The Five Keys to a Good Budget

The language of budgets obscures their true potential. We say “I’m on a budget” when we don’t have as much to spend as the opportunity to spend it in front of us. It’s like saying “I’m on a diet” when presented with a good looking pastry. We say “I have a budget” when we know roughly where our money is spent, and we don’t run out of money at the end of the month.

But a budget is not a diet for your money. Nor is it merely a way to track your spending. A budget is a plan. It is a plan for your financial security. It is a plan for how you spend your money both today and in the future. A tool you can use to anticipate nearly all your spending, so you won’t be surprised by unexpected expenses. A good budget will allow you to do the things that are important to you today and still save for your future when you are living off your savings.

Given that a budget is a plan, what are the keys to a good plan? There are five elements, regardless of what you are planning for, that will make implementation of your plan more successful. You need objectives, an assessment of where you are, the actions you will take, a way to measure your progress and resources.

Objectives: What are you trying to accomplish? You will have short term goals and long term goals. Your overarching objective is financial security, but that is too vague. To be financially secure you will need to have an emergency fund in place, limit your debt and save money for your retirement and your children’s education. There will be other goals along the way as well. Your budget will evolve over time to manage these competing priorities.

To avoid being overwhelmed, you will need to break down your goals into small chunks, prioritize them and assign time frames. You don’t have to accomplish all your goals at once. Start with one goal, and you can build on your progress.

A good place to start is your emergency fund. An emergency fund is savings you will use to pay your bills if you lose your job. A minimum amount of savings would be enough to cover three months of your expenses. If you don’t know what your expenses are, you will have a better idea after you complete the second element of your plan; the assessment of where you are.

Using your emergency fund objective as an example, you might decide to set aside $50 per week for this purpose until you reach your goal. If you know how much you need, you’ll be able to put a time frame on this objective. Once you’ve established an emergency fund, it doesn’t need to grow. You simply need to maintain it.

You can set similar goals for your other objectives. You might decide to use that $50 per week to contribute to your company 401(k) plan once your emergency fund is in place. Maybe you can add enough to that to get your full company match and begin chipping away at your credit card debt. Longer term, you can use pay increases to add to your retirement savings and maybe put some money away for college for your kids.

Assessment: How are you currently spending your money that keeps you from saving it? Not roughly. Exactly. In order to know where you can find that $50 per week, you need to know where your money is going. Track your spending for a few months or use your bank or credit card company’s tools to categorize your expenses. Minimize what you categorize as miscellaneous expenses. The hard to think of categories are things that don’t matter much to you and may be where you will find your savings.

Think about upcoming expenses. Nearly all expenses are predictable to the extent that they will come up eventually. There will be car and home maintenance expenses and health care expense that won’t be covered by your insurance. There might be planned vacations or family gifts. Even if you don’t know when they will come up, you can be prepared for these expenses if you recognize they will eventually come up.

Actions: You can’t just track your spending to reach your goals. You have to do something about it. Define and document how you will change your spending so you can set aside that $50 per week. This is where your plan becomes what you would typically think of as a budget.

For each spending item set a dollar amount to spend for the week or month. Include an allocation for those less visible upcoming expenses. If you will need tires for your car in the next year or so, you might set aside $10 per week. But this isn’t part of the $50 you’re targeting for your emergency fund. It is simply getting ahead of known expenses, so you can set more realistic limits on all your spending categories.

What actions will you take to stay within your spending targets? You could decide to make a temporary sacrifice to reach a short term goal. Chelsea wanted to buy a house, so she sold her car to save up for a down payment. She figured that her all-in cost of owning the car, including payments, insurance, gas and maintenance was about $400 per month. Giving up the car allowed her to save her down payment faster than she could have otherwise.

For short-term goals, there’s nothing wrong with temporary measures. For goals that will take years, your entire career in the case of retirement savings, you will need to take more sustainable actions. You need to incorporate saving into your budget. That means ensuring you have room to do the things that are important to you, by eliminating spending on as much of what isn’t important to you as possible. With a goal in mind you can more easily make those choices.

After Chelsea had saved her down payment and moved into her new home, she decided she didn’t need a car. Public transportation and ride sharing services fully met her needs at a fraction of the cost. Owning a car was no longer important to her, so the extra $400 per month could now go to other longer term goals.

Measure Your Progress: Now that you have documented your budget, you not only have a plan, but you also have a tool for measuring your progress. Continue to track your spending and compare it to your budget. It’s always possible that you under or over estimated a category here or there, and there are times when you won’t be able to stick to your plan.  Make adjustments as you need to reach your goal.

Resources: There are lots of ways to create a budget. You can go low tech and put cash in envelopes for each spending category. A funny You-Tube video shows Gene Hackman and Dustin Hoffman describing Hoffman’s Mason jar approach to budgeting when they were starving young actors.

You can create a spread sheet. Microsoft excel has several budget templates with common spending categories already set up.

Or you can use one of many free on-line budgeting services like Mint.com. Most will link to your bank and credit card accounts if you want that convenience. For a little more support you can buy a subscription to Youneedabudget.com. The service provides education and guidance for how to approach your budget.

Your budget is your plan for financial security. For any plan you need an objective and to know where you stand. With that information you can commit to actions that will help you meet your goals, measure your progress and identify the resources you need. Your budget is a powerful tool that can ensure you meet all your financial goals if you treat it with the care you take with your other big plans.

Image courtesy of Master isolated images at FreeDigitalPhotos.net

 

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