This is a guest post by Austin Frakt, a health economist and university professor. You can find more by Austin at The Incidental Economist, a blog about personal finance, economics, and health care, among other things.
Budgeting is the cornerstone of personal finance. You can’t make a rational financial decision without knowing the state of your cash flow. But if you’ve never developed a budget, working up a detailed one can seem like a daunting task. So many people don’t — and then get into trouble.
Fortunately, budgeting doesn’t have to be complicated. If you are living within your means — with no debt or only low-interest debt that is easily serviced — then a simple budget can suffice for planning purposes.
How to build a basic budget
To develop a simple but accurate budget, assume for the moment you spend the “right” amounts on detailed subcategories like clothes, food, entertainment, etc. (I’ll come back to the situation in which you may not be spending the “right” amounts.) Then ignore these detailed subcategories and build your budget at a coarser level based on your paychecks and bills.
If you’ve kept your paychecks and bills or have access to them online, this process is easy. Take a representative set of them — perhaps those for the past 3-6 months — and write down values for average payments, as illustrated in this spreadsheet.
To make things simple, when entering your paycheck amount, use the amount you receive net of all deductions (e.g., for state and federal taxes, health, disability, life insurance, 401(k) contributions, and so on). That is, use the amount you actually deposit into your account.
Also, enter a representative amount for your credit card bills. Do not drill down into the bills to allocate payments by type (food, gas, clothes, etc.). You don’t need that level of detail for this type of budget.
The accompanying spreadsheet includes the items in my simplified budget with fictional but representative figures and frequencies. Your list may differ. If you spend a lot of cash or make many check or debit purchases, you may need entries to account for those. Since I pay almost everything by credit card, I left out cash and check payments.
Be sure to prorate everything to the month and total it. If the total is less than zero, then you have negative cash flow. That’s a sign you need a more detailed budget to get back on track. This is the case for which seeing the details will help. You’re spending too much somewhere and you’ve got to figure out how to cut back. The simple budget I’ve just described is not sufficient for this purpose.
If your total is positive, that shows how much you have left to save for the future. You can use that average monthly savings figure to predict how long it will take you to save up for some goal (new car, vacation, etc.).
Nothing to it
That’s it. We’re done. Was that hard? I don’t think so. Yet, we now have a budget that is perfectly adequate for a variety of investment planning purposes. It lacks detail, and if that bothers you then go ahead and build in more. It won’t hurt to have it. It just takes more time and effort to develop a more detailed budget.
If the challenge of building a detailed budget is preventing you from budgeting at all then try the simple budgeting approach first. It may be the only budget you need — and the best investment you’ll ever make.
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