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Lesson 2a: Budget

Objective: Create a budget and discuss the reasons for having a budget.
"Too many people spend money they haven't earned, to buy things they don't want, to impress people they don't like."
- Will Smith

The first step to developing a financial plan is to create a budget.  The key to a budget is making conscious choices, knowing where you are spending your money.  Some advisors tell people not to worry about a budget because the actual cash spent is going to be different due to unpredictable events.  Other advisors suggest keeping track of daily spending to the penny in order to create your budget.  In my opinion, a budget is a reality check of where money is coming from and going to.  If you do not attempt to do a budget, then the spending decisions are spur of the moment decisions and not a real conscious choice.  You also need to know relatively well where your money is going in order to set up a reasonable budget, but you do not need to track your spending to the penny.  The time that you would spend on tracking your spending to the penny may be better used in other financial planning efforts, such as retirement planning.  If you meet your targeted savings goal outlined in your budget, you probably have a good idea where your money is going and thus do not need to track spending in detail.  However, if you can not meet your savings goal, you are probably spending extra money, and you will then need to determine where it is going by tracking your spending in more detail.

A budget is about taking responsibility for your choices and actions.  A budget is a series of choices about whether you want to spend more money on:

  • vacations or home repairs
  • cell phones or movie night
  • going out for dinner or retirement savings

There is power in being able to make these choices, and the first step in claiming this power is to set up a budget.  Some people, however, relinquish these choices by blaming others (e.g., the economy and inflation).  By blaming your circumstances you are giving up responsibility for your spending and you create excuses for not changing your spending.  There is no motivation to change your own habits if you don't perceive your behavior as contributing to the problem.  Blaming others keeps us stuck.  Accepting responsibility is the first step towards changing the situation. 

Before creating a budget, check with yourself (and your significant other, if appropriate) about,

  • How willing you are to do a budget?
  • How much control do you believe you have in controlling your budget?
  • How empowered do you feel about your finances?
  • How do you feel about the amount you are saving (or borrowing) each year?

If you have negative feelings regarding any question on this list, be aware of what you are feeling and how empowered or disempowered you feel.   If you are aware of your spending and savings for the year, you can be empowered by your choices which is a key step in a budget.  So, take the first step by creating a budget that reflects your choices on what you want out of your life.

How to create a budget?

Setting up a budget is a relatively easy process.  It is the emotions that we have about a budget and the excuses that we make that make the budgeting process unpleasant.  The steps are simple:

  1. Make a list of your sources of income.
  2. Make a list of your expenses.
  3. Calculate the difference: are you saving money or borrowing money?
  4. Compare your net savings amount from the prior step to the amount you saved or borrowed last year.  Unless there is a major change in your expenses or income from last year, the difference in this year's budget and last year's actual results should be relatively close.
  5. Review your expenses to determine if you want to choose to change any of them.

Then, on a monthly or quarterly basis, review your budget to determine how you are actually doing versus what you expected.  The key is to see if you are meeting your savings goal.  If you are not meeting your savings goal, then you have had additional expenses that need to be accounted for. 

In addition, you should review your next month's budget to make sure that you have the necessary cash on hand for the upcoming month.  For example, do you have a large payment coming up (e.g., insurance premium or tax payment) that you may not have accounted for?

There are some good budgeting tools available on the internet, including:

Or, you can create a budget using an Excel spreadsheet, similar to the one below: 

Questions about creating a budget

  • Should the budget be based on pre-tax (gross) or post-tax (net) earnings?
You can do it either way.  If you do not pay a lot of additional taxes (above your regular withholdings) nor receive a large refund on April 15, then it does not really matter.  Yet, if you do, then you should account for the additional April 15th income or expense by doing a pre-tax budget.  Some people find it easier to do a post-tax budget because this is what they see on their pay check and is thus easier to understand.
  • What if my income or expenses are not predictable?

    Remember, a budget is a preliminary estimate of income coming in and expenses going out.  If there are variables in your income, due to being self-employed, for example, or variables in your expenses, such as unexpected repair costs, do a reasonable estimate.  It is better to take this first step in planning your future than having no plan at all.  However, when you are reconciling your budget, make sure you account for the variability.  So, if you scheduled $1,000 in repair costs but actually had $0 in repair costs, then bank the $1,000 in a repair fund for the following year, because next year you will probably need the extra money for repairs.

  • Should I include my investment income in my budget?

    I would not.  Investment income is usually from savings for retirement or education. Thus, keep this money in a separate account and do not touch it or account for it in your budget.  In addition, all dividends should be reinvested especially in college and retirement funds, because if you spend these dividends, you will not get the expected returns to meet your goals.

Exercise: Create a budget (or review your budget if one is already created) and notice how you feel when doing it (e.g., fear, sense of lack, anger).
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