Preparing a Budget? Ten Tips for Making That Budget Successful

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Mike wrote in lamenting his struggle to make a budget work for him (he attached his budget for me to look at, but I think sharing it with 100,000 readers might make Mike a bit uncomfortable):

I keep trying to stick to a budget, but I keep failing. I go through all the steps that I read about in the workbook, but when I actually put it to work, something always comes up and I can’t stick to it. What’s wrong?

A Better Way To Budget by Jeff Keen at Flickr!If you’re continually seeing failure at budgeting, the best place to look is usually at the fundamentals. It only takes a fundamental mis-step or two to transform a well-planned and well-formed budget into a complete disaster.

Here are ten very powerful things to consider as you build your budget that will point you on the right track towards success.

1. Know why you are budgeting.
If you’re developing a budget just because someone says it’s a good idea, it probably won’t help very much. Similarly, if you’re just following the steps in a personal finance workbook because it suggests this is a great way to move towards financial success, budgeting won’t help much at all.

The reason for budgeting is to help you spend less than you earn. It shows you where your spending weaknesses are and provides the structure for you to get stronger in those areas. I like using the “training wheels” analogy when describing a budget – it’s not a solution itself, but guidance towards being able to effectively and naturally spend less than you earn.

2. Have a specific, concrete long term goal in mind.
For many people, it’s debt freedom. For others, it might be saving for a house or for the ability to make a career change. Whatever it is, having a big long term goal in mind, particularly something that would have a big impact on your life, is useful when planning a budget.

Why? An effective budget is likely going to involve a few difficult choices. You’ll likely be agreeing to cut your entertainment spending and probably planning to do a few other things that on the surface seem like they’ll reduce the quality of your life a little. Knowing that these little choices are in fact adding up to something specific and tangible – and something that you really want – makes the process much more palatable.

3. Know how much you actually make.
The correct answer here is not just your annual salary, nor is it dividing your annual salary into twelve parts for a monthly budget. Instead, you should be basing your budget on your take-home pay per month.

If you make $48,000 a year as a salary, you’re likely knocking off somewhere around $8,000 in income taxes, and likely much more than that when you look at other work benefits and costs you’re paying up front for them, like health insurance. Because of that, using $4,000 a month as the basis for your budget simply isn’t correct – the correct number is likely much closer to $3,000, and possibly below that.

Make sure you know exactly what you’re bringing home as a paycheck, because that’s the number you’ll use as the framework when you budget.

4. Have some accurate data when it comes to your spending, both monthly and irregularly.
Similarly, when you go to plan a budget, it works best if you plan it based on real numbers. This means pulling out your bills and your receipts for the last month or two – all of them – and figuring out what you’re actually spending. Your first “budget” shouldn’t actually be a budget at all – it should instead reflect your spending in an average month.

Don’t forget the irregular bills, either, like homeowners’ insurance, car licenses, auto insurance, property taxes, and so on. These bills shouldn’t be “unexpected surprises” – instead, you should be planning for them throughout the year by socking away a little each month for them.

5. Have checking and savings accounts that have useful budgeting tools incorporated by default.
Does your bank offer automatic transfers from your checking account to your savings account (or, even better, sub-accounts)? Does your bank offer online bill pay? The answer to both of these should be yes.

Now, does your bank charge you maintenance fees on your account? Do you have to pay a lot of ATM fees? The answer should be no.

In short, if your bank is doing these things, they’re actively working against you in terms of making a successful budget work. Many banks offer these features – online bill pay, automatic transfers, no ATM fees, no maintenance fees, and often a nice interest rate to boot. Some options include ING Direct (the bank I use), E*Trade, Washington Mutual, and Charles Schwab all offer solid online checking and savings options.

6. Have a simple budgeting tool that you understand how to use – start with pencil and paper if you have to.
If you’re starting off by sitting down with Quicken or Microsoft Money and you’re quickly overwhelmed by the complexity of the software and the huge number of options available, it’s going to be a lot harder to convince yourself to keep going with this. Your first budget should be incredibly easy to use and manage – and you should understand it from the inside out.

That’s why the best bet is usually to use pencil and paper for your first budget. If you want to move it to an electronic format, I’d recommend trying something simple like PearBudget Online or their free spreadsheet (if you’re familiar with Excel).

That’s not to say that Quicken or Microsoft Money aren’t great options – they are. The problem is that they offer so many options that it can often overwhelm the new user, and if you’re overwhelmed, you’re quite likely to just give up because “budgeting is too complicated.” Don’t let that happen – start with simple tools, then move to more complex ones if you feel a need.

7. Be realistic.
Budgeting is like diet planning – it’s not going to work if you make huge, unrealistic assumptions right off the bat. If you’re trying to diet, moving to a lettuce and tofu diet might work for a few days, but eventually you’ll crack. A much better solution is to be realistic – instead of drinking a sugar and fat-heavy coffee in the morning, cut down to a low fat version, and instead of eating a double cheeseburger for lunch, bring your own cold cut sandwich. Small steps work; big steps result in failure.

The same rule applies to budgeting. Don’t pledge to reduce your entertainment spending by 80% – it won’t work over the long haul. Instead, just average out what you’ve spent on entertainment for the last few months, and pledge to a cap of just 5 or 10% below that average. Then, after some time and some success, trim it a bit more. Going whole hog right off the bat will almost always end in failure over the long run.

8. Have some support from at least one other person.
Whenever you’re attempting to make a significant change in your life – and a budget is a harbinger of significant financial change – things always go better with support. Look to your spouse, your parents, or your closest friends for help.

If you’re surrounded by a group that’s actively committed to overspending, you’re in the midst of negative support – the kind of support that will cause you to abandon your plans. Take some tentative steps to find a less materialism-oriented crowd to spend your time with. After all, if you’re considering a budget, you’re also considering a significant shift in direction when it comes to your money choices, so take it a step further and find healthy support for these new choices.

9. Set some very short term goals that you can easily achieve if you stay on budget.
While long-term goals are great for feeling good about your general direction, they don’t always help with the day-to-day choices. It’s easy to convince yourself that one little slip-up won’t actually hurt your big goals (even though they do, because one little slip-up is often just the first pebble in an avalanche).

One powerful solution is to develop some short term goals to go along with your long term goals. Set a weekly food budget and splurge on a pint of Dove ice cream if you stay within it. Set a monthly entertainment budget and go out to a guilt-free movie if you’re within budget at the end of the month. It’s the simple motivations that work the best.

10. Don’t be afraid to adjust, even radically.
There will usually be moments when you’re learning to budget when you discover that some element of your budget is just not right. It’s not realistic because you forgot about some key piece of information while making your plans, and that means the budget you developed doesn’t really work.

Don’t panic. Don’t abandon your plans. Just go back to your plans, make the needed adjustments, and start over again. This is normal – it happens to everyone. It does not mean your budget was a failure at all – it just means it needed to evolve a little bit.

Financial freedom is a powerful and beautiful thing. Good luck in taking the first steps to get there.

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27 thoughts on “Preparing a Budget? Ten Tips for Making That Budget Successful

  1. Not typically the kind of guy to doom and gloom (Afterall, I’m still dollar cost averaging in the market these days), but I would recommend against using WaMu as a checking/savings bank. Yeah, you’ll be insured up to your first $100k, but I suspect they will be the next big bank to be assumed by a conservatorship like IndyMAC. With WaMu’s shakeup of management, a subsequent $800M of subprime liability ‘forgotten’ in last quarters balance sheets, and considerable exposure to additional subprime liability, I would recommend limiting your deposits to the FDIC insured limits.

  2. #7 Be Realistic – The best one by far. Trying to save 50-60% of your salary when you haven’t ever saved more than 5% might be a bit ambitious. Don’t run the marathon before you run a mile.

  3. I’m in the middle of trying to do this. I started at the beginning of the year but wasn’t consistent initially.

    One of my big problems is with #3, know how much you actually make. My hours are somewhat variable. I have to work at least 20 hours per week, but over the past couple of years I’ve generally averaged about 25 hours per week. This year I’m closer to 22 hours on average, so I’m bringing home less than I used to. And my hubby is on commission and has also been making less than he has the past few years.

    So, I never know exactly how much is coming in but our expenses haven’t declined since last year. In fact, in several areas they’ve risen. In the case of gas prices, our expenses are rising pretty well every week. Recently we’ve actually been running a deficit, not something I can handle on a regular basis.

    But I’m still discovering how much I *don’t* know about how we actually spend our money. Until you start really tracking things it’s very easy to underestimate your spending in a variety of areas.

    So, my budget is very much a work in progress but I expect it will eventually take us towards our goals of getting rid of our debt and building a better retirement. I’ve certainly learned that we’d never be able to get there without it because we simply wouldn’t have the right information.

  4. This post comes at the perfect time for me! I’ve just spent a month recording every penny I’ve spent and am about to put my budget into action. I can’t stress how important #4 (Have some accurate data when it comes to your spending, both monthly and irregularly) is. Without knowing where ALL my money goes, it’s impossible to know where to cut down spending.

  5. Instead of budgeting based on my take-home pay, I include things that are deducted from my paycheck (like taxes, insurance premiums, and 401(k) contributions) in my budget. I like doing it that way to get a better picture of where all of my money is going.

  6. I don’t know what to do with my budget. My income has become very irregular since becoming a student.
    All I know to do is put the brakes on spending as much as I possibly can.

  7. Trent… I just wanted to say — I really appreciate your Budgeting advice. The last few posts on this topic have been among the most lucid I’ve ever read. Thanks for the clarity.

    AND– great pic. Made me laugh! :)

  8. I’m surprised you listed WaMu as well.

    As much as I like banking with them, I am seriously reconsidering changing my account to a more stable bank…

  9. Outstanding. I don’t usually like “List of tips to …” blog posts but this is wonderful starting with the question of what you want to achieve (the first two tips I have ever seen before in a budget how-to post), going on to execution, and ending with how to keep following it, and keeping it flexible. No matter what type of budget you need to create, these guidelines are very solid and universally applicable. I think I follow all of them in my personal budget. Well done Trent.

  10. excellent tips for the beginning budgeter! :) i plan on writing a detailed post on why i use Microsoft Money to keep me in line in the upcoming week or two :)

  11. I agree that it is difficult to budget with the financial software. I tried to budget with Quicken, but it treated the principal paid on my debt payment as transfers, rather than deducting them from my cash. Therefore, I had to do the “real” budget on Excel. (I’m very good with Excel, so that wasn’t a problem.) I also find it impossible to update my 401(k) information in Quicken. So I end up taking information from Quicken, and tracking my Net Worth by month in Excel.

    Trent, last week’s articles were especially good; the best whole week I have read so far. I e-mailed the links to your articles to several friends.

  12. We’ve been keeping budgets for awhile now, but in the beginning it was easier to work some “fudge” factor into our budget. We set aside $100 each month for small emergencies, until we really got a grasp on our monthly expenses. (It was our first marriage, first house, first budget.)

    We don’t need this $100 buffer any more, but it came in handy a few times! My favorite was the time that the windshield wipers flew off the car into a store parking lot… from the road as we passed the store. We turned around and bought wipers, but we were able to laugh about the sitation because we knew the money was there.

  13. Hi! I have a question. I have tried many, many times over the years to do budgeting, and I have always let it slide after a month (once I made it a whole two months!) However, I have my spending well in check (I save/invest about 1/3 of my monthly income) and am not prone to splurges. Also, I can tell you a very accurate estimate of what my bills will be each month – including the irregular ones. Is there a compelling reason for me to continue this budget fight? Frankly, I’m not a detail-oriented person, and I just don’t enjoy it, and since I don’t feel like I get a lot of benefit from it I’m more inclined to just let it go. So the question is: does anyone see any major drawbacks to that or any major benefits of budgeting for its intrinsic value?

  14. For a few years now, I thought I was doing well financially because my budget was done up on a lovely spreadsheet and I balanced out my money each pay. Earlier this year, I discovered personal finance blogs and clued in to two major errors:

    1. I wasn’t paying myself first so wasn’t consistently putting anything into savings, I had it set up so if anything was left unspent that pay, then it went into savings. Duh! How often do you think I had something left at the end of the pay? Switching this around forced me to address my second error…

    2. I had an amount allocated for groceries but never bothered to track how much I was actually spending. For the past three months I’ve recorded every purchase (easy to do, I just save the receipts) and low and behold I am spending significantly more than I had in my budget. The beauty of tracking my purchases is that I now know where I am overspending…turns out I bought more ice cream, chips and pop then I would EVER have believed. Now I am extra aware of these items when shopping and can really work to avoid them in the grocery store – my waistline will be happier too.

    So for me, the fixed costs on the budget were easy (be sure to work with actual costs not estimates) but the one true variable had me off the rails big time.

  15. This is honestly one if the best articles on budgeting I have ever read. It is so helpful and rings so true to so many people who struggle to stick to a budget they make. You have done amazingly with this article. Thanks

  16. All great tips. Here’s how I implemented the second part of #4. Years ago a friend taught me how to set up what she called an escrow account. It is a separate savings account. I had to have a couple hundred dollars to start(to cover bills coming due soon). I have 10 different categories such as dog, car insurance, car repair, life insurance, vacation, christmas, extra taxes (since I have some self employment income), water bill(we are billed quarterly), gifts and misc. I keep track on a tablet. Across the top I list the 10 categories and a total. I divide each bill by 12 and that amount is how much I deposit each month. Some categories don’t get a bill so I guestimate the amount for the year. For instance Christmas, I put $100 each month. Each month I put a designated amount in this account. Sometimes I am withdrawing and depositing in the same month. I set up my escrow account at a different bank from the bank where my checking and regular savings accounts are so it is not easy to move money because in the beginning I didn’t want to be tempted to “borrow” from it. It has worked well for many years. This could easily be done on a spreadsheet. It is a comfort to look at the columns and know that you are preparing for the bigger, irregular bills. I do the same with property taxes and home insurance in another account.

  17. For unearthing the hidden/surprise expenses that destroy the planning, I highly recommend the free Excel workbook Within Your Means. Filling out the workbook is fairly easy, it’s easy to update as you think of things omitted in the first pass, and you get a clear idea of the amount of money available to spend vs. the amount already committed. You can download it (for free) at the link.

  18. Good old pencil and paper–yep. When I actually accumulate enough to make investing possible, I might consider going electronic, but I think odds are I’ll probably just get a good calculator.

  19. I personally beg to differ on this one, Trent. My thought is the first thing Mike should do is track his spending for a month. Once he knows exactly where his money is going he will know where to cut back a bit. As time goes on and his savings build up he can plan/budget ahead for those things.

  20. I think folks should write down what they spend for at least 30 days to get a good basic idea of where their money goes. Then take a year’s worth of utility bills and get the average monthly payment. Put the average payment down for all individual utilities. Then most folks forget the yearly payment of say the Termite letter, car tags etc. I try to put everything into my budget that I know I will have to pay over the year. It’s much easier to put $11 per paycheck away for a car tag renewal than it is to suddenly come up with almost $300 when my bill comes in.

    Also add a “Murphy” savings account for unexpected events that occur. The added bonus of budgeting is when you run out of money in that category (say eating out) you know you can not spend anymore till next paycheck comes.

  21. Useful & practical tips. About managing, I found mint.com to be pretty good, automatic expense categorization and simple budgeting with initial values based on the current expenditure.

  22. Preparing a budget means that you prirotize the needs and less on the wants. There is no definite budget on a yearly basis as we all have varying needs every month so we need to prepare a budget every month alloting every dollar to either spending or saving.

    I would say in budgeting, savings is the most important expense so we need to pay ourselves first before spending. Savings buys our future.

    Also, it would be helpful if you prepare the budget as a family with your wives and children cooperating on the budget preparation. In this way, each would know where bulk of the expenses go and would try to make an effort to lessen those expenses considered as wants.

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