resist temptation to empty the envelope for a reason other than what is written on it. Done correctly and consistently, you should be able to cover off all your monthly costs and expenses without having to dip into other envelopes.

Model #2: The Five-Point Plan

The five-point plan is exactly what it sounds like: five key steps to creating a budget that you can stick to, and that produces results. While often an eye-opening exercise for most, the true purpose of the five-point plan isn't to highlight how much more you are spending than you should be, it's to understand where the money is going and to prepare a plan to manage it. Here are the five points:

  1. 1. Go through your banking statements and/or online banking and create a balance sheet.

    First of all, do you get monthly bank statements in your mailbox and/or sent to your email? If so, it's time to start looking at them.

    Take some time to go over your bank statement and make a list of your expenses as well as the money you earn. The whole point of this is to see where your money is being spent.

    Next, separate your expenses into categories and create a ‘balance sheet' where you write out what you've been spending on each category. Budgeting is all about balance. No one is expecting you to starve yourself or stop driving to work, but there may be ways to trim some of your costs, such as cutting back to one coffee a day or brown-bagging your lunch two days a week.

  2. 2. Take a good look at your spending.

    Go over your balance sheet thoroughly and separate all your expenses into necessary and unnecessary. This is a particularly hard task for most (is getting a haircut a necessity?) but again, the purpose is to show you what you are spending your money on, and how to control it in such a way that it doesn't overwhelm you. Separate your needs from your wants by writing out two lists to split up your expenses. Needs are things like rent, utilities and transportation, while wants can be anything from buying new clothes to eating out or taking vacations. Wants are basically anything you don't absolutely need.

  3. 3. Trim the fat.

    Take a look at your wants list and see if there are any expenses you can cut out altogether. Are you using that gym membership? Are you ordering take-out several times a week? Would it be less expensive to take the train to work? Be honest with yourself about the items you are willing to part with and try a month without them, just to see how it feels.

  4. 4. Set a daily and weekly limit.

    Once you've assessed what you can cut out, set a realistic limit for how much you spend each week, and further break it down into how much you can spend each day. This will help you catch where you've cheated your budget with things like extra meals out and to resist urges to splurge at the grocery store when you've already spent your daily budget. There's no harm in trying different systems for this. If a daily budget is too hard to manage, then opt for a weekly budget so you have more leeway – you can eat out one night but pack lunch the next day for work to make up for that extra money spent. Again, it's all about balance. Everyone in the household can be given their own spending limits to stay in line.

  5. 5. Circle back to your balance sheet and compare.

    Find out what works for you and what doesn't. If you have found that making a lunch each day proved to be too difficult or time-consuming, opt to put a limit on the amount you spend on lunch each day instead. Or if you really miss the weekly beer out with a friend – add another bagged lunch to compensate. The key here is to visualize where your money is going and set goals as to when and where you may be able to control some of your spending.

Model #3: Smart Goals and Percentage Budgets

The smart goals budget is another approach to managing your money effectively. It's about basing your finances around your goals. This type of budget is particularly effective because your goals act as your motivation to save money.

For example, if you are plagued with debt (be it from school, buying a home or just daily expenses), you may prefer a budget that focuses directly on paying off that debt.

If debt repayment is your primary goal, the first step is to ‘take stock' of your debts, which entails laying out all debts by writing them in a list, organized, for example, from highest annual percentage rate (APR) to lowest. This is because generally speaking, if you repay your most expensive debts first, in totality, you should end up paying less money than if you repay less costly debts first.

If you are lucky enough to be debt free, focus on another goal that motivates you. Are you saving for a home? Do you have a child on the way? Are you hoping to travel soon? Whatever it may be, it needs to be at the top of the totem pole.

Once you have a goal in mind, start a separate account to save funds for your goal. Each month, once all your other expenses are taken care of, put as much money as possible into the account.

Some banks offer a ‘locked savings fund' product where you can only transfer money into the account but must physically go into the bank to withdraw funds from it. This is usually the most effective approach as it prevents you from touching your savings unless you really need to.

The Percentage Budget

For those who find dollars and cents, spreadsheets and lists more than a bit daunting, the percentage budget can be an effective option.

Simply put, a percentage budget works by assigning a percentage of your income to savings and the remainder to spending. For example, each month's income could be divided by putting 20% to savings and 80% to spending. This is one of the simplest versions.

You can make it more detailed by assigning percentages to different spending categories: 30% to housing, 10% to transportation, 15% to food, and so on. You can adjust the percentages for future months if you find yourself needing more in one category.

There are several ways to approach these types of budgets, but the intention remains the same: put your future goals at the top of your priority list as opposed to the bottom.

What happens when your budget fails?

Roads are generally paved with the best of intentions, but potholes are facts of life. So, what happens if you don't meet your budget?

First and foremost, don't panic. It's important to understand that you're not going to be an expert right away, and while it gets easier with time, it can still be rocky at the start. Small changes are still wins – and they may still be saving you money.

If you are having trouble with a certain aspect of your budget, the best thing you can do is figure out why. For example, if you're using the envelope budget and you have found that you were unable to stick to the designated amounts, then think about what that money was spent on. Maybe that month was particularly busy with celebrations such as birthdays or other social events. If this is the case, then your budgeting may not be the problem.

Second, remember that for everyone, life is full of surprises. Your budget should include an emergency fund that you contribute to regularly. Having an emergency fund will help you stay on track and stick to your budget even when there's a surprise expense.

The key thing to remember is that budgeting is a bit like dieting: one slip-up does not mean that it's time to give up.

If you are having difficulty sticking to your budget, you may need to try something new. For example, if you find you can't meet your original food budget, ask your mom for some family recipes you love and make a batch of food that you won't mind eating for lunch a couple of days that week.

Either way, don't be afraid to adjust your budget to fit your lifestyle – and don't give up after just one month of trying. Instead of thinking of budgeting as a means of helping you to save money, make it a part of your lifestyle. Not only does budgeting help you save money, it also helps you be prepared for the unexpected. While no one can plan for absolutely everything, having a budget and sticking to it can make unexpected emergencies much easier to deal with.

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