One of the biggest hurdles to getting on track financially is starting a budget. Budgets are scary, especially if you’ve never done one before. It’s hard to know exactly how much to allocate for each category of expenses. If you’re not used to tracking your expenses and evaluating them, it can be daunting to start. When you add in a fear of failure on top of all that, it’s easy to see why many people put off budgeting for as long as possible. If this describes you, then I’ve got a plan that will help you start budgeting with zero risk of failure.
Is Budgeting Really All that Important? Who Budgets, Anyway?
Budgeting is instrumental in helping you take control of your finances. Without a budget and careful tracking of your income and expenses, you have no means to grade whether you’re meeting your financial goals. How can you tell whether you’re spending less than you did the year before on discretionary expenses, like dining out? If you can’t remember what you ate for lunch yesterday, odds are you aren’t going to remember exactly what you spent on lunches all last month.
A budget provides the necessary information to make smart financial decisions. A budget is also a great tool to keep yourself motivated, because you can see how close you’re coming to meeting your spending and savings goals, and track the progress you’re making toward your big financial goals, such as buying a house, buying a rental property, sending the kids to college, or kicking the kids out of the nest and enjoying your retirement.
Sadly, as important as budgets are, a Gallup poll from June 2013 showed that only 32% of households actually have a monthly budget! Even worse, only 30% of households had a long-term financial plan. How can the majority of households make any sort of plan for the future if they’re not even keeping track of what they’re spending? The truth is, they can’t. If you’re one of them, vow that you won’t be for long, and I will walk you through a very easy way to start budgeting.
Step 1: Don’t Budget. Track.
The first step of budgeting is not to budget. At all. That might sound silly, but choosing arbitrary budget numbers and risking failure is one of the key reasons people don’t budget. How the heck are you supposed to decide how much to spend on groceries, how much on healthcare, on car insurance, etc.? You could start by guessing how much you will need to spend on all those categories, or by researching online to see what others spend on those items. But why give yourself a complicated homework problem just to end up with a guess at the end, anyway?
Instead, just start tracking your finances now. If you’re starting in the middle of the month, roll back to the first of the month and plug in your data going back that far. There are loads of options for software you can use to track your finances. You could use Mint, Personal Capital, or my favorite: Quicken.
I haven’t used Mint, but it’s owned by the same company as Quicken, so it is probably pretty similar. What I like about Quicken is that I can keep track of all of my bank accounts, credit cards, investment accounts, and even my mortgage and other notes via Quicken, and it automatically syncs with my financial institutions so I have up-to-date balances on all of my accounts and I can reconcile them to the bank records whenever I feel like it without having to wait for bank statements.
In case you’re interested in buying this year’s version on Amazon:
Whatever tool you decide to use to track your finances is fine, so just pick one and get tracking. Don’t pass judgment on yourself for anything that happens in the first few months. Your only goal right now is to track what is actually going into and coming out of your bank accounts.
Step 2: After Tracking for 2–3 Months, Analyze and Start Budgeting
After you’ve got 2–3 months worth of data under your belt, then start to analyze your spending. Again, don’t judge yourself too harshly. You’re just starting out, and you don’t want to kill your momentum by being too hard on yourself.
What do your basic categories look like? You might choose to add or delete categories, if you find that grouping expenses differently makes more sense for you.
After looking over a few months’ worth of expenses, you should have some idea of what your typical monthly numbers look like. You should run some basic reports, like a report showing all of your spending by category (called “Itemized Categories” in Quicken) and a report showing your bank and other account balances (called “Account Balances” in Quicken) so you can compare your spending for each month. Run the report for the two- or three-month period that you’ve been tracking, and subtotal by month. (Side note: This is why having financial software is so helpful. Can you imagine what a pain in the butt it would be to create these subtotals if you were just tracking your expenses by hand using a check register? Yikes!)
Now that you’ve got your spending organized by category, you can start budgeting limits within each category. Don’t set anything in stone just yet, but come up with a general limit and write it in pencil on the reports you printed out.
Step 3: After Tracking for another 2–3 Months, Analyze and Tweak Your Budget Numbers
Now you should have a total of at least 4 and preferably 6 months of financial data. If you fell behind in your tracking, take a few hours and get caught up. It’s not critical that you have a set day per week that you get caught up with your banking, but it is important that you try to get caught up at least once a month.
Run the same reports that you ran 2–3 months ago, starting from the date that you first started tracking and going until the present date, with subtotals for each month. Has your spending settled into a normal pattern? Did you meet the penciled out budget limits you set in Step 2? If so, great. If not, that’s okay. Either way, examine your spending and see if everything looks as you expected it to look.
If you had unexpected expenses, such as auto repairs or medical expenses, make sure to include a reserve in your budget to cover those items in the future. If you mistakenly forgot to budget for your annual car insurance premiums, because they didn’t fall within the previous 3 month window, that’s okay. Make room in the budget for that as well. The first year of your budgeting is going to be more about learning than setting goals and beating them. You are just getting used to what your expenses really look like on paper, so you have to forgive yourself if you make mistakes or don’t plan perfectly.
At the end of your budget review, set new spending limits and savings goals for yourself for each category. If you have kids, involve your kids in the process. It makes it a lot easier to say no to your kids’ frivolous expenditures if you’re all on the same page about your family’s financial goals. It will also be easier for you to resist your own frivolous purchases if you know your kids are going to be keeping an eye on you, too.
Step 4: After Tracking for Another 2–3 Months, Analyze Again. Are You Failing in the Same Places? Is One Area Easier to Succeed in than Another?
After you’ve got another 2–3 months under your belt, analyze your reports again. Are you meeting the goals you set for yourself? Are you failing in one or more categories again and again? If you find yourself failing in one category repeatedly, take a closer look at that category. Maybe you need to adjust your budget in that area.
If you initially budgeted for auto expenses to be about $200 per month, and then you find that after that initial 3 month period, you had multiple auto repairs and insurance that kicked the budget over the $200/month mark, then adjust the number. There’s no sense repeatedly beating yourself up for having to live in reality. However, if you set your entertainment budget at $80/month, and you routinely blow that budget by $50 per month, you need to adjust your behavior. Try going to the movies every other weekend instead of every Friday night, and take in a Redbox movie on the off weekends. This is the “not fun” part of budgeting, but once you see yourself making substantial progress toward your goals, you won’t even miss the movie theater.
If you’re doing well in one category, and not doing so great in another category during some months, that’s perfectly fine. Spending $50 less on entertainment and $50 more on dining out is still meeting your budget. If it’s too difficult to give up Starbucks pumpkin spice lattes in fall, but you find that you’re always able to trim back on other spending to compensate for it, then great! The idea is not to make yourself suffer in all areas, it’s to prioritize what you really want and make good choices for your budget as a whole.
Last Step: End of Year Review
First, if you made it to this point, congratulate yourself for taking such a big step. You’re now in the minority of households who actually track their finances and kept a budget! Even if you didn’t meet your goals in the first year, that’s something to celebrate.
Run all of your reports that you ran in your 2–3 month checkups. Evaluate your progress over the past year by comparing the first quarter of tracking to the last quarter. Next year, you will compare the whole year to the entire prior year, which will give you an even better comparison.
Did you make considerable progress? If you did, celebrate! Don’t go all out and blow all the money you’ve saved, but cook yourself a nice steak dinner, or splurge on a mid-range bottle of wine instead of the 2-buck chuck you’ve been sipping since you started budgeting. You only get one celebration, so make it a decent one, but then stop. Don’t make the mistake of giving yourself a celebratory dinner, and then buying yourself a congratulatory present on Amazon, and then getting your car detailed, and then all of a sudden you’re just overspending again.
Do you regularly budget? Are there any areas of your budget that you continually struggle in?