One of the questions I hear sometimes is, “What is a monthly budget?” I’m always surprised at this but I can understand where the question comes from.
A budget is simply a tool that you can use to help you apply financial discipline (more on discipline as it relates to finances below). In reality, it’s just a list that identifies your (self-imposed) spending limits on categories of expenses (that you determine) over a given length of time.
The length of time over which you develop your budget is called a budget cycle. Your spending limits are developed with the knowledge of your expected income and your life goals and plans, which can introduce budget categories like “savings” and “401k”, etc..
The ability to establish and stick to a budget is essential for anyone on a limited income to reach retirement in a manner (and on a schedule) that he or she desires. This is the first of a couple of posts I will provide on the important topic of budgeting for personal financial freedom.
Why Budget Monthly?
A monthly budget is simply a budget that identifies your spending limits over a months’ time. This is probably the single most useful budget to create and live by (yes, once you see the results, you may want to develop more than one budget!).
The reason for this is that most of us receive our income (i.e., paychecks) either once or twice a month, and most of our regular bill payments are made monthly. This makes monitoring things against your budget easier. And, in our minds we tend to naturally compare our last-month’s paychecks and what we were billed for that expense last month to what we just got paid/billed this month. So it is probably easiest to develop a budget on a monthly cycle.
Applying Discipline to Your Financial Life
In this busy world we all live in it is easy just to get lost in what we are involved in and forget about the things we have been taught that make our lives easier – one of those being DISCIPLINE. Regular use of discipline regarding your money is crucial to meeting your retirement goals, whatever they are.
It can be a satisfying feeling to actually put your finances on a track to wellness, and part of that is applying a measure of financial discipline to your life. Financial discipline involves regular attention to the details of your finances, including putting effort into planning, an essential first step.
Many (if not most) people don’t have plans or goals for their financial future, and so don’t ever bother to monitor what is happening with their money. And of course, if you don’t monitor and actively manage your money, the world will do it for you – most likely, you will fall into the trap of consumption, failure to save, and eventually (if you really ignore things) financial ruin.
Of course, putting limits on your spending is challenging. Who wants to do that – NO ONE! Especially that first time you actually try to do it! But, as you do it, it gets easier. Ideally, the budget should be used regularly by you, over each successive budget cycle, so that you develop habits that preserve your hard-earned money without so much effort. And developing good spending habits is the whole point of using a budget – learning how to be disciplined with your money.
What About Income and Expenses That Don’t Occur Monthly?
There are other income items we receive and payments we make on either shorter or longer time frames than monthly (for example..quarterly, yearly, etc.). More frequent, regular income and expenses can be worked into your monthly budget pretty easily – for example, if you pay for something weekly, you can simply multiply your average weekly payment by the number of weeks in the average month (a little over 4) and use that as your monthly budget line-item spending limit.
However, there may be some expenses that are harder to work into a monthly budget, either because they occur irregularly or have amounts that fluctuate. Sometimes these expenses are pretty big ones, too, like quarterly or annual tax bills, insurance bills, and the like. In these cases, using another budget cycle for these may make sense, so you can track and average them.
Regardless of your choice for your primary budget cycle (monthly, for example), it should be the “controlling” cycle, because it is here that you should include categories as necessary to put back money to cover these in the future. Then, when those bills come in you will have the satisfaction of having ready money available to pay them, instead of that horrible “surprised” feeling, regret over whatever it was that you splurged on this week, etc.
In my budgeting I include these non-monthly items in the budget under a separate “irregular” income and expenses grouping. This for me is a fairly lengthy list of items, but they are all represented in “monthly” amounts (i.e., if the expense is quarterly, then I represent it in my budget by taking amount that I’m assuming on average for them, divided by 3 months to get the monthly amount). This gives me the amount per month that I need to reserve in my checking account (or in another cash account) that I can then draw on to pay that bill in full when it comes due.
Tracking Your Income and Expenses
The best way to build a budget is to find out what you are currently spending your money on, put it down in writing in front of your eyes so that you can make some conscious decisions about changes that may need to be made. I have written about this in the past, but it bears repeating here, as this is a must for developing a budget. If you aren’t paying attention to how you spend your money you can’t get control of it – you will spend it (which is a problem, unless you make far more than you can spend, and few of us have that problem!).
The results can be surprising – “Do I really spend that much money every month on that?”, “I had no idea my account was being charged so much for this every month without my knowledge!”, etc.. Of course, you may also determine that you aren’t saving enough money, or spending enough money in a certain area, based on your stated life goals.
If you aren’t already, I recommend that you start using personal finance software to help you with tracking your income and expenses regularly. This does take effort, but the benefits are enormous. I’m actually not sure how you can do a thorough enough job of this without using some type of transaction register software program. In a future post I will provide a review of several of the most popular programs, but for now I can tell you that I use the most popular one, Quicken.
Most banks now allow you to download your transactions directly into the software, where it automatically categorizes each one according to previous similar transactions. Then, the only step necessary is cleanup – which is necessary for new transactions, and many transactions where the “previous transaction” algorithm doesn’t supply the right category. Also, you will want to add notes that describe what exactly the transaction was for (for history purposes – you would be surprised how handy this is).
Take the Time To Do This Right
If you are going to go to the trouble to develop a personal budget (and I recommend that you do), then by all means, TAKE THE TIME NECESSARY TO DO THIS RIGHT – your spending patterns should be dictated by your life plan and goals, which you have thoughtfully developed in advance. If you jump into budgeting without these things already done, you are starting in the middle.
My future posts on this topic will assume that you have gotten a handle on your current spending and its alignment (for good or bad) with your well-developed financial goals and plans to meet them.
Don’t get me wrong – anything you do to apply discipline to control your spending will help you in your financial journey to retirement. But you need to have some order about how you go about this – don’t just start in the middle and expect great results. Great results come from deliberate and thoughtful preparation, and that will take some time and effort (although less than you might expect).
In my next post, I’ll address how to develop a personal budget.
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