To create a budget you can live with, you need to set realistic spending goals in each category. First, figure out where your money actually goes now. To get started, collect as many of your bills, credit card statements, bank statements, and receipts as possible for the last six to twelve months and total up your monthly spending. Don’t forget to include any amounts you direct toward savings, including retirement savings. Once that’s done, calculate your average monthly net pay (after taxes and other deductions) by looking at the last six months’ worth of take-home pay. Don’t include unknown amounts such as year-end bonuses, commissions, or overtime pay. Do include other income amounts you receive every month, like dividends or Social Security. You’re figuring out your basic monthly income, so only include money you can always count on.
In addition to your regular monthly expenses, you want to make sure to include occasional expenditures. For the items you identified that get paid quarterly or annually (or anything other than monthly), calculate the yearly cost and divide it by twelve to get the monthly cost. Include that amount in your monthly expenses to get a more accurate picture of where your money is going. For non-monthly expenses that you know for certain you’ll face (like dentist visits), set aside the monthly amount in a savings account so you’ll have it handy when you need it.
To really get a fix on where your money goes, you’ll need to keep track of your cash expenditures too. Save receipts to record later, or jot the expenditure down on a notepad as you use cash. The more often you use an automated teller machine (ATM), the more important it is to write down your cash expenditures, because this is where many people lose control of where their money goes. Tracking your cash expenditures is one of the tougher aspects of budgeting, but it’s also a common source of budget leaks.
Most people are more than a little surprised when they really start tracking their expenses and see where they’re spending more money than expected. Small cash expenditures can add up to significant sums of money by month’s end. That daily cup of coffee is probably costing you almost $600 a year. Three six-packs of beer a week add up to at least $600 a year. If you smoke two packs of cigarettes a day, it’s probably costing you over $280 a month, $3,360 a year, or $33,600 in ten years—and that’s if you discount the impact of inflation!
Find Comfortable Ways to Cut Costs
An important part of budgeting is coming up with concrete and relatively easy ways to cut costs. Setting a spending limit with no thought about how to reduce expenses will be an exercise in frustration as you experience monthly shortfalls. Figure out what you can most easily do without to keep more money in your own pocket.
Once you’ve looked at your actual spending, you’ll begin to see a pattern, and will be better able to identify where you can comfortably make adjustments to start saving money. Consider this a process of self-discovery. You can start with an in-depth look at your largest spending categories, and then move on to the smaller categories. Though it might seem like smaller expenditures would be the easiest to cut, mainly because that spending tends to be more discretionary, paring down your largest expenses can make a bigger long-term impact on your budget.
Once you feel like you know where your money is going and you’ve identified some ways to cut costs, establish a realistic monthly spending target for each category. Start with your fixed expenses (amounts that are the same every month), such as your mortgage and car payment. Then look at each of your remaining budget categories and set reasonable spending targets, taking into consideration what you know about your spending habits and where you can cut back without causing a hardship.
When you’ve set a tentative target for each category, add up the total income and expense categories. Then subtract the total expenses from the total income to arrive at your net income; this might be a negative number. If the net is positive, it represents money available for making additional payments on your credit cards, accelerating other debt repayment, bumping up retirement plan contributions, and working on your other financial goals. However much is left over, make a plan for it. Extra cash left in a regular checking account has a way of getting spent.
If the net number is negative, your planned expenses are greater than your income. Don’t be discouraged, but do reevaluate your income and expenses. Your situation can be improved by increasing your income and reducing any expenses you can.