The benefits of creating a simple budget

For some of us, especially those just starting out, financial planning can be difficult and may seem like a low priority. Living on our own, being truly independent, and cashing a nice fat paycheck every week is quite a change from the lives that we lived back home when maybe we didn't have to worry as much about making ends meet. Hell, I know it happened to me when I first graduated. When making any sort of financial decision, I'd greet it with a touch of arrogance: "I make x-amount of money per year! I can afford to buy a new phone/camera/television/car/house!" or "I make x-amount of money per year! I can afford to go out with my friends to the bar/restaurant/vacation!" Though it was true that I was earning a decent living and that I didn't have to live like a pauper, I hadn't really evaluated the minutia of my transactions to understand that though I could afford a new camera/phone/night out with friends, I couldn't do it every day and expect to not start living in the poor house.

I don't remember where I got the idea or what exactly made it sink in, but I'm glad that the forces that be let me implement it and stick with it. I came up with a budget. My budget is important in my life, and now guides my wallet based on rational and sober decisions. The monthly allowances are prioritized based on my need, and have a mechanism to measure their adherence over time. Following is a brief step-by-step description of how I came up with my budget, how I learned to live with it, and how it has affected my personal spending habits.

1. Start to measure - Your budget will never work if you just come up with arbitrary numbers for your monthly allowances. This whole process will be a lot easier with some personal accounting software that looks at all of your spending from each bank account, credit card, and other source of money. Personally, I use Bank of America's free online banking software called "My Portfolio" which allows you to enter in your non-BOA credit cards' login information to see their transactions in a common list. Every day I can log in to BOA and see a single list of transactions that I made, regardless of the debit/credit card I used. Each transaction is then categorized (which can be changed by you).
   
2. Improve your transaction details - Once you start measuring your transactions, maintain them. Computerized software helps a lot, but will most likely need some guidance from you. Don't just stick everything into a miscellaneous category. Really try and understand where your money is going. Differentiate from a weekend binge and a meal at a restaurant (both of which may purchased from a restaurant). Differentiate purchasing a tank of gas on a vacation from a tank of gas at home. This will let you know if your daily commute is costing you an arm and a leg or all those road trips to the beach. The deeper you go with the level of detail of the transactions, the more accurate your budget will be.
3. Analyze current spending - Once you figure out where your money is currently going, you can start setting goals for how much you want to spend. But don't automatically take your current spending as the budget; use it as a guide. Sum up your spending for the last month and compare that against your income. If you realize that you spent $4,000 last month and your income is only $3,000, figure out why. Did you take a trip or purchase Christmas gifts? It's OK to have some months where you spend more than you make. But if you're consistently spending more than you make on stuff that's in your control, you've got some changes to make. If you brought home $3,000 last month and spent $4,000 on restaurants, electronics, going to bars, and other things that should be prioritized lower, consider it in your analysis.
4. Budget first for the bare essentials - Certain items included in your monthly spending are the bare essentials: rent/mortgage, utilities, car payments, groceries, etc. First, separate your bare essentials into those whose amounts will vary from month-to-month and those whose will not. Your rent/mortgage, car payment, and car insurance will most likely stay the same. Then look at your grocery and utilities spending and figure out what to expect from those categories each month. Each category should have a monthly spending limit. If there are certain items that are not paid monthly (like 6-month car insurance premiums, bi-monthly water bills, etc), put them in terms of cost per month. Subtract the sum of your monthly bare essentials from your monthly take-home pay. The difference is what you have for everything else.
5. Set spending goals for non-essentials - If you're working in Excel, put the rest of your categories below the essentials, in order of priority. These will include things like restaurants, home improvement, personal care, clothing, entertainment, travel, and yes, savings. Savings are a non-essential item, but should be placed at the top of your non-essential list. There's no rule of thumb as to how many categories you can have, but make sure that any time you spend money on anything, you can place it in a category. When coming up with your monthly goal, don't short yourself, but don't put an unreasonable number down, either. After all, what's the point of setting a goal you can't achieve? Don't put zero dollars down for restaurants, because at one point or another, we all eat out.
6. Measure adherence monthly - If the budget you created measures spending monthly, make sure to check your adherence every month and adjust your spending goals accordingly. I make it a habit to do it on the first of the month. And when you monitor your adherence, keep a running total of your spending for each category (the sum of all monthly variances, positive or negative, for each category). If you budgeted $150 per month in gas and are consistently going over budget, you'll have a negative running total and may need to change your allocation to $175 or $200. Similarly, if you have been consistently under budget with home improvement or spending, you can have a month where you go way over budget. The running total helps you understand where you stand with each category. I budget about $200 per month for travel, even though I don't go on a trip each month. But every six months or so, I'll have 1,200 guilt-free travel dollars to play with!
   

Since creating my budget, though I don't make any more money, I have less financial pain in my life. The other day, I was considering buying some new clothes for work. Though I had plentyin the bank to pay for them, I consulted my financial plan (which took about two minutes). "Well, it looks like I went over on my clothing budget last month (which gave me a negative running total), so I guess I can wait until next month to buy the new work clothes." Or, when planning my meals for the current week, I can consult my restaurant budget. "It looks like I've already used half of my monthly restaurant budget this month, so I'll try to buy enough groceries to last the whole week." It sounds simple -- almost juvenile -- but it works. By putting a little bit of thought into everyday transactions, I was able to maintain my lifestyle and not be surprised at the end of the month when I received my credit card bill!

Hopefully with some discipline and effective measurement of your spending, a budget can be an easy way to get back on track or stay on top of your finances.