What Is A Budget, Really?
I hate when people refer to their budget as a spending plan. I understand why they call it that, but I think it is wildly inaccurate.
A good budget is a SAVING plan, and the key to financial success. It doesn’t matter who you are, or how much you make. If you want to win with money, you need a budget, and you need it now.
The Real Purpose of Budgeting
Before we get started creating a budget, it’s important for you to understand the purpose of budgeting. And, contrary to to what you might have heard, a reduction in your spending habits is not the ultimate objective.
The real intent of budgeting, is to achieve your financial goals.
Whether you have a goal to travel the world, become a millionaire, give money to charity, get out of debt, buy a house, or anything else, you need a roadmap to get you there. And that’s exactly what budgeting is — a roadmap to your financial dreams.
It was Zig Ziglar that said, “If you aim at nothing, you’ll hit it every time.”
Don’t be the person that wanders aimlessly through your financial life. If you set goals for your money, and take dead aim at them with your budget, you will hit them every time.
Ok, that all sounds great. But how do I get started budgeting? I’m glad you asked.
The 10 Steps Of Budgeting
My wife and I created the 10 Steps of Budgeting through the financial experiences in our own life. We are not a financial experts. We’re just a married couple, dedicated to their budget.
This process has worked wonders in our financial life, and we are confident that if followed correctly, it will work just as well for you. Are you ready to start budgeting? Let’s Go!
Step 1: Commit To A Routine
As a kid, my dad always said, “It’s easier to keep clean, than to make clean.” It was his polite way of saying, “if you would consistently pick up after yourself, you wouldn’t have to spend every Saturday cleaning your room.”
It may have taken me a hundred Saturdays cleaning my room to learn this concept, but I’m glad I did, because it has followed me into many areas of adulthood. Especially budgeting.
Now, I find myself saying, “It’s easier to keep up with our budget than to catch up on our budget.”
And it is so true.
Before you create a budget, you need to commit to a consistent, daily routine. The best part is, budgeting doesn’t take a huge time commitment. I’m talking about scheduling 30 minutes at the end of every month to create your budget, and then 10 minutes per day to update your budget. That’s all it takes.
I personally update my budget right after I eat lunch, but you might prefer first thing in the morning, or late at night. The time of day doesn’t matter, as long as you are consistent and committed.
If you struggle with consistency, I highly recommend setting a daily reminder on your phone. I did when we were first budgeting, and it was incredibly helpful.
Ok, now that you have decided on a routine, it’s time to set some goals.
Step 2: Set Inspiring Goals
A budget without a goal, is like trying to get directions to an unknown destination. It doesn’t work.
In addition, a budget with a boring goal, is like planning a trip to the dentist. The destination is clear, but I’m betting you don’t daydream about getting your teeth drilled.
If you want to be successful in budgeting, you need to set, specific, measurable goals that inspire you.
A good example of this would be: “Over the next 7 months, I am going to save up $10,000 so I can buy a car in cash for the first time in my life.”
Why is this a good goal?
- It is specific. There is a set amount of money within a pre-determined timeframe. In this case, $10,000 over the course of 7 months.
- It’s easy to measure. If you divide $10,000 by 7 months, you get $1,428.58. That is the exact amount you need to save per month in order to achieve your goal. If you save less than that, you won’t reach your goal. If you save more than that, you will reach it faster. Budgeting for your financial goals becomes pretty simple when you make them measurable.
- Paying cash for a new set of wheels is pretty inspiring.
In contrast, can you see the problem with an ill-defined goal like, “I want to save up to buy a car”?
It leaves too many unknowns. How much will you save? How will you measure success and progress along the way? Does the process of saving for a car inspire you?
Goals like this lead to budget abandonment. Don’t let that happen to you. Set better goals.
If you are still struggling with step 2, I encourage you to read this article by Michael Hyatt about activation triggers and his SMARTER goal setting process. He is a master at setting and achieving goals, and you will learn a lot from what he has to say. I certainly have.
Step 3: Calculate Your Monthly Income
Ok, so it is nearing the end of the month, and you are sitting down for your 30 minute monthly budget commitment. You decided on a routine, and set some awesome goals. What now?
In step 3, you will begin creating your budget by calculating your monthly income.
If you get paid a salary, this is a fairly simple step. Just add up your paychecks for a month.
Though, if you are paid hourly, or on commission, this step might be a little more difficult. I recommend you set your number equal to 90% of your average monthly income over the last three months.
In other words, add up all your income over the last 3 months, and divide that number by 3. Now, take the resulting number and multiply it by 0.9 (90%). Use this number for your monthly income. It will give you a little leeway in case you have a slimmer month.
Finish step 3 by writing that number down.
Well done. Onward and upward!
Step 4: Prioritize Debt, Giving and Saving
Have you ever heard of The Primacy Effect?
It states states that the human brain will naturally put more emphasis on the first items in any list.
This is why in step 4 we put emphasis on 3 things before anything else: paying down debt, giving and saving.
But that doesn’t make sense. How do I budget for those things, before I know all my expenses? Easy, you just do it.
Good budgeters don’t plan their savings around their expenses. Instead, they live within the amount of money left over after they have set aside money for debt, saving and giving.
In simpler terms, if we were to lay out our budget as an equation, it would look like this:
income – (debt + giving + saving) = remaining money
So, why start with debt. I speak from experience when I say that debt is a financial death trap. It not only ties up your finances and forces you to pay interest to somebody else, but it eliminates the interest you could be making on that money if it were invested. It is the worst financial move you can make, and we recommend you get out of debt as fast as possible. Plus, getting out of debt will open doors in every other area of your financial life.
This is why we put it before everything else in budgeting.
If you are struggling with debt, we recommend the Debt Snowball method. If you need more information on it, this article on DaveRamsey.com is a great explanation. Side note, we also recommend you follow Dave Ramsey’s financial baby steps, which you can check out here.
After debt, comes giving. I won’t put a percentage on giving, because it is predicated on the condition of your heart. All I will tell you is that if you are going to give, it should come before saving.
On the other hand, when it comes to saving, I recommend a minimum of 20% of your gross income — as long as you are debt-free.
This 20% should include any retirement contributions taken out of your paycheck, and any additional savings you set aside. It should not, however, include money from an employer match. That is just a bonus, and you will only be cheating yourself if you decide to include that in your 20%.
You should also save for things like: a rainy day fund, car maintenance, medical expenses, and Christmas and birthday gifts. Setting aside money for known expenses in the future is essential to your financial health, and this is the time to address them in your budget.
Step 4 might seem kind of backwards, and maybe even a little daunting. But utilizing The Primacy Effect to place emphasis on debt, giving and saving will change your financial life forever.
Let’s keep rolling.
Step 5: Calculate Your Living Expenses
Now that you have accounted for debt, giving and saving, in step 5, you will add up your monthly cost of living.
Remember that equation from step 4?
income – (debt + giving + saving) = remaining money
From now on, every item in your budget will be pulled from “remaining money.” And we will start with Living Expenses.
This is a very exclusive category. It should only include the essentials: rent/mortgage, utilities, food, gas, health, and phone are the main items in living expenses.
I’m sure there are a few outliers, but you should be covered for the most part if you stick to that list. If it isn’t necessary to live and work, it does not belong in living expenses.
Take some time to go through your bank account and add up your monthly living expenses. If this is your first time budgeting, this number will probably be a little higher than necessary. Try to find any areas where you can make cuts in your living expenses, and subtract that number from your remaining money.
As a rule, your total living expenses should not exceed 50% of your calculated income from step 3. If they do, you need to go through your expenses with a fine-toothed comb, and start cutting.
Remember, you won’t achieve your financial goals if you create your budget to fit your lifestyle. You will achieve your goals if you adjust your lifestyle to fit within your budget.
Ok, once again, lets adjust our equation:
income – (debt + giving + saving) – living expenses = remaining money
Step 6: Mix In Some Fun
In budgeting, it is critical that you set aside money for some fun. After all, what is the point of having money if you never get to enjoy any of it.
In step 6, you will set aside to spend on whatever brings you joy. And, believe it or not, I encourage you to spend it.
To paraphrase one of my favorite quotes, “All work and no play makes budgeting a dull pursuit.”
Budgeting is all about living within your means, and part of living is having fun.
For me, fun money is often spent on woodworking tools, whereas my wife usually spends hers on shoes or clothes.
The best part is, fun money is guilt-free. And to be hones, we actually celebrate it. So when Katie brings home $150 worth of new shoes every month, I am happy for her. And, she likes it when I spend my fun money on a new table saw blade.
The key concept with fun money is that there is freedom within boundaries. As long as you set your fun money to a specific amount, and stay within that limit, you can freely spend your money.
I recommend 5 – 10% of your take home pay be dedicated to fun money, and it should be save-able. That way, if there is something you want to buy that costs more than your monthly budget for fun, you can just save it up and apply it to next month.
If you want to know more about fun money, check out this post I wrote: Budgeting Tips: Fun Money.
Let’s adjust our equation again:
income – (debt + giving + saving) – living expenses – fun = remaining money
Step 7: Provide A Cushion
By this point, you have accounted for: debt, giving, saving, living-expenses, and fun. But there will inevitably be a couple things you forgot to account for; especially in your first couple months of budgeting.
So, I want you to assign the remainder of your money (around 5-10% of your calculated income) to a miscellaneous fund.
Whether it is a surprise doctor’s visit, an auto-pay subscription you forgot to cancel, or that $35 your kid needs for a school project, unexpected expenses will most definitely crop up. The last thing you want to do after all your hard work, is dip into savings, or go into debt.
So, to adjust our budget equation one last time:
income – (debt + giving + saving) – living expenses – fun – miscellaneous = $0
Congratulations, every dollar has an assignment for the month, and your budget is ready to go.
But you aren’t quite finished with the 10 steps. There are still a couple crucial elements to ensure your budget is successful.
Let’s keep our momentum, and head on to step 8.
Step 8: Trim The Fat
Step 8 might be the easiest to understand, but it is probably the hardest to implement. It is time to cut any remaining expenses.
If you still have a few expenses left over after step 7, it’s because they didn’t fit into any of the previous categories. So, get rid of them. No exceptions.
I don’t mean to be harsh, but if they aren’t considered living expenses, and they weren’t important enough to qualify for fun money, then they don’t belong in your life.
Free yourself and your budget from the burden of these unnecessary expenses. Trust me, you will be glad you did.
Trim that fat!
Step 9: Save Any Leftover Money
Remember that miscellaneous fund you created in step 7?
Well, if you didn’t have to spend that money on many surprise expenses, you could have as much as 10% of your calculated income leftover at the end of the month.
Once again, congratulations!
Now, put that remaining money into savings. I don’t care if it is $5 or $500. Get in the habit of saving your leftovers.
Remember, the purpose of your budget is to achieve your financial goals. And if you can squeeze a little bit of bonus savings out of your finances each month, you will achieve them much faster.
I will warn you, this step can get pretty addicting.
By beginning and ending your budget with an emphasis on savings, you will experience a mental shift in the way you run your finances. Instead of looking for ways to justify your spending habits, you’ll find yourself figuring out ways to eliminate expenses; even the ones you once considered necessary.
Just don’t try to reduce your grocery budget without consulting your spouse. That doesn’t go over very well… I’m guessing.
Step 10: Evaluate and Improve Your Budget
Your first couple months budgeting might be a little ugly. All your bad habits and debt will be exposed, and those things can take some time to get under control. That’s ok.
As David Kadavy says in his book The Heart To Start, “give yourself permission to suck.”
Step 10 addresses the ugliness, and is critical to the ongoing success of your budget. It’s time to evaluate how well things worked throughout this month’s budget, and what adjustments you will make next month.
Ask yourself questions like:
- Did I over-budget, or severely under budget in any categories?
- Did I make the right amount of progress toward my measurable goals?
- Which of the budgeting steps gave me the most trouble, and what could I do to change that?
- Were there any surprise expenses this month that I could better prepare for in the future?
Figure out as many areas of improvement in your budget as possible. Then, make those adjustments in your budget for the following month. Just make sure the adjustments align with your budgeting goals. Remember, that is the purpose of budgeting.
Don’t skip this step. Every budget can be improved. The good news is, after a few months of refining your budget, the adjustments you need to make will become smaller and smaller, while your savings becomes bigger and bigger.
Budgeting isn’t always easy. It takes discipline, tenacity and consistency. But with the right plan, and mental approach, you can be extraordinarily successful with your personal finances.
Remember, a budget is a saving plan, and a roadmap to achieving your financial goals and dreams. So, set your financial sights on exactly what you want to achieve, and use the 10 Steps of Budgeting to get there.
You don’t need to be a financial genius. You just need to Be The Budget.
Key Takeaways Of Budgeting:
- Budgeting is not a spending plan, it is a SAVING plan.
- The purpose of a budget is to achieve your financial goals
- The 10 Steps Of Budgeting Are: