The first step towards getting somewhere is to decide that you are not going to stay where you are.
~ John Pierpont Morgan (Yep, it’s that J.P. Morgan)
A lot of people hate the idea of budgeting. They say it’s too constraining. They need more flexibility. I’m not going to lie to you and say I love working on the budget. But I do love it when it’s done. And I love it when an expense pops up and I don’t have to get stressed out about it because our emergency fund covers it. I love it when my kids ask for something and I can tell them definitively whether or not we can afford it and provide the figures to back it up. Setting up a budget gives you more flexibility, not less.
Gordon Pape, as many of you know, is a venerable and well-respected Canadian investment writer. We usually think of him doling out advice about mutual funds, asset allocation, and retirement planning. But in his book 6 Steps to 1 Million Dollars, he says that “everyone needs a budget”. As we pointed out in Your Financial Hierarchy of Needs, it’s important to master the basics before you move on to higher goals. Mr. Pape offers a downloadable budget spreadsheet in Excel format on his website.
So how do you go about setting up a budget? I thought that rather than prescribing one no-fail budget method (there isn’t one), I would give you a tour of some of the different methods out there. You can choose one that’s right for you and your unique situation. Give yourself some options.
Starting any budget requires that you research yourself a little bit first. You need to know how much money is coming in and how much is going out on a monthly basis. I prefer to look at these items on a yearly basis as well, as it gives me a better sense of the big picture. For expense categories like clothing, dining out and even groceries, expenses may fluctuate quite a bit from month to month. I like to know that if I overspent on groceries because I stocked up on some good sale items, it will likely balance out with lower expenditures in other months. If it doesn’t, I need to look at the numbers again.
Budget by Percentages
Many budget plans will have you break down your net (after tax) income into various piles and allocate a fixed percentage to one area or another. Here are a few examples:
3-Step Budget by Andrew Tobias
I came across this one via Get Rich Slowly. It goes like this:
- Destroy Your Credit Cards
- Invest 20% of Your Earnings
- Live On the Remaining 80%
This budget, while simple, is not for me. I like to use my credit cards for the convenience and the reward points, so I have no intention of destroying them. I pay the balance in full every month and I am able to control my spending, so overspending and spiraling into debt hasn’t been a problem. What I do like about the Tobias plan is that he follows the pay yourself first doctrine by cutting 20% of earnings off the top and telling us that we simply must find a way to live on the remaining 80%.
Warren & Tyagi’s Balanced Money Formula
- 50% Must-Haves
- 30% Wants
- 20% Savings
This remains my personal favourite out of all of the budget plans presented here. I’m giving it a spin with our own finances this year. We’re not in balance yet, but I’ll keep you updated as the year goes on.
The 60% Solution by Richard Jenson
- 60% Committed Expenses: regular bills, basic food and clothing, insurance premiums, charitable contributions, all taxes
- 10% Retirement Savings: automatically deducted from pay
- 10% Long Term Savings: discounted purchase of Microsoft stock (as an MSN employee), which can be converted to cash within days – He uses this as an emergency fund.
- 10% Short Term Savings: He has this directly deposited into a savings account and uses it for irregular expenses like new appliances, repairs, vacations and gifts.
- 10% Fun Money: This can be spent on anything your heart desires.
I like the fact that this budget works well for Mr. Jenson and his family, but the 10% divisions wouldn’t work that well for everyone. Further, most of us will obviously not be able to participate in the particular stock purchase plan to which he has access. Still, I think his point was simply to allocate some money for longer term savings or to an emergency fund. That could work for all of us. This is a great example of how, in money or in life, one size does not fit all.
Envelopes & Jars
There are a couple of systems out there that advocate a cash budgeting plan whereby you decide how much you will spend in a certain category and place that amount of cash into a jar or envelope that is labelled accordingly. Once the cash is gone, that’s it – no whipping out the credit card, no writing out just one more cheque, and no visiting the ATM. Gone is gone.
This is probably one of the oldest forms of budgeting and has been endorsed by numerous experts, grandmas and gurus over the ages, including Dave Ramsey. He also advocates a zero sum budget, where every dollar has a name and allocation, whether it’s for food, fun, debt repayment, or regular household expenses. If the budgeted amount goes up in one category, some other category must go down. If you get a raise, make sure you allocate it to the parts of your budget that really need it first.
This is the system used successfully by Canadian personal finance guru Gail Vaz-Oxlade. It works pretty much like the envelope system, but you use jars instead. Again, if this type of system works for you, use whatever you want for the cash containers. Gail has a great guide to building a budget on her site and she includes a useful interactive budget worksheet as well. I like her worksheet in particular because you can work with it online, play with the numbers, and print it out when you’re ready. You don’t need Excel, but she offers a downloadable Excel version too. I love choices!
There are lots of different types of budgeting software out there. Some run on your computer desktop and some are available over the internet. Many are tailored to American consumers and are not all that useful to Canadians. Many people use Microsoft Money, but I understand Microsoft is no longer supporting it. I haven’t tried out any of the online tools and I don’t know a whole lot about them, so I will just direct you to a great review of online budget tools by The Dough Roller.
I personally use Quicken Home and Businessalthough I have a Mac and I needed to get a special program for it to run Windows in order to use the software. Quicken for Mac is not available in Canada. I find this pretty frustrating, but I have used the program for years to track our income, expenses and taxes and it does the job for me. Still, if there is a better program out there for Macs, I would switch in a heartbeat.
Whether you’re a seasoned budgeting veteran or a rookie, I hope you found something you can use here. If you try out one method and you can’t make it work for you, go ahead and try another until you find one that fits. I was going to close by telling you how I go about working on our budget, but the post was getting too long. I’ll tell you about it tomorrow.
Did you find anything here that you hadn’t seen before? Do you have any other good stuff to add to our Budget Shop?