How to Create a Simple Budget

You probably heard it a million times: “You need to budget.” However, there might be a few things in your way of making a simple budget.

First, the word budget might be the most hated word in finance. Nobody likes to restrict themselves. We work hard for our money, and we should spend it the way we want. Some of us might want to live now and enjoy life today. If that sounds like you, we hear you.

Second, is there such a thing as a simple budget? Not many of us like to take the time to track the hundred of expenses we incur every month and tabulate the data on a spreadsheet. In the end, you probably know that if it isn’t simple, you won’t do it very long. We get it.

Lastly, how do you get started? You might know the importance of a budget, but you may not know how to create a customized budget for your situation. You might have a variable income that makes it hard to plan, for example. If you are nodding your head as you are reading this, we get you. 

At MoneyCoach, we specialize in helping families with cash flow issues create and implement their financial plans. We have conceived a streamlined process to help our clients get started with creating their simple budget. Before we share how to get started, let’s discuss why budgeting is so important.

Why is Budgeting so Important

We think that cash flow management, a.k.a budgeting is an essential aspect of financial planning. If you spend more than you take home, you probably won’t be successful at accomplishing your financial goals. It’s that plain and simple. Even if you hire Warren Buffett to manage your investments, he may not help you much if you are not saving money to invest. 

In the end, we are all on a quest for financial freedom. We work hard every day to hopefully, one day, have enough money set aside to retire or reach financial freedom. Having a simple budget may help create a habit of saving a portion of your current income for future expenses. 

We take it a step further. We help our clients take an active look at their spending habits. We guide them to stop wasting money. Knowing where your money goes and diverting more of your money towards things that increase your life enjoyment is also essential.

Now that you know how we feel about budgeting, let’s talk about the philosophy behind what we think is a successful budget process:

The Philosophy Behind our Simple Budget

Give a purpose to every dollar you earn

First, you need to learn about Zero-based budgeting. The concept says that you should give every dollar you earn a purpose in your budget. Being intentional about how the money will flow within your finances will help you envision how money can be spent.

A zero-based budget will help you manage your money and help you meet your savings goals because an adequately implemented zero-based budget should run like clockwork. It is simple math, as long as you stay disciplined.

Avoid spending money you do not already have

Some expenses occur irregularly or without notice. You should consider planning for these expenses by creating a drip of money to a savings account.

At MoneyCoach, we split our financial planning efforts into three different plans: Short-term (0-2 years), Mid-term (2-7 years), and Long-term (7+ years). When creating your simple budget, you should envision what you would like to accomplish over the next two years (short-term plan).

Switching from a mindset of “Spending money and paying it later” to “Save money and Spend later” will make a big difference in your financial success while lowering financial risk.

Start with the End in Mind

When budgeting, you should start with the end in mind. Begin by determining the amount of money you should be saving within your simple budget. We recommend that our clients work towards saving 20% of their net income for expenses within their mid and long-term plans.

Starting with the addition to savings amount will help you determine what you need to do to accomplish your financial goals. It will also allow you to determine what is left to spend within your short-term plan.

Understand the compromises you make every day

The concept of Potential Lifetime Income explains that money is finite. Only a certain amount of money will go through your hands during your lifetime. Therefore, it is crucial to make the most of each dollar you earn to create the life you want. 

Creating a balance between enjoying life today without waste and increasing your lifestyle over time should help you reach your goals. 

Get Rid of Waste

As I said before, you should get rid of the waste in your spending. Imagine if you could get more enjoyment from more dollars you are earning, would you enjoy life more? Would you change the way you spend money now to get more of what you want? In the end, we think that money is a tool to help us live the life we want. Are you currently spending your money in that manner?

Make it Automatic

Richard Thaler, a US economist, won a Nobel economics prize for recommending a change in our 401k program. He suggested that employers should automatically add employees to their 401k plan.

You probably experienced it in the past. It is incredible how much 401k accounts can grow by setting it and forgetting it. The small contribution drips become larger amounts faster than we think.

We are telling you not to stop there. Do the same thing on your other savings plans as well. Make your simple budget automatic to reap the full benefits of saving for the future.

Keep it Simple

Simple is just better. You are busy with life, work, and family. The last thing you need is something that will take much time out of your day. You need a simple budget you can set up and let it do its thing.

Because we know that if it is time-consuming over the long-term, it becomes that much harder to stick with the plan.

Get Everybody Involved

I don’t know about you, but most people we meet tell us that they were never taught how to budget and manage their finances. That is the reason why you should break the cycle. Have your kids involved. Help them create their budget using the same principles as we are explaining here.

Here’s how you should get started:

How to Create your Simple Budget 

Track your spending & categorize your transactions

There are many financial tools you can use to track your expenses. Some of the most popular ones are Mint.com or YNAB (www.youneedabudget.com). Ensure that you link all of your spending accounts, including store credit cards, if you have any. When connecting your bank accounts to the software, it should download 3-months worth of data. That data should give you a basic understanding of how you are spending money.

Split your categories into two groups

We like to keep it simple by splitting the expenses into two broad category groups:

• Committed or Fixed
• Lifestyle or Variable

Committed expenses are expenses we incur to maintain our household:

• Household expenses
• Bills & Utilities
• Auto Expenses
• Health Expenses
• Education Expenses
• Loans Payments
• Insurance Premiums
• Taxes

Lifestyle expenses are things we spend money to enjoy life:

• Food & Dining out
• Entertainment
• Gifts
• Kids Activities
• Personal Care
• Shopping 
• Travel

Once you have split your expenses, determine the proportion of the net income you are currently spending on each of these groups. I shared earlier that you start setting aside 20% of your net income for your mid and long-term plans.

We also recommend that our clients spend no more than 50% on committed expenses. That leaves 30% of net income for lifestyle expenses. The goal is to slowly reduce committed expenses over time as a percentage of net income. We accomplish this by paying off debt payments and increasing our income over time. 

Reducing committed expenses may mean an improved quality of life if more money is available for lifestyle expenses. 

Create a Bank Account Structure

We then help our clients with an account structure. Our Bank Account Structure is the modern-day version of the envelope system. We use the concept to define a purpose for each dollar we make.

We recommend that you have a minimum of 4 different bank accounts, and we advocate that you become even more organized.

Main Checking

• That account is the source of your budget. It receives your income and distributes it to each of your accounts, depending on your budget.
• It pays for your bills, and
• It also holds your emergency fund. We advocate that you use it to save at least 2-months worth of expenses.

HOA Savings Account:

• Accumulate money in the HOA account for unexpected home, car, and health maintenance expenses.  
• Use the HOA account in conjunction with a Health Savings Account if you have one.
• You eventually want to hold one month’s worth of expenses in this account.

Lifestyle Savings Account

• The Lifestyle Savings Account is the account you will use to plan for more large lifestyle expenses: things like a vacation, shopping spree, furniture, Christmas, birthday parties.

That leaves the Lifestyle Checking Account:

• Adopt the account for your day to day lifestyle expenses like going out to restaurants, groceries, small shopping expenses.
• We recommend that you connect your debit card to this account.
• Feel free to get even more organized:
• Some of our clients split their Lifestyle checking account into three different accounts:
• One of the family lifestyle expenses
• One for her
• One for him
• Each spouse can spend and save their money the way they want.

Create your Weekly Transfers

1. We recommend that you establish weekly transfers from the Main checking into each of the accounts based on your budget.
2. We also recommend that you create the transfers to happen every Friday since we tend to spend our money on the weekend for most of us.

Have a Monthly Family Financial Meeting

1. We recommend that you hold a Monthly Family Financial meeting to discuss your short-term plan for larger maintenance and lifestyle expenses.
2. Here’s the link to the document we created to help our clients visualize their short-term plans. Feel free to copy the document for your purpose.

Review Your Bank Account Structure

1. If you realized during the Family Financial meeting that you might not be able to achieve your goals, you might have a few options:
2. You can wait a little longer to make the purchase.
3. You can make changes to your Bank Account Structure transfers. Just make sure that you still follow the Zero-based budgeting process.
4. Or, you can take extra savings from another account.
5. It may take a little time before you optimize your budget transfers. That’s okay. As long as you follow the principles, you will eventually find the cash flow that works for you.
6. Over time you will need to adjust your Bank Account Structure. Continue to optimize your zero-based budget as cash flow changes.

Irregular Income? No Problem

1. If you have an irregular income, we believe it is even more essential to organize your cash flow. However, you may want to add an Income account. Have your commission income or business revenue flow into that Income account and create a steady flow to your Main checking account. The idea is to create stability and consistency, which makes it much easier to budget.

Conclusion: Create your Simple Plan

There you have it, our process to help you create your personalized, simple budget. The process can be time-consuming to get started, but once established, it just happens. Having money flow to be invested should help you attain your life and financial goals.

Source:

Ian Salisbury: “Meet Richard Thaler, the Man Who Just Won the Nobel Prize for Helping You Save for Retirement” 10/9/2017 Money.com

https://money.com/thaler-nobel-economist-retirement-savings-nudge/#:~:text=The%20Nobel%20economics%20prize%20has,his%20contributions%20to%20behavioral%20economics.&text=You%20may%20never%20have%20heard,let%20out%20a%20big%20cheer.

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