There are three basic steps to setting a budget: identifying how your money is being spent; evaluating those expenses to see how they mesh with your financial priorities (see “How do I figure out my financial priorities?”) and cutting or tracking your ongoing expenses to see that you stay within those guidelines.
Sounds simple enough when it’s put that way. The reality, of course, is that most of us find budgeting tedious as well as tough to stick to. “Most of us try to suddenly cut way back and cut expenses from every category,” says Springfield, Ohio financial planner Jill Gianola, “That’s like trying to stay on a crash diet forever.” Try this method to create a more reasonable plan:
Start with your after-tax income. Look at your paystub to determine what you’re taking home each payday after taxes and expenses for health insurance. Don’t count on money that you can’t be sure to receive, such as highly variable year-end bonuses or tax refunds.
Track expenses for two months. Sure, you could write down every purchase you make in a little notepad as you go. But an easier way is to download the last two months’ worth of bank and credit card statements. Then assign each purchase a category such as “clothing,” “groceries,” “child care” or “health insurance.” Even easier: download the Mint.com app on your smartphone, which allows you to track and categorize expenses on the go.
Evaluate. Once you’ve got a good picture of where your money is going, it will likely be clear where you could (or should) be spending less. Your goal should be to reduce your spending to under 90% of your income, with the aim of saving the rest of that money for the financial objectives you deem most important.
Wondering where to find those cuts? “For starters, pick two or three ‘problem children’ categories to work on,” suggests Gianola. For some, it may be easiest to focus on one or two large expenses–eliminating season sports tickets, for example, or trading in a pricey vehicle for a cheaper one. Others might do better by trimming back on small expenses, like that everyday latte that costs you $4.
Revise if needed. Continue tracking your expenses on an ongoing basis to make sure the spending stays within the limits you’ve set. (The Mint.com app can help with that.) Very likely you will discover that some of the goals you set were unrealistic. It’s totally okay to ease them slightly or rejigger among categories. Often it takes two or three revisions before you achieve a budget that you can really stick to.