Budget.
It has to be one of the dreariest words in the English language, and not without reason: people often talk about budgeting in the context of living below a preferred standard, or not being able to buy the things they want. I'd like to propose a new way of thinking about budgets, and budgeting, that is more optimistic, more proactive, more empowering.
Budgeting gives you agency: instead of wondering where your money went, you'll choose where it's going. In addition, a budget can help you clarify needs versus wants, control impulse spending, and adapt to changes in your financial situation. Now, what's dreary about that?
What is a budget?
A budget simply summarizes income and expenses for a given period of time. For most people, a monthly budget makes the most sense, though a yearly budget is also useful for occasional large expenses (tax payments, property insurance payments, etc.) that would benefit from advance planning.
How do I set one up?
Before you spend much time on developing the perfect spreadsheet (or learning one of the many budgeting tools available online), you should gather some data. Don't skip this part, as it can be eye-opening on its own, and will save you heartache later. For most of this article, we'll focus on monthly budgets.
First, you need to know your income: yearly, monthly, gross, and net. Don't forget income from sources other than your job (which may or may not be taxable income, but taxes are beyond the scope of this article): do you get any support from family? Do you receive any reimbursements for your expenses? Try to be as accurate as possible. If you do have to guess, it's better to underestimate your income rather than overestimate it.
Next, you'll want to track your expenses. First, write down all of your fixed expenses for a month: rent or mortgage, cable bill, etc. For expenses that are regular but variable, calculate a monthly estimate based on the last several months. Then, buy a cheap notebook and start writing down everything else you exchange money for: groceries, clothing, even the small purchases that you don't believe add up to anything. (Part of the purpose of this exercise is to determine just how much those small purchases add up.) After about a month, you can start assigning broad categories to these incidental expenses and add the amounts to your budget. Don't throw away your notebook yet, though--you'll still want to track your expenses a few months more to get an idea of the averages for each category, plus your spending habits and trends.
Don't forget expenses that are infrequent or "seasonal," like holiday travel or tax payments. If you doubt you'll be able to easily pay them when they come due, be sure to factor them into your monthly budget (just divide the total amount by the number of months covered) so you can set aside money for them.
If you absolutely, positively, have to make a guess on any expenses (e.g. your vacation is a year away and you have no idea what plane tickets might cost), do the opposite of what you did with your income: overestimate your expenses rather than underestimating them.
Balancing the budget
Now it's time for a reckoning. Once you've gotten your income and expenses down, figure the totals for both. Which one is bigger? If it's income, congratulations, but don't start looking for ways to spend the "extra" just yet: are there liabilities in the expense column, particularly of the revolving credit or high interest type? If so, consider increasing your payments toward those first, and/or adding to your emergency fund.
If your expense total is higher, we have some more work to do. You basically have two options: increase your income, or decrease your spending. For many people, decreasing expenses is the logical step. Below are some tips that will help you determine where you might be able to cut costs:
Identify wants versus needs
Review your spending categories, particularly the discretionary or variable variety. While many of your expenses are likely fixed, you may be able to find some wiggle room in these other areas. Is there anything you can remove entirely? Any subscriptions you forgot you even had? Variable expense categories like groceries, clothing, and entertainment may have room to cut back, since you have more control over the amount you spend. Finally, look for small expenses that might add up to large monthly expenditures--that daily $2 Snickers bar from the vending machine is actually costing you closer $50 a month (not to mention there are healthier choices anyway!). You might also find it useful to allocate an "allowance" for your variable spending categories. Remember, the point is not to deprive yourself but to reign your spending in.
Set your goals
Budgets aren't meant to make your life bleak and joyless, but to empower you to meet your present and future financial goals. Review your budget regularly with an eye to the following:
Short-term goals: 0-12 months (e.g., creating or topping off an emergency fund)
Mid-Term goals: 1-5 years (e.g., saving for a down payment on a home purchase)
Long-Term goals: 5+ years (e.g., retirement savings)
Remember the SMART acronym when setting goals, whether financial or otherwise. Your goals should always be Specific, Measurable, Achievable, Relevant, and Time-Bound. If your goals are too vague, they're more likely to go off the rails. There's plenty of information online about creating SMART goals.
Avoid the debt trap
The key to financial success is living responsibly within your means; frankly, it's impossible to build wealth if you don't follow this one rule. If your income is fixed and you don't have the option to increase it, the only avenue left is cutting your expenses. This is an area where it's helpful to try to change your mindset around spending. Many people have found the concepts of "real hourly wage" and "life hours" that are explored in the book Your Money or Your Life (Vicki Robin) to be incredibly helpful in changing their mindset around money and spending.
Staying on track
Budgets are living documents that should change as your life changes. If your circumstances or goals shift, you'll want to rework your budget. Schedule a regular meeting with yourself to review your budget--if you're just starting out, you should review monthly to get a better idea of your spending and also catch any expenses you might have forgotten when setting up your spending categories. If you get off track, forgive yourself and move ahead. With enough time, effort and honest self-reflection, you'll find your financial situation changing for the better.
You may even find that the word "budget" doesn't sound so dreary after all.