In this article I want to discuss budgeting. Often when it comes to the “B” word, people want to do it, because they think they should. I believe if you walk through the budgeting process outlined below, you will keep doing it because you feel rewarded. You will be deciding where to spend your money. Managing money isn’t that much different than managing your diet. Dollars-in need to match (or be less than) dollars-out.
Here is a blueprint for budgeting. (For related reading, see: 6 Life Events That Call for Professional Financial Advice.)
Gather Data on Spending
It's important to have as much information about your spending habits before you move on to the next steps. You can use an Excel spreadsheet or try technology like Mint.com, or you can just gather all your credit card and bank statements.
Slice and Dice Expenses
- Define one color as category 1—“can’t control.” These are expenses that you don’t think you have much control over and are usually fixed in nature (i.e. taxes, mortgage, etc.). Add to this category your savings goals such as retirement, education, and other large purchase goals.
- Define a second color as category 2—“some control.” These are expenses that you need, but you might have some control over (i.e. groceries, utilities, etc.)
- Define the last color as category 3—“total control.” These are discretionary expenses you can decide to make or cut back (eating out, vacations, vices, etc.)
- Walk through your statements and highlight expenses accordingly.
Ask Yourself Goal-Defining Questions
- What did I love at five years old? Do I have any of that in my life? Can I add that back into my life if it is missing? For example, I loved playing teacher and doing math (yes, even at five years old), so I’m lucky to be doing both in my own way. But if I wasn’t, then I might ask myself, how do I add that into my life? How much would it cost? Or perhaps, how much would I earn from adding it back in?
- The next three questions I learned from behavioral finance speaker Carl Richards:
- If you were to become a millionaire today, what would you change in your life? I used to ask the question in a different way: What if money were no issue? What would your life look like?
- If you were told you had six years to live but you would not be in any pain and would not suffer, what would the next six years look like?
- If you were then told the same thing, but it was only one year, what would the next year look like? These questions require some soul-searching. I’ve known them to lead to complete life changes (including my own). (For related reading, see: How to Create an Effective Budget.)
Decide How Each Item Supports Your Goals
Love your house? Great! Then don’t make any changes. But understand you are choosing to spend some of your money to maintain your sanctuary. On the savings goals, make sure you are paying yourself first through automated savings.
For those items you need but have some control over: Set a dollar figure that you want to spend on that (or need to) and set that money aside each week in an envelope—color code it if that makes it easier. If you are a die-hard credit card user, then pick one of your credit cards and target that card for those monthly expenses, but work to make sure it stays under the limit you set for yourself.
For category three, which I call the pleasures of life, decide which one truly brings you pleasure. This category needs an envelope too—or that separate credit card! For example, if you love going out to eat, that’s absolutely fine, but are there other items that you don’t really want; they’ve just simply crept into your life? An example in my life: I love a good bottle of red wine, so I don’t want to give that up, but I’ll give up going shopping at a retail store in a heartbeat. This is where vacation planning would also fall. In planning for a big trip, move a portion of the cost of that trip each week into a separate account, then the money will be there when you need to pay for the trip (vs. paying for the trip after you’ve taken it). A great way to do this is to set up an automatic transfer in to a separate savings account.
For some, I even encourage writing the goals on the envelopes. That way, when you pull the money out to see what is available, it will likely make you hesitate and ask yourself how important this purchase is to you and your goals.
I would recommend a quarterly review of these goals and spending desires. Spending money on the things you love and feel passionate about puts you in control of your money and helps keep you focused on your future. (For related reading, see: 5 Financial Planning Decisions You Won't Regret.)