Twenty Something Sense

This section will start by telling you why you need a personal budget and the move into how to create a budget.  These sections will cover the basics and we will next explore creating your first budget (via spreadsheet), and using tools such as Quicken and Mint.com to manage your budget.  Stay tuned for updates via the blog.

Why do you need a personal budget?

I think the question of ’Why should you use a budget?’ is often times used in self-defense, but it is a valid question none-the-less.  Typically budgeting has a very negative connotation attached to it and most think, like a diet, that budgeting means spending less (as with a diet - eating less). What you will learn is that budgeting is quite the opposite.  When done correctly a budget should tell you where you can spend (or save) your money it will not tell you to stop spending money.

There are many reasons to create and use a budget, but they can all be boiled down to what we call the ‘Three Values of Budgeting’.  A budget will empower you to make better decisions, give you the visibility into your spending habits to save more money and overtime greatly aid your financial security.

Here is a brief summary of the ‘Three Value of Budgeting’ which will be used through-out the budgeting material.

You will make better decisions with your money - With a budget, you will be able to make better informed decisions, such as deciding if you can afford your dream vacation or if you need to save more money.

You will save more money - With a budget, you will be able to understand where you currently spend your money which will show you where you can afford to cut-back and save money.

You will decrease your financial risk and increase your financial security - With a budget, you will be able to build a savings cushion and have clear visibility of your financial standing. This will reduce your risk, increase your financial security and let you sleep better at night.

So, if you would like to make better decisions with your money, save more money and decrease your financial risk while increasing your financial security, budgeting is for you.  The next section, below, will give you an understanding and mindset of how to create a personal budget.   In this section you will see elements of the ‘Three Values of Budgeting’ and you will get to see them in action if you continue on to create a budget!

If on the other hand you are still not convinced why everyone should at least have a basic budget, I highly suggest reading one of our guest bloggers posts entitled “A Plan, a Failure and a Lesson-Learned”.  Or if you prefer, do not hesitate to leave a comment or contact us to gain guidance or get questions answered!

How to create a personal budget?

How you decide to budget will largely be a combination of the complexity of your financial situation and what makes you comfortable.  For some people you own multiple houses, have several credit cards, several loans (cars, student loans, etc) and hold multiple jobs.  For others, you have one job and live with your parents.  On top of this, basic budgets will suffice for some while others will seek the lowest-levels of information about their income and expenses.  Through the budget spreadsheet and budget software sections you will begin to decide what type of budget works for you and this will continue to evolve over time.

I have personally had some type of budget for around 15 years and my budget has also fluctuated based on what is going on in my life.  The ability to adjust your budget depth will come with experience.  Over these years of budgeting, I have found 3 primary rules for budgeting to always hold true.  If you stick to the CIA (Conservative, Iterative and Accurate) method you will be very successful with budgeting and reap all 3 of the ‘Three Value of Budgeting’.  Below are the 3 primary rules for budgeting:

Conservative - Budgets should be conservative in nature in that they should not depend on certain future events such as raises.  Following our 2 major terms of income and expense lets walk through a couple of examples.

Income - You should estimate the amount of money you are going to make in your budget as the amount of money you currently make.  Do NOT factor in bonuses, raises, commissions or other types of income as these can be highly-variable and you have no control over them.  The trap that most people fall into is trying to account for a raise, end of the year bonus/commission or some other type of income.  When that variable income is lower than expected or is non-existent, the budget will fail and you will be put in a very difficult position in order to find money to cover the now missing income.

Expense- Expenses should be estimated slightly higher, thus conservative, than they typically are.  The reason for doing this is to factor in a small amount of cushion for the times where your expenses are higher than normal and to gaurantee that all of your expenses will be covered.  This gives you breathing room and in turn should make you more confident that your budget will hold true regardless of your expenses.  As an example, I estimate my bills to be about 10% higher than they are on average.  By estimating my electricity to be $100 when it is generally $90, I am confident that I will be at or below budget for my electricity bill and have confidence that have set aside the appropriate funds to cover this expense.

Iterative- Budgets should be reveiwed and adjusted frequently.  Some will find it necessary (or almost addicting) to check their budgets daily or even more frequently and others will find it only necessary to check their budgets weekly.  I suggest reviewing your budget on a weekly budget at a minimum.  This ensures that you are on track and if you have gone off the tracks, you will have caught this flaw fast enough to get you back on budget.

The second part of an iterative approach is to actually adjust your budget as necessary.  Budget adjustments primarily take place for those that are new to budgeting and don’t have the proper knowledge to accurately estimate their expenses.  This is to be expected and will take time to master.  After reviewing your budget and adjusting it over a few short months, you will find that adjustments going forward are minimal and most of the time unnecessary.  As your life-style, income and expenses change, you will need to make adjustments to your budget, but this will come naturally after a couple short months of understanding basic budgeting.

Accurate - Budgets should strive to be as accurate as possible and this element is deeply tied to the previous 2 rules.  Although keeping an accurate budget may seem counter-intuitive to being conservative and keeping a buffer on your expenses, accuracy is what allows you to estimate your expenses in the first place.  The only way you will know how much your electricity bill is on a monthly basis is by monitoring (think iterative approach) this expense over time.  Thankfully as you will see in the budget software section, there are many tools out there to help you do this.  By taking an iterative approach you will have a very good idea (accurate estimate) on the amount of most of your expenses.

The other part of accuracy comes on reporting your actuals against your budget.  Your initial budget will outline what should happen with your money, but it is critical that you report (or using a tool) the exact amounts of expenditures across the categories you select for your budget.  If you are not accurate and honest with yourself about your spending habits you will take away the advantage of the iterative approach and will never find a truly optimized and efficient budget.  On the flip-side, remaining honest and accurate with your actuals will provide you the necessary information to provide conservative expense estimates using the iterative approach.  Over time you will find that this leads to much more accurate budgets which means you will have complete control over both your spending and savings!

At this point, you have read a flurry of information regarding budgets and what they should provide for you.  Its time for the rubber to meet the road and for you to get started with your first budget!  In the next set of solutions I will provide you with a ‘how to’ on your first budget (via spreadsheet) and take a look at budget management tools Quicken and Mint.com. Stay tuned for these updates via the blog!