I don’t budget. Well I kind of do, but not in the traditional sense of the word. When people hear budget, they usually envision sitting down and setting up spending limits, line item by line item for every type of expense they can think of. At the end of the process the result is usually something that looks like this (and this is probably short):
There are a few problems with trying to budget like this. One, it takes a lot of time and effort to create and keep up with, two, it’s much too detailed. Attempting to budget for every little expense is a recipe for disaster. Life is random and things change. Some months you may go out to eat more, others you may buy a ton of new clothes. What is the point of making a detailed budget when things change so often?
Here is one example that points out flaws budgeting using this method. Say you have a food budget of $200 for the month and use Mint.com to track your spending. On the 22nd you get a text message stating you are about to exceed your food budget, are you going to stop buying food for the next eight days? Probably not, you will end up going over budget on food and hope to come in under budget elsewhere.
This is no way to operate! What I propose instead is budgeting by type of expense. For this method you need no more than three categories; fixed expenses, variable expenses, and savings. This is how I personally budget and it has been a very effective system since I have implemented it.
So how do you set up a budget like that? Let’s follow an example.
Before you begin
- You will need three bank accounts, one for each category mentioned above; fixed expenses, variable expenses, and savings, and ideally access to direct deposit through your employer.
1.) Figure out your take home pay (if you are unsure what take home pay is, read this)
- For this example we will assume net income is $2,800 a month.
2.) Determine what your fixed and required expenses are:
- These are the expenses that stay the same or are similar every month and you must pay them. Items like your mortgage or rent payment, car payment, etc.
- Helpful tip, I include my electric, water, and other utility bills in this category even though they may change from month to month. I do this to ensure I will be able to cover all of my required payments and avoid any surprises.
- Let’s say fixed/required expenses total $1,000 per month, we are now left with $1,800 ($2,800 – $1,000)
3.) Setup a savings goal
- For this example our goal is to save 15% of our take home pay for the year, this equals $420 a month ($2,800 x 15%)
4.) Calculate the remaining amount, which is our monthly allowance for variable expense
- Using our example, after fixed expenses and savings we are left with $1,380 ($2,800 – $1,000 – $420)
- That $1380 is for everything else not accounted for above, dinning out, clothes, entertainment, etc.
- To get a little more detailed we can divide this number by four to get an approximate limit on how much we can spend on variable items each week, in this case $345.
- Now all we need to do is spend less than $345 during the week and our budget has been met.
5.) With the amounts calculated above set up direct deposit through your employer so the proper amount goes to each account automatically
6.) No more worrying!
- Now that your money is automatically categorized and spilt the day you are paid, no more stressing and wondering if there will be enough in the bank enough to cover the car payment, rent payment, or any payment. All you need to do is keep a close eye on your weekly spending limit.
Our revised simple budget for the example now looks something like this.
 The value I use is the highest bill from the previous year plus a few additional dollars as contingency