Of all the steps in your financial journey, step 4 is probably the most difficult. This is the step where you take your actual monthly income and expenses and reconfigure them in a way that you can start working on your goals. You will be creating a map of where you’re money will go (also known as that dreaded “B” word, budget).
What is a Budget?
The word “budget” has a negative connotation to it, and I’m really not quite sure why. A budget doesn’t mean you can’t spend money on things you want, because you can. You can choose where to put your money. A budget is simply a written guide to help you spend your money on the things you’ve identified as important to you. Perhaps the negative feeling people have about the word “budget” is that it reminds them that there are limits to how far money can go.
Constructing Your Budget
There are a lot of budgeting guides out there, so I’m not going to try to reinvent the wheel. Do a google search for “create a budget” and you’ll find thousands of worksheets and programs. When you documented your monthly spending in the previous step, you were laying the groundwork for your budget.
There are a number of expenses each month that are absolute necessities that must be paid: the mortgage/rent, electricity & other utilities, food, insurance, gas, healthcare, vehicle loans, credit cards, etc. So, these are the first things to add to your budget.
Next are all the discretionary items. These are things that aren’t absolutely necessary, but we choose to have them. This includes things like cable/satellite, a family pet, eating out, cell phone plan add-ons (data, texting, etc), entertainment, etc. If you were in a negative cash flow position in the previous step, these are the first things that need examined.
This is where things can get painful. If you’re in a negative cash flow position (where more money is going out than coming in) something has to change. It’s important to point out that there are two sides to this coin, and both of them are worth exploring.
The first is the income side: make more money. Maybe it’s possible for you to take a second job or volunteer for overtime at your current job. Maybe you have piles of unused “stuff” at home that you could sell on eBay or craigslist. From a longer term viewpoint maybe you could get some additional training to have better higher-income job opportunities. The point is that there are other options than cutting spending alone. Maybe you’ve already cut spending to the bone and can’t possibly cut any more.
The second budget adjustment is to reduce your expenses. There are a lot of opinions about the best ways to do this.
Some say to look at your largest expenses first:
– Can you refinance your mortgage to a lower rate or move somewhere with lower rent?
– Can you get lower car or homeowners insurance rates with another company?
– Can you sell a car and get a less expensive one instead?
Some say to look at the smaller things:
– Can you pack your lunch for work rather than eating out?
– Can you brew your own coffee in the mornings instead of going to Starbucks?
– Can you switch to basic cable rather than the deluxe package?
– Can you switch to a cell phone plan with less minutes?
The important thing with budgeting is to spend your money on things that are truly important to you. As an example, television isn’t that important to us. Therefore, we don’t pay for cable. Instead, we have a $7.99 subscription to Netflix, and this works great for us. Budgeting isn’t about never doing anything you want to do. It’s about spending on things you really value. We use the money we would spend on cable and choose to spend it on our dog. Just keep in mind that ultimately, your monthly expenses can only go as high as your monthly income.
Now, I know that there are some severe budget situations out there where even the smallest luxuries need to be cut, at least temporarily. I know it isn’t “fun” to have to cut things from your budget to pay off debt. But the more you can cut, and the sooner you can pay off debt, the sooner you’ll be able to live the life you want to live. It’s important to keep your goals in mind, because the sacrifices you make today are what make it possible to achieve those goals tomorrow.
If you have a specific question about your individual budget situation, feel free to send me an e-mail at Justin@thefamilyfinances.com and I’ll listen and give advice tailored to your situation.