Before we get into the details of budgets, I have to ask some questions. I have very different ideas of what is important in my life compared to you and your goals. So before anything is laid out about what a budget is and how to build one for yourself, lets ask ourselves about our goals.
- What is most important to you: Retirement, Paying down debt, Travel, Children, School… The list goes on, but you need to ask yourself and prioritize what is most important and what is least important. (If you don’t have an idea of what your priorities are, I’ve put a link at the end that is very helpful)
- How do you feel about risk? Some people feel differently about taking risks in life than others. Would you feel comfortable with less money in the bank knowing that you have spent money on something you really want or need? Or would you rather have a big cushion in order to be able to sleep at night?
- How long do you have? How close is retirement or college or your trip from right now? This helps narrate how fast or slow you need to accumulate money to accomplish your goals.
Once you have asked yourself these questions we can start to look at a budget. A personal budget is very similar to how a company works. There are cash inflows and there are cash outflows. Those are the only two options.
I like to think of a personal budget as the track to your race toward your goals. Without a track we could be running really hard and fast but toward that tree over there in the distance. Getting ourselves on the track, and in the race we want to race in helps us work towards the goal we have in mind.
The track does not limit how fast or slow you run, and in some cases it even allows you to move side to side some distances. Okay the metaphor is starting to collapse, but you get the point. The idea of a budget should not be constraining, but instead freeing to be able to know your working towards something.
Once you figure out what you want to work towards, the next step is writing down (yes writing down somewhere) your monthly income. That is the best place to start. If you have to look at your bank account or your pay stub, that’s great. Once you know your monthly income you can start to organize the outflows of your money.
In order to figure out how much you can save, you have to figure out how much you spend. The best place to start is your rent or mortgage and work down from there. Insurance, car payments, loans, utilities, groceries, phone bills all are outflows. (Notice I didn’t say shopping… yet). Writing down those necessary expenses help you understand the absolute least amount of money you have to spend in a month.
Next write down any extra spending that you do during a month. And you can estimate if you want, or you can get as detailed as looking at your past bank statements. Things like shopping, movies, eating out and other extra expenses that you don’t have to spend money on during a month.
Okay, here’s where the math comes in, so suck it up, because this is important. First we subtract your necessary expenses from your monthly income. This will give you the amount of money that you have extra to spend during a month. After that, subtract your extra expenses from your income with the necessary expenses already subtracted. This will give you the total amount of money that you theoretically could save every month.
Don’t be worried if this number is negative. And don’t be shocked if it is way higher than you thought. Now that you know these numbers you can work with them to help you get to your goals.
Use this number, the amount you can save each month, to help you build realistic timelines for your goals you’ve laid out. Keeping in mind the other two questions I asked about risk, “How much money you would like to have saved up”, and your timeline, “How fast you need to save”, will help you determine where you can put your monthly extra money. Knowing how much you can actually afford to save opens up your world to all the possibilities that you can think of.
There are many more guides and tools online that are helpful in getting your budget set, and I highly recommend looking at these tools in more detail. Because the more you think about and plan this aspect of your life, the more you are able to actually do the things you want to do.
Please let me know if you have any questions, you want more examples, or if you have any comments below and I will do my best to answer them.
Dave Ramsey is a great resource for budgeting and I’ve linked his list of easy priorities for what your money should go to if you don’t have a great idea of what that could look like: