Minding our finances has become a big trend over the last few years, and that is a very good thing! However, like with many things, there are good ways to keep money under control (these will make our finances grow), and bad ways, which will cripple away our assets and send us back to square one on the net worth ladder. Moreover, when it comes to budgeting, there is no one-size-fits-all tool and it is much more a matter of composing one’s own recipe through experimentation over our personal situation and goals. In this post, I will share my approach to personal budgeting.
Before I begin though, I feel obliged to say that this piece of content is for entertainment purposes only and does not stand as any kind f recommendation as per the topics of personal finance strategy and planning. If you need specific advice on that topic, please seek professional advice from an accredited advisor. Thank you.
Why budgeting? What is the point of budget?
In order to grow your money, as in your savings, you need to get an accurate figure of how much you spend, then yo need to compare it t how much you earn. This first calculation will determine whether or not you overspend your money. If you’re not overspending, that’s great news because it means you live below your needs and have money left for savings. If you are overspending, that means that you have to determine the amount of potential debt that you have to pay back.
Moreover, once you get the global amount for your spendings you can determine which expenses are your actual necessities (rent/mortgage, food, utilities, transportation…) and which ones are more discretionary (subscription services, movies…). This distinction will be helpful if you ever have to draw cuts in your expenses and will give an instant overview of how much you can recover from these cuts.
So, budgeting is a dashboard which you can use to manage your money, sustain your lifestyle and make plans for the future. It is fundamental tool that allows you to build up your finances as a shelter from the unexpected events of life (getting and/or keeping out of debt), or work towards your projects.
1 – Get an accurate vision of your income and expenses
The first thing you want to do (if you haven’t done so yet) is knowing in a pretty accurate manner how much you and/or your household bring in every month and how much of that is going out in expenses. At this stage, it is important that you remain transparent and adopt a purely analytical stand on these movement. Meaning that it is important not to minimize anything and just report the numbers as they are. At the end of this first step, you will have a basis which will allow to design the right approach through the next steps of this process.
In order to perform this task, you will need to go through your latest bank statement and pay stub, as well as credit card statement. It would probably help to plan ahead of time and keep receipts for purchase at hand for the whole past month at hand. Then you can easily know what was what as per each one of your expense.
Need help with budgeting and tracking expenses?
Check my personal financial dashboard spreadsheet to help you to lay down your income and expenses, as well as your saving capacity. Available on PC and Mac OS.
2 – Figure your current net worth
Usually, we lean toward thinking than net worth isn’t something we should care about unless we are millionaire. Well, that’s not true! We actually all have a net worth and our bankers monitor it permanently. It is time for you to actually consider your own net worth as well. It may be small or it may be high but budgeting is all about numbers and it is most important that we keep an accurate knowledge of these.
Basically, the net worth is the balance between the money you have (between your earnings, your savings/investment, and your property), versus what you own (mortgage, credit card, student/car loans…).
From the first step above, you should have established either you are leaving above or below your means. Let’s consider that is the case, then (should you have done for some time already) you are likely to have a significant amount of savings and could mean the next step for you could be to optimize some of these savings into investment so you can reach better return while putting your money to work.
If on the contrary, you find yourself on the other end of the spectrum. It is likely that you will have to focus on limiting expenses, pay off debt, and overall adopt some defensive strategy to rebalance the situation and get money working for you instead of you working for money.
3 – Draw the (honest) line between your needs and want
Whatever your situation is, you need to keep your mind clear when it comes to spending your money. For that, financial-savvy people use the concepts of Needs and Wants when considering their expenses. This distinction helps them to trim out unnecessary expenses as only needs are perceived as legitimate in this case. That why, if you don’t do already, you should!
Examples of needs are:
- Primary housing expenses (mortgage/rent. No, that Airbnb rental for the holidays is not a need)
- Utility bills
- Insurances (e.g auto, life, health, home)
- Property taxes
- Transportation (gasoline / transit pass)
- Debt repayment (credit card, student loan, car loan)
- Medical expenses
- Child care
Examples of wants are:
- Dining out & food delivery
- Entertainement (movies, concert)
- Gym/club membership
- Cable streaming services
- Home decor and furniture
- Vacation (I know… stay strong!)
- Clothing and accessories
4 – Determine the right method for you (50-30-20, Pay-Yourself-First, envelopes, zero-dollar)
Now that you have a better knowledge of your situation money-wise, you should be able to take on the next step and determine the right method for you. There are mainly 4 approaches to personal budgeting and you can use one or the other according to your current situation and goals.
The 50-30-20 rule for personal budgeting 101
This approach is useful for getting started with budgeting and set yourself on-track to reach your financial goals. By allocating a predetermined share of your income for all your needs (50%) and your wants expenses (30%) while reserving the last 20% for savings, you have a healthy foundation to reach goals either it is paying down some debt or build a nest egg for the future. And on top of that, you still have room for discretionary expenses so you don’t feel like you’re sacrificing too much for your lifestyle.
If you want to start tackle down your financials, but you don’t know where to start exactly, this is definitely the right boilerplate to jump start your journey.
The envelope system to control spending
This method is specially designed for you if you need a more rigid framework to be put in place to keep up with your financial goals. It is a cash-based approach that allows you to set up a spending limit for every spending topic in your lifestyle: groceries, utilities… But also and more important discretionary expenses like takeaway food, drinks, and entertainment. On each payday, all you have to do is put a predetermined amount of cash in each envelope and use that money to cover those expenses. When the money is gone, that means you have to cut on any further expense in that area until your next pay-check. If there is some leftover, you can either put it into savings or leave not the envelope and withdraw less money from your next paycheck for that envelope.
It may seem difficult to believe that actually works, but it does. That is because as human beings, we acknowledge somethings as a real, physical, things only when we can see it and touch it.
Therefore, a bundle of cash that leaves our hands to go into someone else’s is definitely more meaningful than handing a credit or a debit card or writing a check. When you’re actually watching your money go away, you know it’s gone. And that pushes you to think…
Pay Yourself First (PYF) to build your nest egg
If you live to save (money), that is the right approach for you. The logic here is to reverse budgeting not to focus on expenses but rather on savings. So, every month or whenever you get paid, your top priority is to save a fixed amount of money before you even pay your bills. It is pretty radical and you should definitely a clear idea of your recurring expenses as well as a good sense of budgeting before dipping into this method just because, even though you put them in second and save in the first place… well you still have a pay your bills! So you can’t blindly in this and it’s critical that you have a clear idea of where you are at at any time here.
The zero-dollar budget
In this method, each of your expenses has to be accounted for as you map out how you will be using your money to the last cent. That’s right, here you take all your money and share it according to your goals between savings and expenses. Like with Pay-Yourself-First, using this method also requires a pretty accurate vision of your current financials and goals, as well as a good understanding of budgeting. So maybe not the best one to start with if you all new to the concept.
5 – Choose the right personal budgeting tools for you
Before you start your journey into personal budgeting, it is important that you consider how much time and energy you will be able to put in that commitment in the future. Indeed, taking such a standpoint early on will help you in choosing, not only the appropriate method but also equip yourself with the right tool to pilot the process and land things successfully later on.
For example, a standard Excel spreadsheet coupled with a zero-dollar budget approach would require frequent and detailed inputs from you in order to make it a success and reach your goals. Therefore, some of the tools and methods make the commitment stricter while some others make it more flexible… Whereas a well-designed spreadsheet (like this one) used alongside a 50-30-20 method will make it easy for you to get a clear vision of your expenses and goals while saving hours that you can spend doing what you enjoy the most!
Best budget apps
Another type of tool out there is budget apps such as Mint or Zerodollar. Some of them are free and have been around for a while and others just came into the market and are available for a subscription fee every month. These apps offer the opportunity to sync your bank accounts (for those holding accounts at various financial institutions) to provide some tracking of your expense and an overall vision of your financials… However, the free ones tend to suffer from latency while syncing the data at some point. Personally, I don’t like the idea of giving access to my bank account to anyone else but me, so I use my own spreadsheets. But that’s just me.
Personal budgeting… that’s it!
One last piece of clarification about winning at budgeting: although you have to know your numbers at first (how much you make versus how much bleeds out), moving on, t’s not so much about the numbers but understanding the relationship that we have with money, setting clear goals for ourselves and be aware of our own capacities when it comes to personal finance. From there you will know better about what needs to be done, and what you have to learn.