How to Budget

Budgets work best when you tie them to personally important financial goals (e.g. a vacation, a new purchase, etc.). Without correlating your spending plan to a goal that requires you to prepare financially, your budget will likely fail. Goals give purpose to budgets. Without goals, budgets simply become math exercises in frustration: you add, you subtract, you fail, why continue?

Everyone who has tried to budget has found that their hoped-for expenses add up to more than their income. The resulting frustration requires time, effort, and sacrifice in order to resolve. Without associated budgeting goals, this frustration will lead to desperation or to the abandonment of the budget altogether.

Goals give budgets meaning, and meaningless budgets waste your time and energy.

Your goal(s) should identify what you want to do that requires you to budget and save, when you want to make the purchase or spend the money (include date and year), and how much money you will need (both total amount and how much that breaks down to on a monthly basis).

To exponentially increase your likelihood of achieving the written goal, share your goal and plans with someone else and then report your progress on a regular basis. A study from the Dominican University in northern California reports that such actions can lead to a 71% greater likelihood of reaching your goal.

While most budget forms list your income first, followed by your expenses, you should hold off on adding your income. By working on your income first, you turn your budget into an activity of trying to spend as much as possible without exceeding your financial resources.

By calculating your expenses before estimating your income, you will consider your expenses with a more rational and less emotional approach, leading to better outcomes in the end. Additionally, your budget no longer takes the form of a math exercise with you trying to subtract to $0. Instead, it becomes a tool to prioritize and calculate your regular spending. This will not guarantee a balanced budget, but it will give you a realistic starting point.

For regular bills such as rent or mortgage, cell phones, insurance premiums, debt payments, utilities on level pay programs, and media subscription services, add the expected payment required. For variable expenses such as gasoline, utilities not on level pay programs, gift-giving, and groceries, do your best to estimate your monthly spending in the category. Take into account seasonal factors such as rising gasoline prices in the spring (and falling gas prices after Labor Day), birthdays and gift-giving holidays, or large family gatherings and meals.

If you remain unsure of how much to estimate for each category, review your bank statements and any receipts you may have kept from the past month or two. If neither are available, your first budget step may actually include tracking every expense and purchase for the next 30 days or so in order to get a realistic estimate of your spending. Write down and add up every purchase. This will require time and effort, but you will have a much better idea of your spending by category than you could have otherwise.

Once you have prioritized and calculated your regular and expected expenses, you will next determine your expected monthly income. Before you easily calculate the income your employer says you earn each month, keep in mind that you absolutely need to use your net income and not your gross income.

Gross income is the amount of money your employer says you make. In your personal finances, gross income is a fantasy. It includes lots of money you never get to spend, like social security and Medicare taxes, not to mention income taxes and potentially health insurance premiums.

Net income is the amount of your paycheck. Net income includes the amount of money you have available to spend and use to pay bills. Always base your household budget on your net income.

Most budget forms will include a field for you to enter your income at the top. If you work freelance or own a small business, you may have inconsistent and unpredictable income. In such cases, estimate your income on the low end. It would be better to experience the pleasant surprise of having more income than expected versus having less.

Now that you have reasonable estimates of your upcoming expenditures and your expected income, simply subtract your planned spending from your projected income.

• A resulting figure above $0 means you expect to live BENEATH your means.

• A resulting figure near $0 means you expect to live WITHIN your means.

• A resulting figure below $0 means you expect to live ABOVE or BEYOND your means.

Many consumers remember their parents or teachers telling them when they were younger, “live within your means.” Perhaps as a tribute to the power of parental and educator influence, 60% to 80% of American households have consistently lived “within” their means since the late 20th century. Unfortunately, Mom, Dad, and the teacher got it wrong. “Living WITHIN your means” is perhaps better described as “living paycheck to paycheck.” It means you have nothing left over after paying your bills. It means you save nothing and invest nothing. It means a single financial bump in the road of life can send you into a financial tailspin that can takes years to recover from, if ever.

Instead, commit to living below your means by building your savings and investment accounts.

If, after subtracting your expenses from your income, you find the resulting figure near $0 or below, you should consider your options for increasing your income, decreasing your expenses, or doing a bit of both. Without making any of these adjustments, you will most likely run out of money before the end of the month and will need to make some difficult decisions about which bills to pay and which to let go into default (unpaid) status.

Too many households jump immediately to cutting their expenses when faced with a negative projected balance in their budget. While an effective way to balance the household budget, adjusting your spending should not be the only consideration. You should also consider ways to increase your income.

Increase Earnings

The most common options for increasing income include the following:

Seeking a better-paying job: While potentially the best option over the long-term, this typically requires months of work to find and secure new employment, let alone the three weeks it will usually take to work before you receive your first paycheck. Additional education and training both offer great potential to increase your regular income. Obviously, though, they both take months or years to complete. Besides the time factor, the greatest potential downside to the option of seeking higher pay at another employer involves human nature. Unless disciplined and redirected, the more money you earn, the more money you will spend. Earning more money does not guarantee a fix to your household budget.

Seek a raise from your current employer: Although this process typically requires less time than looking for a new job, it can feel much more intimidating. It is a rule of business that employers cannot pay you what you are worth (the revenue you directly or indirectly generate for the business) and certainly not more than you are worth to the business. If your boss paid you more than what you directly or indirectly contribute to the company, the company would soon join the ranks of out-of-business businesses. Still, with a little research, you might find your paycheck in the lower range of expected incomes for workers with your job title. Armed with such information and a list of how you contribute to the success of your company, you will feel empowered to ask for a pay raise.

Second job: When the budget looks tight for the next month, you might consider moonlighting at a second job. Many people work evenings, weekends, or seasonal jobs to make ends meet during difficult financial times. Do not allow this to become the norm, though. If you start using the additional income to cover regular bills and obligations, you will quickly begin to feel trapped in an unfulfilling lifestyle.

Side hustles: The side gig economy offers scores if not hundreds of ways to earn additional income outside of your normal employment hours. While most side hustles take many months if not years to build and begin contributing sufficient income to make much of a difference in your budget, others can generate enough within a week or two to help you meet some shortfalls in your spending plan. An Internet search will result in lists after lists of side hustles that you might consider. Find one that sounds both promising in terms of short-term income and interesting to you personally.

Adjusting Spending

Households who put together a spending plan will often skip steps 1-3 above and start with step 4. Then, when they find they are projecting a $0 balance or worse at the end of the month, they begin to cut expenses based on emotional reactions. Emotion-based financial decisions tend to oppose those that will, in the end, serve your long-term interests best. Nature seems to have hard-wired us to react emotionally in order to make choices that satisfy us immediately rather than taking long-term consequences into account.

Fortunately, you started with step 1 and, most critically for adjusting your spending, also completed step 2. Now, instead of relying on emotions to adjust your anticipated spending for the month, you simply start by eliminating expenses related to your long-term wishes. If that is insufficient to balance your projected budget, begin eliminating your trivial wants. In many cases, you may even need to eliminate some or many of your lifestyle expenses.

If you regularly struggle to pay for any lifestyle expenses, you should revisit and reconsider your financial obligations for your home, transportation, communication needs, and critical wants. A large percentage of households over-commit themselves in these three categories, living in homes or apartments beyond their means, making massive monthly car or truck payments that overwhelm their income, or placing multiple state-of-the-art cell phone devices on monthly payment plans that eat up their discretionary income.

Now that you’ve successfully created and set up your household budget, let’s take a look at why you’ll want to create the often overlooked backup budget.