This post will teach you a simple but very effective way to establish a household budget. These simple 9 steps on how to make a budget can get you on track to achieving your financial goals.
How to Make a Budget
1. Set Goals: “A goal is just a dream with a deadline.” –Marjorie Blanchard. Why is setting a goal the first step? We need to start with a “dream” to give us focus and something to strive toward. It is best to be specific and set a date to accomplish your goals. Here are some examples:
- Eliminate all debt (excluding mortgage) by March 1, 2015
- Have $2,000 in reserve cash within 3 months (set specific date)
- Have 3 months worth of income (be specific with the amount) by June 15, 2015
- Pay off mortgage within 10 years (set specific date)
Notice how these goals give a specific amount with a timetable. Simply stating “get out of debt” or “build savings” as goals are not specific enough. Your goals need to be realistic but you should also aim high. “Reach for the stars – You might not always get a star, but at least you won’t end up with a handful of dirt.” –Leo Burnette.
2. Identify Monthly Waypoints to Achieve Goals: Navigators will often use waypoints along a journey to ensure they stay on course on a planned route. We will use financial waypoints to make sure we stay on track to hit our goals. Step #1 gave us our goals, now we need to identify how we are going to achieve them. If you set a goal to increase your savings from zero to $10,000 in 12 months then you will need to save about $833.33 a month. So your monthly waypoint is to add $833.33 to your savings. If your goal is to eliminate debt by a specific date, this will be a little harder to calculate because interest will be accumulating. Debt calculators can help you determine how much principal you need to pay off each month to reach your goal. Your monthly waypoints will be the additional amount applied to your debts. Write down your monthly target because we will need it for step #4.
3. Calculate your monthly net income: Now it’s time to compute your “take home” income. Add all sources of income to include wages, tips, supplementary income, investment income, etc.
4. Calculate Estimated Monthly Expenses: List ALL your monthly expenses, no matter how small. Look at bank/credit card statements, receipts, bills, and anything else you can find to calculate your spending habits. Categorize your expenses in two categories: fixed and variable. As a general rule I put everything that I cannot change in the fixed category and anything I can easily change in my variable category (with a few exceptions for things like insurances). Now it’s time to take the number from step #2 to include with your expenses (labeled “Contribution to Goal” in the table below). I recommend putting this amount in your fixed category. Though saving deposits/additional debt payments/investments are things that you control, it helps to mentally see it as something you can’t (or won’t) change to keep you on track for your goals.
Here is an example of a household’s monthly expenses:
5. Compare Net Income With Estimated Monthly Expenses: The following table shows that expenses exceed income by $590.
We can now either find a way to increase our income or cut expenses to get that number to zero. The following table shows the expense cuts to balance the budget with the changes in red.
If needed, this is also a good time to access the feasibility of your goals. You may find that the monthly amount you plan to save/invest/pay off debts is either too high or too low. Ensure that your goals are both realistic and challenging. If the goals are not realistic then adjust them. If your goals seem easy then you can increase the amount or shorten the timeline. “Do not lower your goals to the level of your abilities. Instead, raise your abilities to the height of your goals.” –Swami Vivekananda.
6. Record Monthly Expenses: Keep detailed records of expenses to track your progress throughout the month. In some months you will catch breaks and have money to spare. Other months you will have unexpected expenses and have to make additional cuts to balance your budget. During these tough times it is important to keep focused on your goal and the progress that you have made.
7. Reassess and Make Necessary Adjustments: Toward the end of each month, compare your “Actual” expenses with your “Estimated” to help you make adjustments to your monthly budget. After a few months you can begin to track averages or trends in each category to make your “Estimated” expenses more accurate.
8. Reward Yourself: I have to constantly remind myself is that my ultimate desire in life is for my family to be happy and safe. Financial freedom is a means to that end, not the ultimate goal in life. If you budget $100 for entertainment then spend that money doing something you enjoy. If you budget for $450 a month for food then get the best food that you can with that money. If you try to live on ramen or half-price expired food for 6 months, you’re not going to be happy and you’ll eventually trash the budget.
9. Set New Goals and Move Forward: Once you reach your goals (and you will), take another look at your financial situation and make new ones. Always remain a student of money management because you can never learn all there is to know. Set new goals to stretch yourself, increase your net worth, and achieve financial independence.
Please share your own success stories in the comments section below. We look forward to hearing from you.