Creating a basic budget

Marty, a regular reader of this blog and a blogger in his own right at Coffee With Marty, recently asked,

So, in the past, I have tried to come up with a budget and always failed. Is there some kind of guidelines out there for a 20 year old college student?

Well, my first thought when I ponder this question is: it depends. Creating a budget that works for you can be a pretty intimidating proposition. Like Marty, many people try to come up with a budget that just doesn’t work for them. My personal budget is pretty meticulous. I have very specific amounts that I set up for a lot of different categories. This works for me because most of my expenditures are automated and I check my accounts on a daily basis.

What I’m trying to say here is that, if Marty were to follow my plan, he would probably fail again.

There are some things, however, that everyone will need to do to create a successful budget.

1. Figure out how much money you make. It seems obvious, but you would be surprised how many people only look at the amount of money left in their checking account and ignore how much money goes in. Let’s face it: without income, budgeting is impossible. If you don’t know how much money you make on an annual (or at least per paycheck) basis, start here.

2. Take a look at your expenses. The next step is to understand where your money is going. The good news is that, assuming you use a debit or credit card for most of your purchases, this is very easy to do. All it takes is a piece of financial software like mint.com, which will automatically track and organize your expenditures. In fact, once you connect your account information with mint, there is very little you will need to do. It will categorize every transaction and provide you with up-to-date graphics and tables to help you analyze your spending patterns. Once you know how you’re spending your money, you’ll be ready for the next step.

3. Determine whether or not your income exceeds your expenses. If you consistently spend more money than you earn, you will quickly pile on a lot of debt. Once again, this seems obvious, but most people who wind up in financial trouble skip this step in their money planning (or, more accurately, the lack thereof).

4. Notice what you could do without. When analyzing your spending, did you notice that you spent $400 on dining out at restaurants last month? What about that candy bar habit that you justify because it is “only” a buck? No matter what you find yourself spending money on, it is likely that there are some things you could cut back on to save money.

5. Find a plan. The plan you use for your budget should be easy to implement and manage. The more your are able to automate your budget, the better. This means that your paycheck should be on a direct deposit (assuming your employer offers it). You should sign up for the free bill pay your bank offers but you never figured out how to use. If you need some more help here, take a look at the following simple budget plans.

The balanced money formula

With the balanced money formula, your goal is to use no more than 50% of your income on items you need. This includes your mortgage or rent, car insurance, groceries, utilities, and other things you are required to pay for whether you like it or not. The next 20% of your income should be used for saving and investing.

If you passed 5th grade math, you’ll recognize that you have 30% left over. This amount is to be used for discretionary items and wants. This could include your cable, restaurant budget, and video game fund.

Note that the balanced money formula is intentionally very basic. It will not help every person to achieve their financial goals and it may need to be adapted to your specific needs. It is, however, a good place to start as it guarantees that you are at least living below your means and contributing to savings.

The envelope system

This budget plan is a little bit more complicated than the balanced money formula, although the two could actually be used in conjunction. You will need to do a little more planning to get it set up, but it is very easy to use once it is in place.

To get started, you will need to determine how much you would like to spend in whatever areas you feel are the most important. Note that the envelope system is not typically used for larger, necessary items that are typically the same amount no matter what you do, but rather should be used for categories where overspending can be problematic. Categories might include: groceries, dining out, Starbucks, play money, or clothing.

Each month (or paycheck), you head to the bank and take out enough CASH (as in, if you don’t have cash, you don’t spend money) to cover all of your budgeted expenses. You then divide that cash up into the amounts for each category in your budget and place it into a physical envelope. When you go to the grocery store, you only pay with money out of your grocery envelope. Once you run out of money in your envelope, you are done spending in that category until the next budget period.

I like this system because it forces you to only spend money you have. I don’t like it because I prefer to let software track my expenses for me. Although I have never used it, there is another piece of software called Mvelopes that allows you to create virtual envelopes that track your digital dollars. It is the same concept, but avoids the trip to the bank and the difficulty of carrying around a bunch of envelopes.

Get started

I hope that gives you a few ideas of where to start with your budget. Remember, keep it as simple as possible. Otherwise, you are destined to fail. Whatever system you choose to manage your budget, get started as soon as you can. The sooner you start, the sooner you are to being on your way to achieving financial freedom.

Do you have any other advice for Marty? What strategies do you use in your own budgeting?

Photo by _ES.