As much as most people dislike thinking about a budget, there is universal acceptance that this is one of the ways to get hold of your personal finances. Keeping a personal budget comes up in almost every other book about personal finances and still most people are doing it wrong.
I have also tried several times in my life to stick to a budget with various degrees of success. Over the years, I think I got to a good-enough spot, but it still not optimal. Recently, I stumbled upon the book You Need a Budget by Jesse Mecham (link to Goodreads). and my personal process finally clicked with Jesse’s method.
In this article, I will walk you through my mechanism (influenced by YNAB) to track my family’s finances. If you follow the eight steps, you will be able to self-organize your budget.
Time to read
Time to read: 10 minutes (based on 150 works per minute).
Introduction to budget types
There are roughly two ways of doing budget. There are two types of people – those who wash their cup before they drink tea and those who wash their cup after they drink tee. The same is with the budget. You can do it at the end of the month, doing a recap of your expenses. This is very important, but it is only the first step – getting to know your spending. And only after you get there you can do the second step – start planning your expenses.
This article is about the second (and better) way of running a budget – the plan ahead method.
Why are we not naturally good at this?
There are several reasons about this. First of all, life is unpredictable. It may look like a series of random events. But is it really so? If you are driving a 10-year old car, are the expenses for fixing it random? They might appear random, because you do not know when exactly is it going to happen. But you can anticipate with certainty that within the next twelve months, you will have to spend money for car repairs.
Just one more example. A lot of people spend a lot of money around the Christmas holidays. This leads to the January depression. On top of that, I hear you say, my sister’s birthday is in December. And that’s not all, my kid’s school fee is due in January. And so on. Well guess what? These are all events that you can anticipate and budget for in advance.
This article will show you my way of budgeting which keeps my ahead of my family’s spending and lets me “age my money” (quote from the book). My method mostly works for salaried employees. The strategy for self-employed or for people with irregular income is worth discussing in a separate article.
How can you create a personal budget?
I am not offering a miracle solution. My own journey took me several years. Feel free to pick only the steps that seem reasonable for you.
Step 1: Document your spending pattern
Everything in finance starts (and ends) on a spreadsheet. Years ago, I started documenting my monthly expenditures on a spreadsheet. I kept it really simple – money in and money out. Back then, my income was not very regular and this helped me recap the month.
Then, I started recognizing the two types of expenses – fixed and variable. A fixed expense is your mortgage or rent, home maintenance fee, car lease installment, phone bill, or, electricity bill. Variable expenses are the restaurant dinners, groceries, clothes.
The hardest part is tracking your expenses if you have more than two credit cards. So my first recommendation is to limit your credit cards to one if you live alone or two if you are a family. You can also consider a shared credit card account with two plastics. This will consolidate your spending.
Step 2: Automate your spending cadence
The second step is to automate and optimize your spending cadence, especially the fixed expenses. One of the things I noticed is that my bi-weekly mortgage payment was due on the day before my salary. This was very inconvenient, because every month I had to worry about having enough money in my chequing account to cover the mortgage.
So I made a plan and made some changes. I moved my mortgage payment after the salary – this way I could stop thinking about that. Then, I created a reminder for my credit card payment so that I can take full advantage of the period where I can pay back without getting fees. And I started automatically saving a portion of my salary in a savings account. For more details about this step (especially how to get out of debt), read this article: How to Self-organize Your Personal Finances.
Step 3: Break down into categories
After all that work, I was able to start breathing easier and I could set my mind on the actual expenses. I started breaking down my monthly spend in categories:
- Mortgage or rent
- Phone and internet
- Utility bills
- Fees (e.g., school fees)
- Taxes (e.g., property tax)
I keep a loose definition of fixed and variable. Fixed expenses have a certain due date (which is known in advance). Variable expenses are usually on our credit cards.
Step 4: Set a monthly limit
My next step was to use past date and set daily limits to each category. This was easier for the fixed expenses. But setting limits for the variable expenses helped me make them more predictable. For example, the groceries expense varied a lot in the beginning. But when I started tracking it more closely, I was able to make it more predictable.
There are some categories which are more seasonal. For example, you usually buy clothes in sprees before or during the season. Gifts as well. I found that these categories are usually under budget for several months until they explode for a month or two.
Step 5: Track each category
I was tracking my categories for more than one year adjusting the limit every other month or so. Here, I want to put a reminder. Discuss all these with your spouse. It is very important that he or she is onboard with all these. Show data about the monthly spend, especially when it is way over the budget. The goal here is not to pinpoint, but to find the categories which are important for each of you.
Step 6: Setup accounts
Finally, this is where the YNAB came into play. Jesse Mecham calls it “a new way to look at your money.” I took his advice by creating accounts instead of categories. Actually, my bank account does not allow that, so I needed to do it virtually (in my spreadsheet of course). Each spending category became an account, I merged some, and split others, where it made sense.
Step 7: Assign each dollar to an account
So the logic is the following. Every time I receive an income of (for example) $100, I assign it to the different accounts (based on my budget). All these are arbitrary numbers, just to express my point:
- 10% for savings (remember – pay yourself first)
- 40% for mortgage
- 20% for groceries
- 10% for guilt free spending
- 10% for the emergency fund
- 5% provision for gifts
- 5% for the vacation fund
You get the point. In the old days you would have labelled envelopes and you would put certain amount in each envelope. And then, when you need to go to the grocery store, you will get some of the money in your groceries envelope and go to the store. The equivalent in my process was that I review my credit card statement each month and I subtract the money spent on groceries from the groceries virtual account. It may sound like a lot of work, but it is easy once you get your spreadsheet organized.
The main point (again borrowing from the book), is that you “age your money”. You use the money that first came into the envelope to pay the most recent bill. This was you get ahead of spending.
Step 8: Review, adjust
Do this and you never have to touch the spreadsheet again. NO! This is not how it works. Do this and you will review and adjust it every now and then. If the money for grocery runs out, you will borrow from another envelope. And you will adjust the deductions from your next salary. If you max out your emergency fund to zero, you can borrow from another fund and adjust the amount you put there. Jesse Mecham calls that “roll with the punches”, because life is always unpredictable.
Having a budget is the best way to get ahead of your spending. It can be a tedious and hard effort but it pays off over time. Feel free to use my experience and the rules that I have uncovered to create a process that works for you and your family.
What are the next steps?
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