How to Build the Best Budget
Your budget sucks. Here’s how to fix it.
For years, I enjoyed the thrill of building a new budget. Every new budget was the one that would finally stick. I would get fired up about cleaning up my finances and paying off my debt. I’d build a budget in Excel with all the hopes and dreams of it working.
Then, when something came up a few days later that wasn’t in the budget, the whole damn thing would come crashing down. It was the same story over and over again.
The problem wasn’t that I was a failure, incapable of sticking to a budget, the problem was that I wasn’t building my budget to reflect my actual spending habits.
There’s a funny thing that happens when you decide on a budget number made of thin air and the desire for it to be true — it rarely reflects reality.
In order to figure out what that reality is, you’ll have to look to history and determine how best to move forward.
Start With Your History
Print three months of all your statements — every bank account, credit card, loan, everything.
While one month is helpful, three months gives you a better picture of your regular spending.
We are all prone to forgetting less frequent expenses or we may have an “irregular month” of spending and think it isn’t the norm, but by looking at three months of transactions, it will honestly tell you what is normal.
Create Your Budget Categories
Decide on some basic categories. These do not have to be set in stone for the rest of the life of your budget.
To start, base them on things you want to track.
For instance, in my budget, I have my rent, renter’s insurance, utilities, and cable/internet (yes, I have cable, I know I’m a weird millennial) all in one category. Since these expenses aren’t something I want to dig into at the moment, it doesn’t make sense to track them all separately. Instead, I have one Rent/Utilities category in my budget.
On the other hand, I am keeping an eye on how much cash I’m dropping at Disneyland as an Annual Passholder. Therefore, I have a separate category to track my Disney trips that’s not included in my Dining Out or other spending categories.
Do what feels right for you and as you go through your expenses, you may find that you want to add or remove categories and that’s completely okay.
Here are some ideas for budget categories to help you start:
Categorize Your Transactions
Using a sheet of paper or a spreadsheet, start going through the first month’s expenses. Depending on your style, it may be easier to go through all the statements category by category or to go through and categorize all transactions on each statement.
Either way you choose, go through until you have categorized every transaction and add up the totals of each category for Month 1 as well as a total for all of the spending categories, this will give you your total expenses for the month. Repeat the process for any additional months you choose to do.
When I do this, I cross off each line as I tally it to avoid counting something more than once or missing a transaction altogether.
Note: I recommend saving split transactions, like Target/Walmart trips, and any reimbursements, like Venmo, until the end, since they may take a little digging or deciding how to split them.
Are You Outspending Your Income?
For each month, write down the income you earned and then subtract your total expenses from the previous step.
If the number you‘re left with is positive, that’s great! It means you’re spending less than you’re earning.
If the number is negative, then your spending is exceeding how much you’re bringing in. This isn’t the end of the world, but it shows how much a budget will help.
Finding an Average for Your Budget
Once you have all of these numbers, create another column and find the average expenses for each category, including income.
This is where it’s really helpful to have more than one month’s worth of expenses to look at. If you went through one month, the average will be the numbers determined in the previous exercises, but if you did three or more (you overachiever!) then add up each of the expense categories and divide it by the number of months you reviewed.
Building Your Budget
Now it’s time to take all the pieces and create a budget that is based in reality.
This step can be quite eye-opening. I constantly felt as though I wasn’t eating out that much. If I only looked at one month’s expenses, I would have thought it was an anomaly, but by looking at my average number and being able to see all three months of those expenses, it helped me see that that number was not an anomaly.
My dining out spending was nowhere near where I wanted it to be and it helped me to prioritize changing that habit into something that was more in line with my goals.
Go through each budget category and determine what you think, based on the averages and the previous months of expenses, is something that seems realistic. Some of these expenses won’t fluctuate that much.
My rent doesn’t change, but a lot of my regular spending isn’t as regular as you’d think, so having these guidelines to help determine a baseline budget is incredibly helpful.
Regardless of whatever amount you choose for each category, make sure that your income is higher than your expenses.
If you consistently spend above your income then this is your wake up call that something has to change because you are digging yourself into debt and getting further away from your goals.
By going through your previous expenses and determining those averages, you will have a clear, realistic view of your current spending habits and you can see where you want or need things to improve.
After you go through your expenses, check out these awesome budgeting apps to help you stay on track.
This article was originally published on Reel Cents, a blog dedicated to simplifying personal finance and transforming relationships with money.
