Have you ever felt that way as you stared into the abyss of a spreadsheet filed with what seemed like meaningless numbers? If you have, you’re note alone.
Budgeting money down to the penny seems to be the method behind most budgets. Like dieting by counting every last calorie, however, budgeting to thepenny can be an exercise in futility. This type of zero-based, nitty-gritty, detailed budgeting takes time you don’t have and the patience of Job.
Plus, trying to stick to a strict, to-the-dollar budget can invite failure. What if you need to spend a little more on a new pair of shoes and a little less on a dinner out than you had originally planned? Either your whole budget is ruined, or you have to spend more time recalibrating it for the rest of the month.
When it comes to figuring out how to budget, if you are willing to think outside of the box, there is a really simple way to do it. My wife and I have followed this approach for years, and it helped us climb out of debt and save for retirement. It’s a simple three-step budget, and here’s how it works.
Step 1: Save First
The first and most important step of budgeting is to save a portion of each paycheck. Even if you can only save a few dollars a month, make saving a habit you never break.
For many, this may be limited to saving for an emergency fund or contributing to a 401(k) at work. Ideally, you’ll be able to save at least 10 percent of your income, if not more. It may take some time to build up to this savings rate, but it’s an important goal to set and reach. And if your employer matches a portion of your retirement contribution, you’ll want to be able to save at least enough to benefit from the match.
For many this could be the first and only step to budgeting. Save what you need to, and then spend the rest. But this simple approach can create two related problems.
First, without an eye on your spending, you may be missing opportunities to save even more. Second, you may find yourself spending more than you have after setting aside savings. This overspending may take the form of dipping into the money you’ve saved, or worse, running up credit card debt. To avoid these problems, let’s turn to the second step in our simplified approach to budgeting.
Step 2: Budget Where It Hurts
There is no need to track spending in areas where you never overspend. Remember, the purpose of budgeting is to provide you with valuable information that can inform your spending and saving decisions. Tracking every dime of gas you put in your car, for many, is simply not necessary. The same can be true for what you spend on utilities or at the grocery store.
This type of budgeting generally hinges on your finding your problem areas – those areas and situations in which you consistently spend more money than you should. If you’re spending less than you make and not going into debt, you may not have any true problem areas. But maybe you want to cut back on some spending to reach other financial goals – like saving for retirement, paying down debt, or saving for a new home. In this case, pinpointing potential problem areas can be helpful.
For many, you’ll need to track only one or two spending categories. Common areas of overspending include clothes, restaurants, and gadgets. For some, the monthly spending isn’t the problem; it’s big purchases like vacations.
Whatever areas of overspending you’ve identified, those are where you should budget and track your spending. If done right, however, you’ll only have a couple of categories to track.
Step 3: Plan for Periodic Expenses
Finally, you’ll want to plan for expenses that you pay just a few times a year. These expenses might include car insurance, life insurance, gifts, vacations, and even some utilities. The easiest approach is to determine the cost of each of these items, divide the cost by 12, and save that amount each month in a savings account. When the cost comes due, you’ll have the money to pay the bill.
The importance of step 3 should not be underestimated. An unexpected bill like a 6-month car insurance premium can wreck a monthly budget if you aren’t prepared. It’s a great feeling to have the money set aside in advance for these expenses, and it gives you a more accurate picture of the money you have to spend each month.
Back in the day, if you wanted to budget it was common to use envelopes. When I graduated from college, we didn’t have the internet or any of the amazing tools like Manilla to help keep track of our finances. To make budgeting even easier, take full advantage of these online money management tools.
Finally, keep track of your net worth monthly. This may seem like an odd tip for an article about budgeting, but keep in mind that we don’t budget for the sake of budgeting. We budget to reach certain financial goals. At first those goals may be just getting to the end of the month with some money left in the bank.
Hopefully, however, your financial goals will grow to include getting out of debt and building a nest egg. If so, your personal balance sheet is how to keep score. It will help you track your progress toward paying off debt and saving for retirement. In turn, the progress you make can help motivate you as you implement the 3-step budget.
Rob Berger is the founder of the popular personal finance blog, the Dough Roller. He hates budgeting to the penny.