This article on building a better budget is the written version of a workshop I gave last week at a local public library. It refines material from several past posts on the subject. If I'd planned ahead, I could have used this for Financial Literacy Month in April.
For most people, budgeting is about as fun as a trip to the dentist. But using a budget doesn't have to be a chore, and it can have huge benefits. If you pick a budget that fits the way you live, it can help you meet your goals more quickly. The key? Don't think of a budget as a constraint. Real Life is a constraint; a budget helps you break free so that you can spend on what's important to you.
Why Budgets Fail
A lot of people get frustrated with budgeting because it never seems to work. They never reach their spending targets. Or emergencies break the budget. Or it seems like so much work for so little reward. I hear you. I've been there. But if you follow a few rules (or maybe “guidelines”, if you prefer), budgeting can be less stressful and more useful.
Based on my own experience — and based on comments of GRS readers like you — I believe there are a handful of reasons most budgets fail. In fact, I wrote about these in Your Money: The Missing Manual.
You may encounter trouble with your budget if:
- It's too complicated. People have a tendency to make budgets more complicated than they need to be.
- It doesn't reflect your values. A budget should help you achieve your goals, so make it personal. If you try to use somebody else's budget, you're going to have a tough time.
- It doesn't reflect reality. When you build a budget, base it on your actual income and behavior — not on some imaginary you.
- It seems like a chore. Don't let your system bog you down. Your goal is to have a budget that works, so keep looking until you find one that works for you.
Extrapolating from these common problems, it's possible to come up with a set of guidelines to help you build a better budget.
The Four Rules of Budgeting
Here are four rules I follow when building a budget for myself:
- The first rule of budgeting: Don't worry about perfection. A budget is a target. Your spending won't be perfect the first month. Or the second. Or the third. If you can't get your money into perfect balance, get as close as you can. Learn to make adjustments, and don't give up.
- The second rule of budgeting: The big stuff makes more difference than the small stuff. Yes, you should clip coupons and shop at thrift stores. But you can save thousands of dollars at once by being smart when you buy a house or a car. Decrease your major expenses — like housing and transportation — and you'll have a lot more room in your budget for the fun stuff.
- The third rule of budgeting: Make plans based on your real life, not how you wish life would be. Don't budget for possible salary increases and ideal spending habits. If you spend money on coffee every day, make that part of your budget. If you haven't received a raise at work, don't count that in your income. Budget for reality, not wishful thinking.
- The fourth rule of budgeting: Keep it simple. If using your budget is a chore, you'll never follow through. Include only as much detail as you need. Find a way to track your spending that works the way you do.
Here are some other tips for building a better budget:
- Think yearly. Yearly budgets are more accurate because you'll remember irregular expenses, like Christmas gifts and property taxes. Create an annual budget first, then divide by 12 to get monthly numbers.
- Target problem areas. Do you buy a lot of music or spend too much on dining out? Add a “music” or “dining out” line to your budget. This will allow you to indulge yourself—within reason. (I budget for comic books, for instance.)
- Track your spending. If you don't record your spending, you can't know if you're sticking to your budget. Find a method that works for you: Use pen-and-paper, a spreadsheet, Quicken, Mint, PearBudget, etc.
- Get out of debt first. Think of saving and debt reduction as interchangeable. While you have debt, your main focus is to get rid of it — saving money is secondary. When the debt is gone, then you can save.
- Make it a habit. Review your budget at the same time and place every week (or month). If you make this a routine, it'll be easier to stick with your budget in the long term.
- Consider the Envelope System. With this popular method, every time you get paid, you put cash in envelopes designated for specific budget categories. When that cash is gone, you're done spending for the month. Learn more from No Credit Needed or Frugal Dad.
And remember: If one budget doesn't work, try another. Don't just blindly use a budget from somebody else — even Dave Ramsey or Mary Hunt. Use their ideas as a starting point, but tailor them so that your budget fits your life. That's what I did, and it worked.
The Balanced Money Formula
It's no secret that I'm a huge fan of the Balanced Money Formula. Until I discovered this simple budget framework, I struggled to find a budget I could actually follow.
The Balanced Money Formula is a broad budgeting system outlined by Elizabeth Warren and Amelia Warren Tyagi in the book All Your Worth: The Ultimate Lifetime Money Plan. It divides expenses into three categories: Must-Haves (or Needs), Savings, and Wants. Getting these three categories right is the key to reaching financial balance.
- Needs are housing, utilities, health care, transportation, insurance, and basic groceries and basic clothing.
- Savings includes retirement accounts, emergency savings, and debt repayment.
- Wants are everything else: cable TV, cell phones, haircuts, swimming lessons, dog food, tithing/charity, books and magazines, vacations, and food and clothing beyond the basics.
The Balanced Money Formula is based on your net (after-tax) income. It says that with your take-home pay, you should spend less than 50% on Needs, at least 20% on Savings, and the rest (about 30%) on Wants. These are targets to aim for.
When I discovered the Balanced Money Formula, I felt liberated.
First, the sheer simplicity of this budget framework freed me from having to track dozens of categories. Instead, I could just track my spending in three categories. (And then, as time went on, I was able to add in other categories for areas I wanted to track: comic books, dining out, and so on.)
Second, this budget gave me permission to spend. After I got out of debt in 2007, I clung to my frugal ways. Or, rather, my cheapskate ways. I was afraid to loosen up. But discovering the Balanced Money Formula made me realize that as long as I was paying my bills, keeping out of debt, and saving enough for the future, it was okay to spend my money on things that mattered to me. In fact, that's essentially what money's for.
Budgeting Sets You Free
When you use a budget, even one as simple as the Balanced Money Formula, you'll need to make constant adjustments. But once you get the most important expenses figured out (your Must-Haves or Needs), you usually don't have to worry about them much. Your housing payment doesn't fluctuate from month to month, for instance. Your insurance premiums stay pretty constant. The same is true for your Savings. Once you get used to saving a certain amount, that becomes a habit.
Your goal, then, is to trim your Needs and boost your Savings until they're both at respectable, sustainable levels. If you can keep these two broad categories where they should be, you can spend everything else on Wants. Spending on fun stuff is less stressful when you know you can afford it.
There are dozens of other great budgets out there, of course, including Richard Jenkin's 60% Solution. And I'm certain that you have your own set of personal guidelines when budgeting. What rules do you follow when building a budget? Which methods work for you? Which do not?
As part of my workshop last week, I created a series of handouts. This post is largely drawn from that material. You may find it useful to download these for personal reference:
- Building a Better Budget handout [64k PDF]
- The Balanced Money Formula worksheet [104k PDF]
- The One-Page Guide to Personal Finance (2011 Edition) [71k PDF]
Let me know whether or not you find these useful. And I'm open to suggestions for further printables, too.