You have come here to learn more about a personal budget. There are questions on your mind, such as “Should I create and keep a budget for my finances?”, “Why do I always feel overwhelmed, when it comes to paying the bills?”, “Why can’t I make the money last until the end of the month?”
As is our mission, I want to help you to understand if you need a budget, and most people do, as well as how you can create and maintain your budget.
What is a personal budget?
Let’s first clarify what is and what isn’t a personal budget. Any budget is a plan about how you earn your money (income) and how you’ll spend it (savings and expenses). A personal budget is any such plan that involves you and all people that depend on shared income.
If you are single, living alone, the personal budget is just your finances. If you are married you (most likely) share a budget with your spouse. If you have a family with kids and pets, you have a household budget. When I shared an apartment with other students, we had a joint budget for internet service, groceries, and household supplies. Besides that, I had my personal budget that listed my contribution to the shared budget.
Typically a budget is drawn up once a year, then detailed to a monthly budget. That way, you will include expenses or income that do not occur regularly. For example expenses for travel and vacations, only occur once or twice a year. However, the purpose of a budget is to plan for these expenses, likely to put aside monthly some money towards the one-time expense.
Do you need a personal budget?
Frankly, creating a budget and tracking it is a bit of work. You really want to justify this effort. Also, creating a personal budget and sticking to it is likely to cause some emotional pain, because you have to make decisions on what you want to pay for. If your money supply would be unlimited, budgeting would not be needed.
Not many of us have a flexible side job, like Thomas, which they can use to increase income as needed. Nevertheless, Thomas also lives a modest life, so that vacation expenses are low.
Apparently, Cindy struggles to make ends meet. She needs a personal budget and needs to track it closely. Even as she does so, she sometimes can’t make it and is embarrassed to ask for donations in kind to meet the basic needs of her kids.
Bob and Nancy live more comfortably, but they need to limit expenses to only spend what they earn.
These examples show the needs most of have to earn enough and also to spend only the money we have. Without a plan, you are going to face the end of the month with an empty checking account and wallet. Or worse you are rolling over a balance on your credit card.
None of these households spoke of long-term savings, such as saving for a down payment on a house or building extra income in retirement. Nor did they speak of how an emergency can wreck their current balance of income and expenses. However, what emergencies and retirement have in common, is that they happen eventually for most of us. One thing is certain, you sleep much better and live more relaxed when you are prepared for it.
Same people are better than others to intuitively spend the right amounts. But most people do better if they make a plan, what income they’ll expect each month and which portion they want to save for the long-term, as well as what expenses they will have each month. This plan needs to balance, so that incomes, savings, and expenses add up to near zero.
A household budget is a social exercise
Money is an important part of a relationship and life partnership. In a study, 50% of divorced couples said financial problems were a factor in their separation. I take it that financial problems are foremost a communication problem. A joint household budget is a very good tool to communicate financial goals and how to achieve them in a relationship.
A conversation about money is not easy, but it actually is a conversation about values and priorities in life. Seeing this exercise in a positive frame the personal budget is an opportunity to build joint dreams, such as the kind of vacations one plans or what kind of house one wants to build. Such conversations require honesty. However, this openness builds trust and can strengthen a relationship.
Talking about money is also an important teaching tool for parents and a lesson children want to learn. Many children ask their parents how much money they earn. Sometimes, it is curiosity and sometimes they sense that money is an important worry that their parents have. Most parents don’t feel they can tell their children about the family income, because children do not understand the complexity of expenses one has. That is probably true for young children. However, when is it the right time to give your children the financial education they need to succeed in life?
How much personal budget do you need or want?
Hopefully, I convinced you that you need a budget. However, it can be a simple one.
To determine how much budget you need, you want to focus on the savings portion. How much you save determines your financial independence and how you sleep at night.
Single and saving enough
If you are single, know what your financial goals are and that you meet them every month. If you further balance your income and expenses every month, then this is all the budget you need. I call this a minimal budget. It simple lists:
- All incomes
- All savings
- The remainder as expenses
You still want to document this and track every month if all your real incomes and expenses are meeting the plan. I’d further recommend calculating your savings rate and benchmark it against recommendations, such as the 50/30/20 rule.
That is all there is. You probably need a little over an hour to draw up this document and a few minutes every month to track the plan. Every your you spend less than an hour reviewing for the next year. You might want to have a conversation with someone you trust about finances, just to make sure you have not missed anything.
In cohabitation, married, with kids or not saving enough
If you are sharing your life and money with someone, I highly recommend drawing up a budget and make joint plans. After all, money is only a substitute for the experiences in life and any money plans reflect such lifestyle expectations. You want to understand what your partner values that can be bought with money. This is not limited to expenses. You also want to understand each other’s ambitions, climb up the career ladder, and increase earned income.
Just as important is the conversation about saving for future expenses and retirement. This can include large purchases, such as a house or a boat, places of living as well as plans to retire early or to start a business. If the current savings rate does not support those expectations, the plan needs to be adjusted. Saving always means foregoing consumption today to meet future needs.
The conversation around money is not a static one. Desires to save or spend money change over time. Many people realize late in life that they did not save enough to continue their lifestyle in retirement. some people at a later stage in life seek more individual fulfillment in work and desire to change jobs for lower pay but with more meaning or to become one’s boss. An annual budget conversation can be the catalyst to reflect on one’s life and communicate such changing sentiments.
How to create a budget
All you need to create your personal budget is a few financial documents and a sheet of paper. You don’t need a bookkeeping program such as Quicken or a fancy app on your phone. However, I’d recommend using some electronic paper to save a few trees.
The minimal budget
The bare minimum of a budget is a list of
- Income sources
- Main job
- Investment income
- Social Security
- Annual expenses that need to be put aside monthly
- Medium term planned expenses (car, down payment for a home, starter capital for a business)
- Long-term savings to invest for retirement or to gain financial independence
As long as you actually put aside your savings goals and still have a penny left over at the end of each month, this is all you need. I’d still calculate the savings rate to track over the longer term and to assess if it meets the longer-term financial goals.
You can read more about the minimal budget (with a spreadsheet template) and try it out.
The zero based budget
The zero-based budget is a more detailed plan of income and expenses. Its name comes from the principle, that you need to justify the amount in each savings and expense category for every single planning period. This is in contrast to traditional business or government budgeting, where each category was rolled into the next period and increased automatically with a certain percentage.
This kind of budgeting encourages you to watch out for savings and expense reductions.
To create a zero-based budget, you want to list your income just as with the minimal budget and also the savings. However, you’ll look at your expenses in more detail. List expenses for
- Non-discretionary, often called fixed expenses
- Travel to work
- Discretionary, also called variable expenses
- Dining out
- Entertainment (TV, Internet, cell phone, subscriptions, …)
- Vacation travel
- Non-discretionary, often called fixed expenses
Discretionary spending can be reduced in the short term. Non-discretionary spending can usually only be reduced with drastic measures, like selling the car or moving in with family.
The envelope budgeting system
The envelope budgeting system forces you to spend only cash. The underlying assumption is that modern payment systems like checks and credit cards remove you from the visceral experience to spend money.
In the envelope budget, you create an envelope for each non-discretionary expense category. You fill each envelope with the planned amount of cash at the beginning of the month. For each purchase, you need to carry the appropriate envelope with you and spend only the money from this envelope.
This spending of physical currency encourages you to be more aware of your spending habits and stops you literally from overspending the planned amount. Because you are not allowed to use money from a different envelope. It also demonstrates real consequences if you did not plan your expenses appropriately.
Budgeting apps and services
While you don’t need any budgeting apps or services, they can certainly help you to plan and track your expenses. Many apps connect to your credit card and bank accounts. They pull each transaction and categorize them auto-magically. This saves a lot of work.
Some apps also help you to automate saving money for future purchases. They round up CC purchases to the next dollar or more and put the money into an investment account.
However, all these services and conveniences add another cost to your expenses. They are just another subscription that drains your budget. You might want to consider if the cure is not adding to the disease.
Personal budget rules
Whatever budgeting system you adopt, if on a sheet of paper, a spreadsheet, or an app, there are a few budgeting rules.
1. Incomes must balance savings + expenses
If your income is not greater than your planned savings and expenses, you are set up for failure. Failure to hit your budget repeatedly will lead to stopping the process because the effort seems wasted.
While I list the savings always first, in reality, that is what will be reduced, when you don’t meet your plan. Because any financial obligation, such as a subscription or loan payment will need to be met. The result will be that you will not put away enough savings for your long-term future.
2. Track your budget against the real numbers
Balancing the plan numbers is important to not set yourself up for a bad outcome. However, tracking the real expenses and correcting differences in the plan is even more important. Otherwise, you are living on a dream budget, which has nothing to do with your reality.
3. Categorize expenses as detailed as needed
Don’t make personal budgeting more work as it needs to be. Income sources are usually a limited number. You can easily list them all.
Expense categories on the other side can become very detailed. You don’t need to separate your budget for breakfast from going out with friends. You also don’t need to break out theater from sports entertainment. There is no real value in these details. The opposite is true. The finer you make your expense categories, the more likely you are to not match planned expenses with real expenses. And the more often that happens the less value you’ll see in your planning efforts.
4. Classify your expenses in needs and discretioanry
Classifying your expenses into needs such as food and discretionary such as dining out is vital. While both categories nourish your body, food is essential and you can’t eliminate that expense. However, you can stop spending on discretionary items. It is painful to go cold-turkey on dining out and your friends will miss you. But it certainly is a possibility.
If you are living a prosperous lifestyle, you probably also spend more on food than absolutely needed. However, in normal times this would be more effort to break out than it is worth. But be aware that you might spend on fancy lemonade instead of water, pay for organic products, and purchase a few brand products instead of the cheap store brand. If necessary, you can reduce even your non-discretionary expenses.
5. When life changes, the budget needs to be redone
A budget reflects your lifestyle choices. If life changes, be proactive to change your personal budget as well. When life changes unexpectedly, then you will be glad to have a written budget. The emotional load will be much less if you can review one by one your budget items and eliminate what does not fit anymore and add what is needed now.
With a budget document, you can embrace changes, like getting married, the arrival of a child, the loss of your job, or the death of a parent.
Assessing your budget
Once you did all the legwork of compiling your personal or family budget, you can start the fun part to assess your budget.
First, check for your budget to be balanced. You can do this on an annual basis. Do all the inflows balance with the outflows? If yes then you are in good shape.
Next look at the monthly plan. Do you have a provision to save for irregular bills, such as real estate taxes or annual subscriptions? If not, you need to add those to your categories and check if everything still balances every month. It is not a sound budget when you rely on credit card debt to finance irregular bills. You want to accumulate this money in a savings account and when the bill is due, transfer the money back to the checking account to write the check.
Do you save money for your medium-term savings goals, such as replacing your car, going on vacation, or other large purchases? Does this money go into one or more savings accounts? Does it reflect your goals?
Do you save money for long-term investment goals, such as retirement money? Any money you don’t expect to use in the next 5+ years should be invested.
What will happen if there are emergencies? It is best to have an emergency fund to cover for a damaged roof or a broken car. If your emergency funds are not at full level, your monthly budget should contain a line item to re-fill it.
Tracking your budget
A plan is worthless if you don’t execute it. If you plan on spending $120 / wk on groceries, then you need to have a way to check if you are sticking to this plan.
Collect the information necessary to track your expenses and check maybe once a week if you are on track or if you are overspending your planned budget for one or the other category. If you check weekly, you will remember when doing the next purchase, that you are already over for the months and need to cut back to stay in line by the end of the month.
Financial apps can help you to categorize your expenses and alert you when you are reaching your planned limits. However, they cost additional money and it might be overkill to get this information the moment you spend it. However, if you use them wisely and look at the remaining budget before spending, they can work.
Every month you need to have a hard look at your financial performance. You need to check if you can cover the outstanding bills and credit card balance. You need to check if you have overspent and need to cut back on items next month.
With all that checking, also congratulate and even reward yourself when you have stayed within your personal budget. If you can hit the budget 4 out of 5 times and only miss it one time then you are a budget wizard and you will be motivated to keep up the good work.
There are many ways to hack your money so it instills good habits and leads to successful personal money management. I will list just a few that mostly reduce the effort and mental stress personal budgeting can induce.
Separate accounts for checking, saving, and investing
Separate accounts for checking, goal-saving, and investing. This is natural, as most banks offer you checking and a savings account as a pair. Also if you want to invest money you will open a brokerage account or two.
You might have different savings goals. If you do, you can also have multiple savings accounts. However, as you are already doing a written budget, you can as well keep a tally for which goal the money in the savings account is earmarked. For example, you may have $8,500 for replacing the car (in 3 years) and $1,600 for this year’s vacation (in 2 months).
Pay yourself first
It is a good practice to transfer money on the first day of your budget cycle to the savings account and the brokerage. Many call this “pay yourself first.” This way you see your balance in the checking account reflects your monthly budget. If you don’t do this you will be tempted to make impulse purchases.
Align all the monthly expenses
Try to align the monthly expenses around the date where your income drops into your checking account. This way you avoid the illusion that there is lots of money in your account/wallet and you can spend it on impulse purchases. Even more importantly, you need to pay only once a month bills and the rest is CC or cash spending.
For credit cards, you can call the bank and arrange the change of the date. But also utilities or other subscription services allow this change. Give it a try and call. You can also have two checking accounts, one just for this month’s bills due.
Thousand is the new zero
Banks make it expensive to overdraw your account. They charge exorbitant overdraft fees, just to transfer money from your savings account to your checking. Even more so, if you let a check bounce, they charge you hefty fees. To avoid this, make sure you have a planned security cushion. I personally keep $1,000 as my alert balance. If the checking account falls below $1,000, I transfer some money from my emergency fund.
Hold your emergency funds in cash
As we are speaking of emergency funds. You should have one. If you keep the written tally of earmarks in your savings account, you can as well add your emergency cash to it.
If financial emergencies are rare for you (less than once a couple of years), you can even count your savings for medium-term goals as emergency funds. The consequence will be that in case of an emergency, you have to postpone that medium-term spending goal until you replenish your savings.
Pay your credit card balance ASAP
In today’s banking environment, there is no interest payment on checking or savings accounts. So the due date of your credit card statement is pointless. If you get into the habit to pay that balance in full right away, then you are sure to not forget the date and never incur the hefty late fee. It also saves you from an interest rate hike on the credit card.
This aligns nicely with the hack to “Align all the monthly expenses”.
Make appointments to review and track your budget
Even if it is just yourself, make calendar appointments for the budgeting process. It frees your mind if you have set aside time to track and review your budget. It further gives your mind time to think about future goals and not interrupt your every day to remember you wanted to change financial priorities.
As mentioned before if you have a joint budget with any other person, it is imperative to schedule time for a conversation at eye level. It is not enough to delegate this to one person only.
Take Action NOW
You made it this far in this long article, probably because you are serious to take better care of your money. I hope you learned something along the way. However, all effort will be lost, if you don’t take action.
If you have no time or headspace right now, then schedule your first appointment where you will tackle your first budget.
In that first meeting assess where you are. Do you struggle with your budget? What are your savings goals? Where is the document that contains your personal budget?
If you want to get started here is an easy guide on how to implement your first budget.