This week’s blog topic is a basic pillar in a person’s financial planning life. The prospect of creating a budget can be cumbersome if not also a bit daunting. Often times, first time budget builders look at a budget as restrictive and relate the term to negative thoughts and feelings. In reality, having a budget can be very liberating! The opportunity to know exactly where your money is coming from and where it is going creates a situation in which you can be better in control of your financial life. We stress budgeting in our financial planning with clients as we too know that this is a basic cornerstone to starting good financial habits! With that, let’s get into how to create a budget.
Step 1: Identify where your money is coming from
You need to know where your income is coming in from and how much is coming in. It is impossible to budget how much you can spend on different expense avenues if you do not know how much you have to work with. Often times people will have a ballpark estimate of what they are bringing in, but for budgeting purposes it is important to know what you are bringing in on a monthly basis and what you have brought in in the past. For salaried employees, this is as simple as looking at the net pay you receive on your weekly or bi-weekly paystub and using that number to calculate your monthly income. For hourly employees, this will require a bit more math as you’ll want to look back at the income you’ve brought in over the course of a few previous months to accurately budget for incoming future cash. Outside of earned income, you will want to make sure you account for any other income streams you may have come in.
Step 2: Identify your expenses
This step is also pretty self-explanatory. There can be no budget if you don’t know your expenses. This is the part of budget building that makes people cringe. A lot of people do not know what money they are sending out the door each month, and are afraid to find out! It can be a scary proposition to see how much money you are wasting on certain groups of products and services. As scary as it is, knowing your expenses down to a single monthly number will help you start the next step.
Step 3: Create a cash flow statement
If you want to know the net difference between how much you are bringing in and how much you spend each month, the cash flow statement will lay that out. This is, in fact, what a cash flow statement is. By finding how much money you have left each month after expenses, you can start to see how much money you are actually saving each month. Many young people struggle with the fact that their bank account is not growing, but they aren’t looking at the numbers as to why that is the case. After identifying how much you are saving monthly, you can then move on to overviewing areas where you can improve!
Step 4: Identify the items that are 100% needed for daily living and the items/services that could be tapered back/removed from your budget
There are multiple different expenses that you will NEED to account for. Mortgage payments, utilities, car insurance premiums and health care costs are a few expenses for things you need to pay for and will be consistent line items in your budget. While there are ways to slightly decrease these expenses, they will still be present in the budgets of most young to middle aged people. There are also, however, expenses that are not necessary for daily living and can be either decreased or removed from your budget completely. These are often called discretionary expenses because they represent products and services that are consumed at the discretion of the person. Examples of these expenses include eating out at restaurants, entertainment like streaming service subscriptions, and even partaking in different sports activities like golf. Some people, like me, would rather not talk about how much they spend on golf and this topic may hit close to home. If you want to start saving more or having more cash available to deploy in different areas, you need to find discretionary expenses that you can attack and either lower or completely remove from your life.
Step 5: Revisit your cash flow statement
With more cash now available to you, revisit the cash flow statement and start thinking of how you want to deploy your new assets. Think about how you can use this cash to invest more in your investment accounts or save for your other financial goals. Think of your emergency fund and if you should save more there before increasing your investments.
While this topic is not pertinent to all of our readers, most of you probably already have a budget that you actively monitor and stick to, I know that we have a lot of young readers who haven’t started to deal with their own finances yet. To those who do not have a budget, hopefully this blog has made it evident that it isn’t hard to start one and that is important to have one!