My wife has brought it to my attention that while I often say “make a budget”, and I still think that’s good advice, many people may not know just how to go about doing that, especially for the first time. I’ve boiled down the process that my wife and I went through when we sat down to make our first “real budget” to Ten Steps. Warning… you’ll need a pencil and paper.
That’s my actual paper budget for March 2018. Enjoy my fantastic handwriting. I make it prettier for this blog. If you’re interested in the pretty version you can check it out here.
Step One: Get Out The Old Yellow Pad!
While I know a lot of millennials may have never seen a yellow pad, let alone used one, it’s my preferred method for this step. There’s something visceral about physically marking something onto a piece of paper permanently that is simply lost when you’re using technology. While there are tons of great apps, spreadsheets, google docs, and templates that you can use once you get the Basics down, I suggest at least about your first 3 months of budgets are done On Paper. If you feel like it’s too much of a hassle or you’re thinking that you’re just “too busy” to do something like that… I’d encourage you to take a minute and really think about whether that’s a legitimate concern or an excuse. After you’ve done that just ask if this is important to you. If it is… go to God damn Walmart and drop the $.70 on a yellow pad notebook. There! I’ve given you your first discretionary spending item!
Step One: Pull Up Your Bank Account
The first step to making a budget is going to be to log onto your bank account and pull up the ledger of your transaction. I say that’s the first step because honestly, if you’ve never made a budget before, I’m guessing you won’t know the numbers needed, without looking, to handle the rest of the process.
Step Two: Put Your Income At The Top Of The Page
There are TWO sides of a budget. People often seem to forget that budgeting is a two-way street. You simply can’t frugal your way endlessly toward zero. You have to consider that the incoming and the outgoing are equally important. It’s also important to remember that you have Control of Both sides. You don’t have to just try to spend less and less. Luckily, you can earn more and more if you’re wiling and adequately motivated. Now that we’ve got that out of the way, it’s important to use your income for THAT MONTH for each budget. Too often I see people who use “averages” for their monthly pay. Or they look at last month, even though it had unpaid holidays etc. and just reuse that number. That’s not the way to go about this. This is going to be different for everyone, obviously. The vast majority of people are paid on a bi-weekly schedule, but some are paid monthly or weekly. You know what you get paid. You know how much you’re going to work, and if you’re handy at operating a calendar, you know how many paydays you’re going to have in a given month. Calculate your monthly pay, total bring home. Take that big, audacious, awe-inspiring, jaw dropping number, and put it at the top of the page. That’s all the money you’ve got for the month, now to go about spending it wisely.
Step Three: Calculate Housing Costs
To put it simply this would be your mortgage or rent, but there is more to it than that. Be sure to include in this line item anything that is directly and inexorably tied to your housing. For those of us with a mortgage an example of these types of costs would be HOA fees, or escrow added onto your mortgage payment. If you choose not to escrow then you need to add your taxes and insurance separately to that number. For those of you who are currently renting added costs may include things like maintenance fees or paying for parking in your complex (if it’s mandatory). Once you have that number locked down, write it at the top of the page directly under your take home pay. Now divide it by your take home pay for the month. A good rule of thumb is to keep your total housing cost under ¼ or 25% of your monthly take home pay. This isn’t necessarily a set in stone rule. For example if your take home pay is $12,000/month and your house payment is $3600/month that would be 30%, but your family won’t starve on the remaining $8400. Note: if you own a home, you’re broke, and you’re paying a guy to cut your grass… that’s not a housing cost. If you chose to buy the most expensive reserved spot in your apartment complex because it’s right outside your door and it rains a lot where you live and you have kids and there’s lots of stairs and you just don’t have that much time and it’s safer here because you can see it from your window and the remote start works from right in your living room and the cars always get broken into in the other lot blah blah blah… that’s not a housing cost. These are what I call lazy taxes (I paid them all by the way) and if you’re broke… Congratulations! You’re probably done paying them once you make a budget.
Step Four: Add Up Your Other Necessities
First of all you need to define what a necessity is. Necessities are things that are literally necessary for life, and nothing else. Outside of your housing costs, Necessities include: your utilities, transportation costs, and groceries (within reason). Also included in this category would be health insurance, if it isn’t provided by your employer. Utilities are things like lights and water, not Netflix. Transportation costs are the costs of operating your vehicle legally, such as insurance, and gasoline. If you don’t own a vehicle your “transportation” line item would be something like a bus pass, or maybe a set amount you give to a co-worker to carpool. Groceries are just that, Groceries…as in food purchased from the store to be prepared at home. More importantly there are a few things that are NOT necessities. “Fun” money, anything involving restaurants, date nights, a $500 car payment because you need something “safe”, new clothes (unless they’re literally in need of replacement), debt payments, video games, jewelry, vacations, and cable TV are all examples of things that are Not necessities. You take those necessities, the four walls of your budget and put them under your income at the top. The total of your necessities, including your housing, should be no more than 50% of your take home pay. This leaves you with half of your take home pay going toward what could be called “discretionary” spending.
Step Five: Minimum Debt Payments
The next step is to list all of the minimum debt payments you’ll have to make for the month. If you’re carrying a balance on a credit card, have a car payment, student loans, or any other type of debt that you pay on monthly, list the minimum payment for each on the page. Don’t worry, the plan isn’t to simply make minimums forever. We’re just setting up a stable backbone for your budget. By setting it up this way first, even if you intend to make more than the minimum payment on any given debt, you’ll have a real idea at the bottom of the page of what your “discretionary” money is for the month.
Step Six: Other “Bills”
Next on the paper I would put any things that you are charged on a monthly basis for that are not necessities or debt obligations, but are relatively fixed costs you’ll have every month. Obviously you may have some tough decisions to make at this point. If you’re missing the 25% and 50% rules of thumb on the categories above, this would be the point in the budget where you have some real month to month control and can start to cut back. Examples of monthly relatively “fixed” bills would be:
Memberships (gym, country club, etc.)
Subscriptions (Netflix, magazines, etc.)
By the bottom of this list we’re probably getting close to the fun part of the budget…that is unless you’re in the red at this point. If you find yourself at this point with no money leftover it is simply time to make some tough decisions. What can you live without? What are you willing to do without to get control of your financial life? If you’ve made it this far, and you had money left over after the necessities that have been chewed up by debt payments and other “bills” that you’ve chosen to accrue, then the blueprint is in front of you to change your life. You just have to make the decision to do it.
There are four remaining steps to creating your budget, but it’s important that you don’t consider these sequential “steps”. Take the remaining income after you have completed steps 1-6. You can then take stock of your remaining four options for your income, and divide the remaining money according to your goals.
Step Seven: Pay Off Debts
At this point you should take as much as you’re comfortable devoting to this goal, and start with your Debt Snowball. You should take all of your debts and list them in order of total balance from smallest to largest, regardless of interest rate, and put all of the money you can allocate to debt payoff on the smallest debt. As you pay off your smallest debts, you take that same amount of money you had allocated, plus the amount that you’ve freed up by knocking out that specific debt’s minimum payment, and you throw it on the next one! As the snowball gains momentum so will you. You’ll pay off debt faster than you thought was possible when you can actually see some progress and feel the traction of making concrete steps toward your goals.
Step Eight: Save
“Save” is obviously a massive oversimplification. It can mean anything from throwing cash under the mattress to buying individual stocks. The most basic level of saving is saving your emergency fund. I personally feel your first saving goal should be to save up an emergency fund of 3-6 months of expenses (although more is not discouraged). When considering how much you need in an emergency fund it’s important to consider the sources of your income. If you are a two-income family with no children, and you can afford to live on one of your salaries, you would fall on the 3 month stockpile side of the emergency fund spectrum. If your family relies on only one spouse working outside the home, you have 5 kids, and your only income is that of an independent musician, I’d consider you on the “high risk” end of the spectrum, and you’d be best off to have much more than 3 months sitting on the sidelines for an emergency. Remember, this is and Emergency Fund. An emergency fund is mean to be insurance against disaster and crises. This is not an investment. Simply park this in a savings account. Just accessible enough that you can get to it in case of emergency, but not so easy to access that you’re tempted to buy dinner with it.
Beyond the simple “saving” of money, you can start to invest. I personally suggest doing this starting in your company’s 401(k) but only if your company offers a match. It’s silly to pass up on free money. After you’ve contributed to the match I’d encourage you to switch over to a Roth IRA and max that out for the year before returning to your 401(k). If your specific 401(k) is full of awful high cost options and doesn’t offer a Roth, feel free to invest straight into a taxable account. If you’re interested in my strategy and how we choose to invest, check out my post on how we plan to invest this month. If you’d like to learn from people who have way more money, expertise, and experience than me, I’d suggest a few books you can read. Anything by Dave Ramsey, A Random Walk Down Wall Street by Burton Malkiel, and The Richest Man In Babylon by George Clason. If you’re more interested in the technical nuts and bolts of choosing real investments, I’d suggest checking out The Intelligent Investor, and One Up On Wall Street.
Step Nine: Give
I wouldn’t ever tell anyone how to give, but I would encourage anyone to give charity of some sort a shot if you never have. There are multiple studies that have shown a strong link between generosity and happiness. I personally don’t choose to “tithe” a tenth of my income to my local church, but I would support anyone’s decision to if they felt strong conviction that the money would be well spent. Aside from that giving can be anything you want it to be. I’ve even heard of people who simply set aside “X” dollars at the beginning of the month and use it toward random acts of kindness (giving to the homeless, paying for someone’s meal, buying a single mother’s groceries). The best part of giving is that there’s no wrong way to do it. Give generously and often.
Step Ten: Spend
We’ve finally made it to the fun part. This is where the true “discretionary” spending comes into play. This is date nights. This is buying gadgets. This is buying video games. This is the part of the budget where everything remaining is “gravy on the biscuit” and you can choose to spend this last bit however you want. Some people call this “blow” money but I feel like you’re just giving yourself and excuse to Waste money. Having extra money isn’t an excuse to throw money away, but it is good to just set aside a certain amount that you can use toward just having fun. I personally plan to start taking some of our leftover “entertainment” money and picking a few very speculative single stocks. While I don’t plan to make any money doing it, I think it’ll be a fun possibly productive way to spend money that I’d otherwise blow on something like a video game. It’ll also be a valuable source of learning about the market, as I’m sure I’ll repeatedly make a total ass of myself. A big part of earning and saving money is finally just enjoying it. So at this point in the budget feel free to kick back and just Enjoy it! You’ve worked hard for it, and you deserve it!
There you have it, my somewhat longwinded answer to “How do I make a budget?” Thank you so much for reading and I hope if you haven’t started yet that you now feel confident that you have the tools to at give it a try for the first time. If you have any comments or stories about the first time you started budgeting please leave them in the comments!