Monday, November 8, 2010

Five Steps to Creating Your Budget and Sticking With It

You know what you earn, what you spend and what your financial priorities are -- now put them together to create a budget and I'll explain how.

Finally! NOW we'll do a budget. Budgeting isn't hard, but I wanted to establish a foundation for why you're doing a budget and how to do it. Wax on, wax off Daniel-san.

Remember, we defined a budget as "the amount of money that is available for, required for, or assigned to a particular purpose." A budget is how you plan to use the money you have earned and/or that is available to you to live your life. Without a plan, you will either wind up in debt or spend that money on things that really don't make your life easier or more enjoyable.

A budget is not a list of things you aren't allowed to spend your money on. Its point is to help you set priorities. So a budget helps you figure out what to spend money on. A budget need not be complicated. Heck, it doesn't even need to be called a budget! Call it your spending plan, your spending allowances, your fiscal plan, whatever makes you feel more comfortable starting it and sticking with it.

Five Steps to Create a Budget
1. On a piece of paper (preferably use a spreadsheet program or an online service such as, write down your NET income per month. What's Net income? Your gross, or total, income minus taxes.

2. List your savings goals -- how much money do you need to save each month to save 10% for tithing, or to build a $1,000 emergency fund or to save three months of living expenses? List each thing you plan to save for and how much each month you need to put away.

3. Add up your monthly savings goals and subtract the total from your net income.

4. Now, list all your fixed expenses -- these include rent, mortgage, utilities, debt repayment (remember, if you have debt, especially high interest debt, your number one financial priority is to pay it off), loans, car insurance, public transportation, etc. Add up your fixed expenses and subtract that total from the amount you got in Step 3 (DON'T start again with your net income).

5. If there is a positive number left after Step 5, CONGRATULATIONS! This is your spending money for whatever you need and want. If there is a negative number after Step 5, then you've got some problems (and a clearer picture of why you might be going into debt or running short each month).

If you have a negative number after Step 5:
Look at your biggest expenditures and see what can be cut. Perhaps your savings goals or your debt repayment plans are too aggressive for your current situation. Maybe you're paying a lot more in rent than you can afford. Maybe your cell phone bill can be reduced. Look to cut fixed expenses first, because that's where you'll save the most money. If you can't, then you need more income. If, for some reason, that's not possible, then you may have to eliminate your savings goals until you pay off debt (not to keep paying for a lifestyle that's above your means).

If you must cut your savings goals until you can pay down debt, still contribute to your 401k if your employer is offering a match. Also, try to save $1,000 in a mini-emergency fund to protect you in the event of unforeseen expenses.

If you have a positive number after Step 5:
This is where you lay out your spending priorities and use your spending record (see! yet another reason you kept it!) to determine just how much you spend on those things. Start subtracting those monthly expenses from the remaining amount. When you hit zero, that's it, no more money.

Are you already rubbing your temples and saying "Debt Hater, I ain't doing all of that!" Well, tsk tsk. I think this is much easier than trying to keep your head above water while you go broke! But, still, there is a quick and dirty way to do this too, but you still have to do some math. I happen to like Ramit Sethi's Conscious Spending Plan allotments in his best-selling book "I Will Teach You To Be Rich." Basically, you take your net income and divvy it up this way:

Fixed expenses (including debt repayment): 50% - 60% of net income(60% if you own a home)
Investments (401k, 501c3, IRA): 10%
Savings (vacations, gifts, holidays, home downpayment, wedding, unexpected expenses): 5% - 10%
Spending Money (whatever you want!): 20% to 35%

Take your net income and see what these percentages add up to. If it turns out that your fixed expenses are 70% of your income and your spending money is 30%, then you see where you have a problem! You've left nothing for savings and investments. Start chopping down your fixed expenses and cool down the spending until you get your proportions on track.

Me personally, if you're in debt or have expensive purchases (like a car or home) you want to make, you should bump savings to 15% and lower spending money to 15%. Remember, it's about priorities AND time.

Any questions? Please leave them in the comments, I'd be happy to answer any that I can.

Debt Hater is a personal finance blogger who paid off nearly $16,000 in credit card debt (not including a car loan!) in four years, just like she planned. You can visit her blog at