Using a budget is the best way to make sure you’re spending your money on the things that really matter to you. Have you ever wondered where all your money goes? Have you ever looked at your bank/credit card statement and asked yourself, “How did I spend that much in one month on eating out (or something similar)? That is exactly what happens when you don’t use a budget.
What I’m talking about is creating a budget, and then sticking to it by tracking your expenses. Budgeting is the first step towards achieving financial independence, and It’s actually very easy to do. Follow these steps to get started.
Step 1: Set Goals
When you want to get directions to a particular location, you enter the destination. That’s what you need to do when creating a budget. First, you need to consider where you want to go. That means establishing financial goals. Setting short-term, mid-term and long-term financial goals is an important step toward becoming financially secure. If you aren’t working toward anything specific, you’re likely to spend more than you should. Important goals for achieving financial independence include:
- Getting out of debt
- Owning a home (without a mortgage)
- Having a fully funded emergency fund
- Retiring early
This list is not all inclusive. It is important to identify your own personal financial goals.
Another thing to note on these goals is that they will need to have additional criteria added to be truly effective. Your goals should be SMART:
Specific: state exactly what you want to accomplish.
Measurable: state the exact dollar amount you need to accomplish your goal.
Attainable: list the necessary steps to reach your goal.
Relevant: make sure your goal is meaningful so you can stay motivated.
Time-bound: set a date to meet your goal.
So for example, take a look at the first goal of being debt-free and make it measurable by listing all your debt. Make it measurable by stating an amount you will dedicate in your budget to pay off the debt. Be sure it is attainable. For example, if you make $3,000 per month paying all of that towards debt is probably not realistic unless you get another source of income. Be sure you understand why you want to be debt-free to make it relevant to your life and help motivate you to stay on track. Finally, set a date to complete your goal.
Example: I will to pay off $20,000 in debt by allocating $700 from each monthly paycheck for 2 years and 4 months.
Step 2. List Your Expenses
In order for your budget to be realistic, you will need to have a good grip on your current expenses. The first part of this is to look back at your last 30-60 days and see what you spent your money on. You can use pen & paper or a budget app (I list the one I use in Step 5).
Use your credit card and bank statements to document what you’ve spent money on over the last 2 months. Add a line item for cash in case you’ve withdrawn cash and can’t remember what you spent it on.
Don’t forget to look over your calendar and identify expenses that may not occur monthly, such as biannual auto insurance premiums, holidays & birthdays, professional dues, and annual medical exams (including veterinary exams).
Include items from your goals such as the amount you will allocate to pay off debt or savings.
Step 3. List Your Income
At this point make a note of all net income — that’s income after taxes. Just look at your pay stubs if you’re a regular employee. If you are an independent contractor, then you’ll need to set aside 25 – 30% of your earnings for taxes. Then record the remaining as net income. Don’t forget to include any side gigs, freelancing, or investment income that you may receive throughout the year.
Step 4. Compare Expenses and Income
Now that you have a list of all the money coming in (income) and all the money going out (expenses), compare them. Your ultimate goal is to have a budget that accounts for every penny. However, some expenses are variable like gas and groceries. What you will do for those items is to give yourself an allowance for each item based on past spending habits.
In order to reach your goals faster, look for areas you can save. For example, you may have spent $400 on eating out last month. You can give yourself an allowance of $200 for eating out and when you hit that limit, you don’t eat out anymore. It’s pretty simple.
Step 5. Track Your Expenses
The best way to make sure you are sticking to your budget it to get into the habit of tracking. You can still choose to use pen & paper or an Excel spreadsheet, but I use a free app called EveryDollar. The thing I like about using an app is that I can record every transaction as soon as it occurs. For example, when I fill up my gas tank. I pull out my phone right away and input how much it cost. You can upgrade to EveryDollar Plus for a fee to link it to your credit cards and bank account. There are plenty of other apps that do that as well.
Step 6. Review Your Progress Each Month
It is important to take time to review your progress. First, it is very motivating to see how well you are moving towards your goals. Second, it will help you make adjustments if needed. See how you did each month, where you overspent and underspent. Then you can make minor changes to your budget according to what you’ve learned.