Budgets are an amazing tool for getting a clear picture of your financial situation and for planning for the future. They make it possible to see, in one overall place, the exact state of your monthly spending. You know where every dime is going. You know why every dime is going there. You can also see exactly where your financial situation is headed if you stick to that budget.
Sarah and I used a very tight budget during the first few years of our financial turnaround. It provided us with a very specific plan for how we should spend our money, how much we could put towards debt every month, and so on. Along with our debt repayment plan, our budget paved the way to debt freedom.
We still budget, but it's not as tight as it once was. Mostly, we use it as a guideline and as a way to model our expenses and savings into the future.
Of course, budgeting isn't always that easy. It can be a challenge - particularly at first - and there are many potential pitfalls along the way. Here are nine of the steepest challenges we've faced while budgeting and the solutions we use to make sure that they don't happen again.
Problem: Our Category Estimates Are Way Off
Our first attempt at a budget involved a list of categories that we found in the back of a personal finance book (probably The Total Money Makeover, but it might have been one of the few dozen others that we studied at the time). We simply copied down the list of categories in there, made our best estimate for spending in each category based on the handful of bills and receipts, and tried to live by that budget.
It failed - big time. Almost every category was way, way off. Our energy bill ended up being much higher than we expected. Our food bill was lower. Our entertainment budget was way higher. The numbers just didn't match how we really lived over the course of a month.
That first budget was completely useless and we knew it.
Solution: Start Your Budget From Scratch
The solution was to start our budget completely from scratch using a really sensible method that showed us what we were actually spending.
Over the course of a few months, we saved every single receipt and bill. We had a pile of manila envelopes on the table, each representing a particular category, and whenever we spent any money at all, we put the receipt or bill into that manila envelope. If we went to the grocery store, we got two or three copies of the receipt and then highlighted items for each category.
The purpose for all of this was to get some realistic pictures of our spending. A good budget needs to be based largely on how you actually use your money.
Once we had three months (or so) of receipts, we sat down and assembled a real budget for the first time. We added up all of the receipts in each category, then divided that number by three. That's how much we really spent in an average month on each category.
Those numbers became our initial budget. We decided to add a little bit more to the total for our variable required bills, like electricity - I think we added $10 a month to those bills. Other than that, those numbers were our budgeting targets. Our goal was to spend less than that on food, household supplies, entertainment, hobbies, and so on.
Problem: Budgeting Seems Like a Ton of Work
This first "real" budget was done entirely manually. As I said, we had a pile of manila envelopes on the table that we used to collect receipts and then we assembled the budget using a spreadsheet program.
We kept using the "manila envelope" system for receipts and bills for a while, but it took effort to keep remembering them. Eventually, we moved to an "inbox" where we would just dump those things and go through them once a month, but it would take a couple of hours to sift through all of the receipts and bills and another hour to calculate everything up and see how we were doing.
It was a ton of work - and not particularly fun work, either. After a while, we started coming up with reasons not to take on that task and, for a month or two, our budget really didn't get checked at all. We were still doing okay, but we were drifting. We just didn't want to do all of that "accounting" work.
Solution: Use a Budgeting Program That Makes It Easy
This turned around completely when I received a copy of Quicken as a gift for Christmas that year. I dove into the program headfirst, setting up our budget in that program and doing lots of forecasting.
A budgeting program just makes it really easy to enter receipts and bills. You just type them in and the program puts them in the right category for you immediately. There's no sorting. There's no adding. You just type in the number.
A few years later, I discovered two systems that I liked even better. The best free budgeting software I've ever found is the PearBudget spreadsheet. I used this for a few years with great success as it was a vast improvement over my own spreadsheet mess; I even preferred it to Quicken.
A bit later, I discovered my favorite budgeting software of all, You Need a Budget. I currently run this program both on my desktop computer and my smartphone so that I can actually enter expenses from everywhere. It all syncs up wonderfully and it makes everything about as effortless as humanly possible.
Problem: I Don't Know Where to Put Some of Our Expenses!
One big challenge we faced was figuring out where exactly to put some of our specific expenses.
For example, let's say I bought a board game. Is that an entertainment expense? Is it a hobby expense? I wasn't sure. What about a book on personal finance? Entertainment? Hobby? Household? All of those make sense, at least to me.
There were quite a few expenses like that and it often felt like I was handling them in an inconsistent way, meaning that our budgets weren't exactly accurate. If I filed items in the "household" section one month and then filed the exact same items under "food" another month, it created a distorted picture.
Solution: Edit Your Categories
If you're finding yourself unsure where certain expenses go, then the problem is with the categories themselves. You're trying to fit round pegs into square holes when you have the power to change the holes whenever you'd like.
We made several changes to our budget over the course of several months that involved introducing new categories and merging categories. We had a new "business expense" category. We merged "entertainment" and "hobby" together into one category because we were often unsure as to the difference.
We also made strict definitions for some of our categories. "Food" consisted solely of things that you actually eat; if it is not consumable, it goes into "household."
Eventually, the problematic items became fewer and fewer until they essentially ceased to be a problem. I might still find one or two items a month that don't perfectly fit, but that's such a minor problem that I don't worry about it. One or two items that aren't perfectly sorted aren't a big deal; twenty or thirty items are a big deal.
Problem: I Regularly "Forget" About Certain Bills and Savings
We had lines in our budget for savings, which was a very good thing. We wanted to build up an emergency fund, save for a house down payment, and even start saving for the expenses for our next child. It was a smart move to put those things in our budget.
The problem was that we would often forget to put that money aside. We'd include it in our budget, but that didn't mean that such savings actually happened. Instead, we'd just find ourselves with a surplus in our checking account at the end of the month.
If we were on the ball, we'd transfer that money to our various savings accounts so that we could continue moving toward our goals. Unfortunately, we weren't always on the ball - sometimes that money would go to other things, like an extra payment on a student loan.
While that wasn't necessarily a bad move, it did mean that our money wasn't going directly to the place that we intended.
Solution: Use Automatic Bill Pay & Savings
We fixed that problem by adopting an automatic bill payment and savings system, something offered as part of the online services by our bank.
We simply set up a few automatic transactions that occurred on the last day of each month. Money would go into our emergency fund, our down payment fund, and a few other places where we had set aside savings for other specific goals.
We also set up a few automatic bill payments simply to cut down on the manual work that we needed to do. For example, our garbage bill needs to be paid every three months and it's a consistent amount, so we set that up to happen automatically so we didn't have to think about it.
You can't "forget" these things when they're done automatically for you!
Problem: Irregular Bills Send My Budget Out of Whack
When we first started budgeting, our big irregular bills were renters insurance, auto insurance, auto registration, and life insurance. These bills came in on an irregular basis - some every quarter, others every year.
In the first drafts of our budget, we didn't include these things. Then, when these irregular bills arrived, they sent our budget into a tailspin.
After we moved into our home, the irregular bills became far worse. We had property taxes and homeowners insurance, both of which were pretty hefty bills. These things wrecked our budget.
We needed a better plan.
Solution: Average Your Bills
Our solution was to add a new budget category - "Insurance and Taxes."
The amount to put into that budget category was a bit trickier. Our solution was to simply total up all of those irregular bills - property taxes, homeowners insurance, auto insurance, auto registration, and life insurance - over the course of a year, then divide that amount by twelve. That's how much we budgeted for those bills. We also included a 5% "overage" so that we wouldn't be in trouble if and when those amounts adjusted upward over time.
So, let's say our annual property tax was $3,000, our quarterly auto insurance was $300, our annual vehicle registration was $400, and our annual homeowners insurance was $800. That totals up to $5,400, which we divided by 12 to get $450 per month. We added a 5% overage - $22.50 - and so we started putting aside $472.50 a month for these bills into a separate savings account.
Whenever those bills came in, we'd just take the money from that account and move it back to our checking, making it easy to write a check for those bills.
We applied the same principle to our irregular bills, like our energy bill. We calculated an annual average for the bill, added 5%, and that's how much we budgeted for it each and every month.
Problem: Little Emergencies Cause My Budget to Fail
At first, our budget was really tight. We locked it down to our exact spending from the previous months rounded to the nearest $10 and stuck with that budget.
We quickly learned, however, that not all months are exactly the same. One month might see some extra household costs when one of us got sick with a cold. Another month might see a boost in food costs when we had household guests.
Even though we were doing a great job of controlling our spending, these month-to-month variations still led to a number of overages in our budget that we just didn't like having. We had a "Flex" category, but it was getting eaten into oblivion almost every month.
Solution: Add Breathing Room
We solved that problem by adding flexibility to almost every category in our budget. We altered our budget so that every category budgeted for 10% more than we actually spent in a typical month.
Let's say, for example, that our food spending in an average month was $400. In our budget, we would actually account for $440 in that category. That way, if we had a few guests during a special month, we wouldn't go over our budgeted amount.
We liked this approach because it meant that we came in under budget in almost every category almost every month. We then had "leftover" money to apply toward whatever our most pressing financial goal was - usually, it was debt repayment.
It was this "breathing room" strategy that actually led us to such rapid payoff of our debts. We just rolled that extra cash into our highest interest credit card, which was part of our debt repayment plan.
Problem: Silly Splurges Wreck Our Plans
While we had a pretty clear budget cap for "Entertainment/Hobby" spending, we would sometimes go over that cap because of a silly purchase or two. We would go out, buy something without thinking too much of our budget, and then, at the end of the month, realize that we overshot our target - sometimes by a fair amount.
This was a silly mistake, of course, but it still caused budgeting problems. When we would overshoot a category, that meant that the money needed to come from somewhere else. Thankfully, we did have some breathing room in our budget, but when we ate up that breathing room, it took away from our progress in paying off our credit cards.
We needed a better solution.
Solution: Use an Envelope System
For several months, we moved to an "envelope system" with regard to our entertainment spending. At the start of the month, we would withdraw a cash amount from our checking account equal to the amount we had budgeted for entertainment. We'd split that cash in half and put each half into a separate envelope.
One envelope was mine, one was Sarah's. From that envelope, we could basically spend however we wanted. If I wanted a board game, I could buy it - it just came from that envelope. If Sarah wanted a new cell phone, she could get it - it just came from her envelope.
Whenever we went out, we would just take some cash from each of our envelopes in case we saw something interesting when we were out and about. At the end of the month, if there was money left over, we just let it carry forward to the next month.
After a while, we became used to this system and used to being more responsible with our entertainment spending. This allowed us to eliminate the envelope system, taking it off much like a six year old removes training wheels from a bicycle.
Problem: Big Emergencies Wreck My Budget
In the late summer of 2006, a tornado struck, damaging the rear end of the pickup that I drove. It shattered the back window and did some damage to the bumper and the bed of the truck.
Naturally, this was something that insurance could help us with, but there was a problem - we had a $1,000 deductible. This meant that I needed to come up with $1,000 to pay for it.
I didn't want to put it on the credit card. I also didn't want to wreck my budget. Still, I needed $1,000 - and quickly. I ended up splitting it between the two, soaking up almost every dollar of budget excess and also putting about $400 on a credit card.
It was disheartening. It really felt like negative progress. I felt like there had to be a better way of doing things.
Solution: Have an Emergency Fund
There is a better way of doing things - it's called an emergency fund. It simply means that you have a certain amount of money set aside in your savings account for big emergencies.
We started putting aside $200 a month in a new budget category called "Emergencies." That money went via automatic transfer to its own savings account. In the early stages, to fill it up quickly, we spent a month or two dumping our "overbudgeted" money in there as well.
Whenever an emergency happens that exceeds our budget's flexibility, we just tap that emergency fund. Since it's getting refilled each month, it's not a big deal to draw it down when necessary.
Our goal is to have six months of living expenses in there at all times. We prefer not to rely on credit cards for this, because credit cards assume that the banks will continue to extend credit to us, which might not be a given in a case of identity theft or job loss or other credit problems.
Problem: My Spending Is Changing
Over time, your life will change. Your rent will go up. Food prices will rise. You'll get a new job that pays more - or less. You get married.
Many events in our lives can alter our budgeting plans. When we moved into our house in 2007, many of our categories changed. When our daughter was born in late 2007 - and then our third child arrived in 2010 - things changed again. My career change in 2008 also triggered some real budgeting shifts.
Solution: Revise, Revise, Revise
Whenever a life change occurs, part of that change involves revising your budget. You need to sit down and re-evaluate your income and your expenses in light of the recent changes in your life.
Yes, it's a lot more fun to budget when your income has gone up or a big expense (like a mortgage payment) has disappeared, but it's also a necessary task when income goes down or your expenses go up significantly.
If nothing else, it can make sense to revise your budget once a year to take into account things like the change in the cost of living, change in property taxes, and so on. The dollar amounts that worked a few years ago probably won't work now.
If you remember nothing else from this article, remember this: a budget is a living, breathing document. It's a guide that helps you balance your pressing financial needs, the things you want, and your big overarching goals. Those things aren't static - they change. Your budget has to be able to change with it.
Over the years, I've found that keeping a budget is incredibly rewarding. It helped me get a firm grasp on where my money was actually going and aided me in making smart decisions about where my money should go. Even with the difficulties we ran into along the way, the experience was well worth it.