Following the Money: A Beginner's Guide to Budgeting

Posted by Financtitute on September 20, 2023 · 11 mins read

This is the third part of the Financial Independence Series:

  1. Understanding What It Means To Be Financially Independent
  2. Exploring the Spectrum of Retirement: From Mini Retirements to Barista FIRE
  3. Following the Money: A Beginner’s Guide to Budgeting
  4. Building Your Safety Net: The Importance of an Emergency Fund
  5. Unleashing Financial Growth: A Journey into Stocks and Index Funds
  6. Alright, So How Much Do I Need To Retire?

Budgets – it’s that thing we all know we should have, but many of us never quite get around to creating or sticking to one. In case you are not familiar with what a budget even is, a budget is a way for you to track and plan how you will spend your money every month. If you don’t have a budget you might just be spending every last dollar in your bank account and not realizing where it is all going. It’s no wonder why so many households don’t have the cash to cover even a $400 emergency (source). Having a budget created will allow you to know how much is coming in, how much is going out, and how much you are saving. It’s the first step to being able to plan further into the future. But let’s face it, budgets can be hard to create and even harder to follow. Don’t worry; I’ve been there too and have some handy tips to make this easier.

Tools To Help You Budget: First off, let’s talk tools. If you’re old-school you can do this on pen and paper, or if you want, you can track it on Excel. But personally, I’m all about Mint. It’s an online tool that connects to your financial accounts – checking, savings, credit cards, you name it. The beauty of Mint? Once you’ve set it up, it works like magic. It tracks your spending, creates nifty graphs to visualize your habits, and even warns you if you’re veering off your budget path. You might need to correct a few transaction labels at the start, but it should get easier as Mint learns how to categorize certain transactions. Plus, you can keep tabs on your finances right from your phone. Mint also has a tool that can help you start with a ballpark budget as well that you can check out. You don’t even need an account to use this tool.

Start With Your Income: First things first, let’s find out how much money you’re bringing in. I like to know both the gross number (your income before taxes) and the take-home amount (what’s left after Uncle Sam’s cut). The reason? I use gross income to calculate my savings rate (more on that in the next post) and net income for budgeting. After all, it’s the cash you’ve got in your pocket. Another reason you might want to use the take-home amount is if your workplace has pre-tax savings plans like a 401(k), you might want to stick with net income for budgeting simplicity.

Listing Your Expenses: Now, onto the nitty-gritty of budgeting. Start with the heavy hitters – your rent or mortgage, insurance, student loans, and car payments. These are your regular bills and typically make up the bulk of your budget. They’re usually consistent, which makes them a great place to start.

Next, tackle the monthly regulars like groceries, utilities, gym memberships, and cell phone bills. Sure, these might vary a bit, but you can take a look at your past spending and make a good guess about your average monthly outlay. If you have no idea, try to make an estimate. Budgets aren’t set in stone and can be adjusted as you figure out how much you really need.

Now, onto the wild cards – the less predictable stuff. Think home and auto repairs or random household expenses. These are costs you should budget for or be ready to dip into savings when they pop up. I sometimes group similar expenses together for convenience, such as lumping all things that occur once in a while (hopefully) such as home and auto repairs into one category. But how you organize your budget is totally up to you.

And last but not least, don’t forget the fun stuff. A super strict budget can be a really depressing. So, give yourself a little wiggle room for things you enjoy, whether it’s treating yourself to new clothes or spending on hobbies. Trust me, I’ve tried cutting this area down to the bone, and it’s no fun. You have to enjoy the ride, not just the destination.

Adding It All Up: Now that you’ve got your income and expenses laid out, it’s time to see where your money’s headed. Subtract your expenses from your income, and boom – that’s what you can save or invest. Hopefully this is not a negative number. If it is, sound the alarms, you are spending more than you make! If this is your first budget rodeo, you might be in for a few surprises (those daily coffee runs and fast food fixes can add up, huh?). This is a great way to see what is coming in and how much is being spent in certain areas. This is also a great time to adjust if you are shocked how much you spend on food at home versus eating out and would like to change that ratio a bit. Or maybe the amount or percentage you are saving is less than you would like, this is a great time to see where you can adjust to meet your savings goals. Now that you have an idea of how a traditional budget works and how much you need per month, let’s talk about some different ways to stay within it.

Sleep On It: These days, companies are always figuring out ways to separate you from your hard-earned money. What I have found helpful is to not just impulsively purchase an item. Instead, what my wife and I have found useful is by leaving the items in the cart or wishlist for at least 24 hours. What we found is that after thinking about it for a while we may not need that latest gadget or another piece of clothing. We may also think about why we even wanted it in the first place and consider an alternative to meet the same goals. At the end of the day, it really made us think it over if it was really worth it and reduced our impulsive spending.

The Saving First Model: If you’re good at spending only what’s in your account but tend to splurge when the cash is visible, here’s an idea. Automate your savings. Have a set amount or percentage deducted from your paycheck or split your pay into two accounts – one for savings, one for spending. That way, your savings are already sorted, and you can enjoy the rest of your paycheck without worry. Make sure you are realistic about your savings/spending. If you are constantly pulling from your savings you may need to reevaluate how much you are spending per month and figure out where the extra spending is coming from as you are going over your budget.

Expense Jars/Envelopes: In a world of plastic cards, it’s easy to lose track of spending. Only 24% of Americans use cash exclusively (source) because, well, cards are convenient. But that convenience can lead to overspending and debt. The cash jar/envelope method is straightforward and super effective. You set aside cash or in our case we used gift cards for specific budget categories and only spend from those jars or envelopes. Each time you spend, jot it down on the envelope or a piece of paper. For example, if your monthly food budget is $500, you deduct dining and grocery costs until the month’s end. No more mindless swiping; you’ve got to be aware about your spending. This approach helped us rein in our careless food spending as we didn’t have to open an app or spreadsheet to see how much money was left in the budget.

What Are We Doing Now? For my wife and I, we have stuck with the traditional budget that I laid out above. However, we have also leveraged the “Sleep On It” and “Expense Jar” method to help us stay in budget. In addition to what I shared above, I have also found that bundling items together made the budget “feel” simpler. For example, we have bundled food/Amazon/Target together as we found that we sometimes get groceries from Target or Amazon. Instead of breaking down the receipt each time, we just lumped all the categories together. Does this mean in some months we spend more on food than other months compared to household items? Sure, but at the end of the day we are still staying under the overall budget and that is what’s important to us.

Creating a budget is a step towards understanding where your money goes and how far it can take you. Over time, you’ll discover what methods work best for you, maybe even combining a few. Remember, life gets pricier as you go along, with rent and food prices creeping up. Periodic budget check-ins help you stay on top of it all.