This article is the 3rd in the series Creating and maintaining a real budget:
In the last two articles “Know what you spend” and “Organizing your expenses” we covered, how to figure out what you spend in a given 12 month period and we’ve gone through the steps of organizing these expenses. We now have the information and tools in hand to create the actual budget. We’ve figured out the what, how much and when of all expenses that come our way in a given year.
Why is the when of a given expense important you ask? Well for those of you who will actually use your budget, to plan for how much to invest or how much to pay towards credit card debt, you need to know what will be available to you at any given month. Months vary quite a bit when it comes to expenses; You’re utility bill will be much higher when you live in extreme climates like the Midwest or places like Arizona, Holiday’s always tend to increase our expenses. Not just on gifts but groceries to feed to whole family at Christmas or Chanukah add up as well. If you’re “lucky” like us and have all 4 birthdays concentrated around the end of the year, your grocery bills for those months look nothing like those for the rest of the year.
For those of you that actually invest some of your excess cash (I know excess what?) at the end of the month, you need to make sure that when that $600 insurance bill is due next month the money is, and actually stays, there till it’s due. Averaging out a $600 one-time expense over 12 months at $50 a month doesn’t help you there.
The same goes for those that are in debt. It is commendable to state you’ll pay $500 towards your credit card debt every month but the reality is that for some months that simply won’t work. Some months you can only pull off $250 but there may be some months where you could do a little more than $500.
Knowing when your expenses occur beyond what expenses and how much they are, empowers you to come up with a much more accurate budget for the next 12 months.
Now that you are creating your budget and now that you know where your money is going you will undoubtedly be surprised about how much you are spending on certain items. I was taken aback by the fact we were spending over $500 dining out every month before I got serious about budgeting. You also tend to underestimate items such as gifts given. Those cousins around the world tend to add up, birthdays, graduations, bar and bat mitzvah’s, Holidays, valentines and on and on and on.
Now that you know what you’ve been spending for the last 12 or more months you can make some educated decisions on whether you want/need or even can keep spending that much. Part of creating a budget is making decisions on what it will look like. These decisions all are about the question, do I have to, do I want to or do I need to spend this much money on category X?
Every item on your list of expenses is negotiable. That said some items are more flexible than others.
If you have a mortgage there is only so low you can go and refinancing is not always a prudent or viable option.
Mortgages can be refinanced and for many of us there is wiggle room but for me it is almost impossible to refinance now that I’ve joined the masses of bloggers in the blogosphere. The re-financing ship sailed when I traded my W2 for the uncertain financial picture of an author/blogger.
Is there any way to get our FEMA flood insurance down? Other than hiring an engineer for thousands of dollars to try to get my property out of the flood zone, with great odds of not succeeding, there is little I can do on bring that expense down.
For each item in your budget in progress you need to ask yourself: How much do I want to keep spending on this?
“I’m spending $300 on dining per month, I really only want to spend $160 per month on dining out.”
“I spent $4000 on discretionary items. A big chunk of that went to our annual updating of iPhones and IPads. Do I need a new IPhone and IPad every year?”
“Do I really need to give my cousins $40 for their birthday? Will they think of me less if I gave them $25? Do I care if they think less of me?”
“I spend how much on clothing every month?!?! (Read shoes)”
Many items you will find, you can reduce by shear will power. Don’t spend on it if you don’t need it or don’t have to.
Then there are items that may require a little more work and thought. You may ask yourself:
“I’m spending $180 on cable every month, do I need to spend that much?” See my post on how we saved over $700 annually on cable.
“We’re spending $340 on fuel every month, we’re about to buy a new car. Should we look into getting a hybrid?”
“We haven’t refinanced our mortgage since it was at 5.5%, would it pay to refinance to lower our payments”
This step in your in creating your budget is all about trying to forecast and dictate to yourself how much you are willing to spend on things. This part of creating the budget is all about choices (some tougher than others). The flexibility of reducing spending varies from item to item but by the time you are done with this step you will have made the right choices and have a real budget that looks forward. This budget will be your guide and hopefully constraint in the spending for the year to come.
Besides being a guide and benchmark to your upcoming spending, you can now also start planning based on this budget. You may find that with the new budget you are able to invest $400 per month more into your stock account. Maybe you can finally start making more than those minimum payments on your credit card(s). Maybe now is the time to start paying off, some of the higher interest ones. You may now finally be able to save up for that vacation that you wanted take for some time, but never seemed to have the money take.
On a bigger scale, you may now be able to gauge whether or not you can start thinking about retirement. You may find that despite all your effort in cutting your expenses, you’re still too living too expensive to retire. It may tell you, you really need to pay off that mortgage first before you can retire.
A proper budget will truly empower you to make sense of, take control of and take action based on your financial landscape.
At this point we’ve completed the first 3 steps of:
You now have an actual budget. Most of the work has been done. Everything that follows is not trivial but mostly incremental to all the work you’ve done thus far.
Will you get the budget right the first time around? Probably not, budgeting is an ongoing effort that evolves over time. You will find you misses some categories. This is where the last step of budgeting comes into play and more on this in the next article Live by and maintain the budget in this series.
Good luck reaching your financial goals.