Lesson 2b: Budgeting - How to
how to have a successful budget.
Some key recommendations
for keeping a budget:
1) Start from the bottom up.
Unfortunately, many people do not sit down to do a
budget until there is a problem. At this point, many of
the budget items are fixed (mortgage payments, car payments, food,
etc.). It is better to do a budget before you make any large
purchases to see what you can comfortably afford. Unfortunately,
many buy a house and stretch themselves too thin because they did
not review their budget before hand, thinking about what
if scenarios. What
if the price for heating the house goes up? What if we decide
to have children? What
if I do not get the raise or bonus that I was counting on?
When doing a budget it
is best to determine how much the large fixed payments will
take of the budget. It is easier to save by analyzing
these purchases. Many are forced to focus on small savings
(e.g., the $5 cup of coffee) because that is the only thing
they are able to cut.
There should be room in the budget for expenses increasing unexpectedly.
2) Be realistic and budget for the unexpected
items (e.g., car repairs, furnace breaks down, etc.).
When creating a budget, I usually factor in $500 or more for unexpected
items that I do not know will happen, such as the furnace
breaking down or the roof needing repair. This, of course,
is dependent on the age and value of your house or car - older or
more expensive houses and cars should have a higher budgeted amount. This
is above and beyond the normal car repairs that are relatively common
oil changes, new tires or brakes.
I am typically a little conservative in planning for non-routine
items. These items are harder to predict and if they are underestimated,
then you will need to tap into savings (or go in debt). This
should be viewed as a contingency fund. You have it if you
need it. Or, if the unexpected repairs do not happen, then
you have extra savings for your retirement or children's education.
3) Understand small amounts can add up.
budget purposes, the first step is to understand how much you are
spending in each area. Then you can consciously know if you
want to continue to spend the money for these small purchases. In
addition, spending $100 more for a special piece of furniture
that you did not plan for may seem small when compared to you total
budget, however, a few of these types of purchases will probably
unless you are able to cut back somewhere else. Some financial
planners focus on the small items as a place to cut your spending
saving a few dollars a day can go a long way to becoming a millionaire. Likewise,
spending over your budget can quickly eat away at your savings goal.
4) Plan for future purchases.
Plan for the down payment for that house, that car,
or that special vacation. If
you don't, then these items will keep on being just outside your
There is a mentality in our society that we will be
happy if we have more money. This can be seen at all income
levels regardless of whether one is making $20,000 or $1,000,000. We
believe that we need just a little bit more to be happy. It
is a scenario of a dog chasing its tail.
So, let's be realistic
on what you really need, and many will find that we already have
what we need
Look at items that you have today that were not around when
your parents were children, like cable TV (or even just a TV), eating
out fund, cell phones, etc. As
a Sheryl Crow's song says, "It's not getting what you want but
you have." Think about what you desire and
then challenge yourself about whether you really need it or if it
is just a want? And, decide will it really make you happy
or are you trying to have what others have?
6) Eliminate emotional spending.
When you are upset, do you go to the shopping mall or Amazon.com? For
some, shopping is similar to an addiction such as alcoholism -
it is habitual and impulsive. Purchases
should be planned and budgeted for rather than decided at the spur
of the moment. This is why infomercials encourage you to
"in the next 30 minutes" by offering free products or additional
discounts. They know you are more likely to buy their product
if you act quickly before you've had time to think. Yet, it
is best to back off of an unplanned purchase for 24 hours. Often,
taking that extra time to think helps to distinguish the true needs
from the unnecessary wants, and consequently eliminates unnecessary
also includes buying your child a toy to stop his tantrum in the
middle of the mall. What lesson are we teaching kids? When
you are upset, material things will make you happy.
For children it may
only be a $5 toy, but as adults it becomes a $50 pair of shoes
or a new sports car to overcome the mid-life crisis. Yet, what
do you tell a child who is having a tantrum in the middle of the
mall. Some options are "It
is not in our family budget" or "I choose to spend our money
on other things" rather than, "We
do not have the money for it." While the latter statement
conveys a sense of poverty or lack, the former statements indicates
that spending is
a conscious choice.
7) Take time to follow-up on your budget.
A budget is not useful unless you test it. The key is not
to track each item (especially if you do not have the time), but
to look at how well you did at accomplishing your savings goal. Savings
is usually the area that we raid first when we blow our budget. If
you did not meet your goal, then you need to see if your budget was
set properly - are you
for all the little
purchases you are making. If there was a one-time expense
that was truly a once in a 10+ year event (e.g., both cars broke
and roof started to leak at the same time) that caused you to go
over budget, then you do not need to change your budget. Yet,
if it was a reoccurring expense (like a normal car repair or child
needing braces), this should be something
you budget for. This is why I normally add an additional
$500+ for unexpected expenses to my budget (see item #1).
I do not know what the exact expense will be (e.g., needing
a new dishwasher or lawn mower), but I know that I will normally have
least one large unknown expense
Note, in comparing your actual savings to your savings target,
you should reduce the actual amount saved by
any new credit