How to Start Budgeting

It can be difficult to know where to start budgeting. There are entire companies built around the art of budgeting, everything from Intuit’s once ubiquitous Quicken software to classic envelope budgeting, where you use actual physical envelopes loaded with cash. In some respects a whole industry of financial self help experts like Dave Ramsey have popped up with the sales pitch of helping you budget. The truth is budgeting doesn’t have to be hard and there’s a really easy way to start.

I am not going to sell you an ideology, method or software. I am a big believer in budgeting, or maybe more accurately knowing what you have and then only spending what you have. To get there you don’t have to attend a conference, buy a book or sign up for a software subscription. It’s actually pretty straight forward.

First let’s take a step back and think about what the goal of budgeting is: it’s to give yourself permission to spend money. That may sound weird at first, but without a budget you’re running wild and free never quite knowing whether or not you should or should not spend money on something. Budgeting is a tool that basically says, “Yeah Stan, it’s OK to buy this right now.” Or, “Sorry Stan, not right now, you need to save up for this one.”

How do you start a budget? I’m going to show you the most the bare bones budget and everything you need to get started. You don’t necessarily need a computer for this, a pen and piece of paper will work; but if you have Excel, Google Spreadsheets or AirTable I recommend using that.

To get started building a budget there are really just two steps:

  1. Identify your income.
  2. Identify your recurring expenses.

This may seem overly simplistic, but as with so many things one of the biggest risks in starting down the path of budgeting is to attempt to boil the ocean. One of the ways you can boil the ocean is with super fine grained categories that you try to shove all of your expenses into. That won’t serve you well in the short run and over time it’ll just get frustrating. Remember, the goal is to give yourself permission to spend money, not to frustrate yourself. The best way to give yourself permission is through simple knowledge, not overbearing process.

If you’re gainfully employed identifying your income should be pretty straight forward. If you’re paid twice a month just take your after taxes pay check and multiply it by 2. If you’re paid every two weeks I recommend building your budget around just 2 paychecks, as that’s all you’ll have most months. That extra pay check you get a few times a year is a great way to tackle debt or to build up savings. If you’re a contractor or have some sort of variable income the best thing to do is spend some time figuring out what a reliable month looks like and basing your month off that.

For the sake of illustrating my point let’s say my after taxes pay check is $2,000. This means that for any given month my total budget is $4,000, and thus I’m going to write this at the very top of my budget.  A drawing of income for a budget

Next I need to think about all the things that I spend money on every month, like my cell phone bill, my mortgage and my car insurance. Your list might look something like this:

A drawing of expenses for a budget  These expenses never change, or at least not until something radical happens like I get rid of my car or cancel Netflix. There’s another category of recurring transactions that can be harder to pin down and those are your utilities, such as gas, water, electric and sewer. If your utility company offers a budget plan you should use it. The budget plan is designed to standardize your monthly payment and cover the spikes that can occur seasonally when, say, it’s cold outside and you need more gas for your furnace. If your utility company does not offer a budget plan then my best recommendation is to use one of three things: (1) Your highest bill, (2) Your average bill, or my personal favorite (3) Your average bill plus its standard deviation.  A spreadsheet table of numbers showing standard deviation

You’re probably thinking, standard deviation, are you kidding me?!? Nope. Here’s the thing, if you use the highest bill then most months you’re over budgeting. If you use the average then most months you’re under budgeting. You need to give yourself some sort of buffer, and the standard deviation can help do that in a rationale way. If you don’t want to mess with the math though, simply average your bill out over 12 months and call it a day.

If like Mrs. Lemon you were left wondering what standard deviation is, never fear! Standard deviation is a measurement of how far apart your numbers are. For the purpose of budgeting it can help you come up with a buffer to use when determining your number. Any spreadsheet software can figure this number out for you, but if you want to learn more check out this link.

Once you’ve dealt with your utilities you’re down to the truly variable stuff, such as groceries, eating out and auto fuel. Most people have no clue how much they spend in these categories each month. If you start budgeting you will eventually, but for now don’t sweat it because again, you’re just getting started.

Let’s take a look at the whole budget together now:

A drawing of a full budget  Based upon our back of the napkin math here, we appear to have $2,873.01 leftover after our recurring expenses. Now the trick is to make sure you don’t spend more than that!

The easiest way to track your spending is with fewer accounts. Many items, like the mortgage (or rent) and utilities often require you to write a check, use bill pay from your checking account or do an electronic funds transfer. If you are a debit account user than using one account is easier than if you’re using a credit card, because all of your payments can come from the same place. If you’re a credit card user you can try to put those fixed costs onto your checking account and then make sure your credit card balance never exceeds the amount you’ve budgeted for as ‘leftovers’ (the part circled in yellow above).

Here’s the next thing to keep an eye on: how much money are you spending each day beyond your fixed costs? If your leftovers are $2,873.01 you have roughly $92 per day that you can spend. Some days you won’t spend any, others you’ll spend more. The point is not to get ahead of yourself. If at the end of a week you’ve spent more than $644 ($92 x 7) you need to slow down and make adjustments.

Save your receipts as you’re getting started. They can be handy to look back at the end of the month and see what you spent money on. This is especially handy if you eat out a lot, or find yourself making surprise visits to Target frequently. Those receipts can help you determine that maybe you don’t need appetizers every time you go out, or perhaps you really didn’t need those new towels from Target.

As time goes on if you track the expenses in your leftovers you’ll start to see a few more categories emerge, such as Groceries, Eating Out, Household Items and Entertainment. Remember what I said earlier about fine grain categories. Whatever you do, resist the temptation! Come up with good round numbers for these things like, $500/month for Groceries and record your transactions and see where things shake out. The most critical piece is not to spend more than the $2,873.01 you have leftover.

Don't make budgeting a burden; remember what we said earlier, the goal here is to give yourself permission to spend money - specifically that money you have. When budgeting works out well you can react to surprises, like a new alternator for your car, or you can celebrate for things like a birthday. Budgeting also steers you clear of debt, especially credit card debt, which can cripple your financial abilities in ways too numerous to count. At the end of the day, budgeting should empower you, and if it's not then take a step back and start over.

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