If you read Cari$ Rules for Financial Freedom, you’ll notice our first rule is “No Budget? No Chance”. What this means is that we fundamentally believe taking control of your finances and achieving Financial Freedom is only possible when you have a personal budget. While we provide a lot of detailed guidance in our Budgeting Series, the purpose of this post is to summarize the process of creating a budget, so you have a big-picture view before diving into the details.
We should note that doing a budget properly takes a little time, but once the initial time investment is made, maintaining it takes minutes every week.
Most of us work on average 22 days a month (or more) to earn our income, but how many of the remaining 9 days do you really dedicate to your financial affairs? We bet the answer is very little or none. Imagine, so much time to create income but so little time spent to try to keep it or learn about money matters. Surely you agree this can’t make sense. Keeping your money is just as important as earning it, but keeping it also takes effort.
What is a budget?
Many times when you ask someone if they have a budget, they respond by saying they earn X per month and spend Y, so they save Z. So, while they think they have a budget, this is really a list of income and expenses, with savings being whatever is left over. This is not a budget.
A budget is a plan. It is a plan to deliver a targeted level of savings each year. The accumulation of these savings provides for your long-term financial peace of mind.
Who needs a budget?
This question is best answered by looking at “wants” versus “needs”. We all want a fancy car, to travel to exotic countries, the latest phone, expensive jewelry, to go to all-inclusive fetes, etc. But we all need basic food, clothes, shelter, etc. It is important to be able to separate needs from wants. If you can easily spend money to satisfy your wants and still have enough funds to retire stress free, you do not necessarily need a budget.
The usual signs of someone needing a budget are:
- You tend to live month-to-month i.e. paycheck-to-paycheck
- You have debt, usually too much
- You usually have a monthly credit card balance i.e. it’s not paid in full every month
- You usually have a very low level of savings, if any at all
- Every big expenditure is a “crisis”
If you meet the profile of someone who needs a budget, really the most important step in the process is just commitment. You just need to commit the time to do it, and then commit to try living by the parameters you set yourself. A budget is not meant to be a financial straightjacket. It does not have to be ridiculously restrictive. Think of your budget as doing a self-portrait, except expressed in dollars, and along the process you will learn a lot about yourself. Creating a budget is a positive activity and you should approach it as such.
We explore these three initial points in the post, Is a Budget Necessary.
Having committed, the next step is to gather a lot of data about your income and your expenses. Truthfully, this is the step that takes the most time: the problem is not your income (you probably know this by heart) but your expenses.
Most people believe they can just sit down and list all of their expenses, because of course, you must know what you spend! But the reality is usually quite different, meaning they can try for hours or days and still not be able to list their expenses and how much was spent, in detail and accurately.
Now, if you are a lucky one who can get this correct immediately, then excellent! For the rest of us normal people, the only way to approach this is to write down every day what you spent, and keep doing this until you get accustomed to your spending habits. It could take a couple weeks, or two or three months, depending on your individual circumstances. It’s usually an eye-opening experience…
This part is important. Many persons think of their income, expenses, and savings on a monthly basis, but this is not a good practice. You need to look at these for 12 months i.e. January to December. Why? Because several items will not arise on a regular monthly basis, but every few months, or only annually (e.g. car insurance, memberships, certain bank fees, etc.). So it is very easy to mislead yourself thinking that because you saved $1,000 this month, it means you’ll save $12,000 for the year. Not likely; probably much less than that.
To be clear, it does not mean you need to wait a whole year to do a proper budget. Once you get a handle on your expenses (as described previously), you just need to project the amounts for the whole year. Will you make a mistake in one of the later months? Probably, but just adjust when it happens and move on, because once you get to the stage of projecting, it’s unlikely you’ll make any big mistakes.
We explore how to gather the data you need in the post, Gather Data for Your Budget.
Pull everything together
There are three points to note here. Firstly, everything we described in “Gather Data” above could be done manually using a pencil and paper. A better approach though is to use a spreadsheet to help you pull everything together. If you check out the Tools section, you’ll see that we have provided a sample budget spreadsheet that you can use as a start (Cari$ Sample Budget).
Secondly, notice our sample is laid out in four sections: Income, Fixed expenses, Discretionary expenses, and Savings. This is very important, especially the sections Fixed expenses (which are broadly your “needs”), and Discretionary expenses (which are broadly your “wants”). We use these sections in our next step below, our 33/33/33 approach.
Thirdly, please note what you’ve done so far is not a budget. This is a list of income and expenses. We have to use this information to create a budget. This next step is what will help you with financial peace of mind and independence.
We show you how to do this in the post, Use Cari$ Budget to Pull Everything Together.
Use our 33/33/33 approach
When you create your budget, you need to decide how much you want to save each year, and then adjust your income or expenses to reach this target. In the short-term, it is usually difficult to change your income, so focus on expenses.
Now, the problem here is deciding the “right” amount of your after-tax income to save or spend. To achieve Financial Freedom, you need to save enough of your income to meet retirement goals (in particular). If you aren’t sure what to do, then use our 33/33/33 recommendation. Our 33/33/33 approach means you try to keep your Fixed expenses to 33% of your after-tax income; Discretionary expenses to 33%; and save the remaining 33%. (You might remember this is Cari$ rule #2, live on approximately 70% of your income and save approximately 30%.)
We aren’t saying you need to immediately start saving 33%. This would be tough if you are currently saving 5%. You can, however, set 33% as your objective/target and every year try to save a little more until you reach your target. You do this by continuously trying to rebalance your lifestyle to keep your Fixed and Discretionary expenses each to 33% of your after-tax income.
Once you decide what is your savings target and the allocation between Fixed and Discretionary expenses, you now have a budget that guides all your financial decisions. Congrats!
We discuss this in the post, Creating your Budget (33/33/33).
Before wrapping up, it is worth connecting the dots between your budget and your retirement goals. It is easy to think that a spending decision today has little relevance in your retirement many years from now, but this is far from the truth. The more you can reduce your expenses now, the faster you can reach your 33% savings target. The faster you can grow your savings, the faster you can invest to further increase your savings and retirement pool.
Therefore, do not view saving each month and year as a short-term decision; there is a very direct link and impact on your ability to achieve Financial Freedom and live stress free.
We hope you found the post useful and would love to hear your thoughts or questions in the comments below!