What is a budget and why is it important?
A budget is a spending plan. In its most essential form, a budget is a list of income and expenses for a specific period of time. You could have a budget for your vacation, a budget for a business trip, or a personal finance budget. I'm referring to the last one in this blog since it is about my personal finance journey.
What do I need to create a personal finance budget for me (or my household)?
To create a budget you need to decide how often you'll update your budget (typically every 15 days) , how long of a period it will cover (typically one month), and some place to write down all the numbers and make calculations. You also need to know how you spend your money. It is good to have a pile of bills from the last month and the last of the bills that come every other month or longer like the utility bills or car insurance. If you earn a paycheck take out the last month's pay stubs. If you work freelance, look at your client payment register and look at checks and deposits to your account.
The period of a budget and the level of detail in a budget really depends on you, but since most regular bills come every month, it is much simpler to do a monthly budget and update it as you go even if you are paid every week, every two weeks, or twice a month.
The frequency you use to update your budget is a matter of personality and dedication. If you like to micromanage and you have free time everyday, you could update your expenses and categorize each one and then compare the end of the month with your plan. It can be great to see how you think you spend your money is different from how you really spend it!
Personally, I think of a budget as a guide. I don't really care where every last cent or peso got spent during the month as long as I'm making the desired progress toward my goals. As soon as I start to fall short I'll make an adjustment. I do however pay special attention to repeating, regular expenses since those need to be reduced, cut, or replaced when my income drops.
Since I don't like to worry about every peso that leaves my pocket I consider my money as going to the following categories:
1. Basic Expense
2. Entertainment/ going out
3. Irregular Expense
4. Savings and Investments
No, I don't actually make those categories on my budget spreadsheet, but that's how I think about expenses for budgeting.
On my actual budget spreadsheet I group them as follows:
1. Expenses (with a list of regular expenses and approx. costs)
2. Savings and Investments (divided by account I deposit the money to)
Basically, on my budget it is:
1. Money I plan to spend
2. Money I have saved
3. Money I end up spending on Entertainment or other misc. irregular expenses.
If you control every peso/dollar that you have then you just have:
1. Money you spend
2. Money you save
What is important when creating a budget?
The most important things to consider when creating a budget are your goals, and to live below your means. That means that all your expenses planed and unplanned need to be well below 100%. (no, 90% isn't well below). If you spend 100% of your money every month, you are not going to have money for anything else and you'll either have to go without or go into debt (credit card!)
Your budget should reflect your goals. If you have no goals then make a list of what is important to you and what isn't important. What makes you happy? What would make you happy? Where do you see yourself in 5 or 10 years according to your current spending and where would you like to be?
Most people want to change or improve their finances, but they are afraid or they don't have established goals. Without goals, it is too easy to just spend money on whatever you feel like and usually end up in debt. Another big problem is that with credit cards and debit cards it is very easy to spend money as long as you have one or the other in your billfold so to actually carry out a budget it is often important to keep those locked away at home most days or get used to having small quantities for cash for spending that day or week. You'll have to find what works best for you.
Where should you create your budget?
You only really need a notebook, a pen or pencil, and a calculator, but I think it is much better to do a budget on a computer since it can calculate percents and averages. It is important to keep a monthly log of spending and/or saving along with income to get a better idea of your progress that you can compare with your general spending plan and your goals.
I know that for USA and Canada there is a service called Mint.com that is useful for making a budget and tracking spending with reports, but that isn't available to someone outside of those countries. There is also special software like Quicken that you can buy, but then you are stuck updating when you are on the computer it is installed on. I tried some budgeting software, but it was more tedious and of course if the hard drive crashed or the system became corrupt, I'd sometimes lose my data and configuration. The best option (at least for those of us who don't have Mint) is to use a spreadsheet stored online (and a backup on your computer). My favorite service is Google Docs (now part of Google Drive). I can create/edit/update my budget anywhere I can find a computer with an internet connection. I don't need to worry about software purchases or upgrades that way.
I recommend that after you set up your basic categories of income, spending, and savings, and of course the subcategories for the level of detail you want, add special calculations that will help you with your goals for example:
Make fields for % saved and % spent (including savings & investment) If the number is over 100%, you messed up or you have unspent money from last month that you forgot to deposit!
A column for total spent and average spent in each category is also very useful. Over time, you'll know your average income, expenses, and savings either as approximate or precise depending on how regular you update it. I'm more careful updating income and savings and less worried about the rest.
A spreadsheet page for calculating your net worth (assets vs. liabilities) over time is also very useful, but it is your spreadsheet so you should adapt it to your needs.
In the next post, I'll write about the spending plan I currently use.
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