Building a budget is easy if you know how to create a spreadsheet on excel and have a gist of your basic expenses, the difficult part is KEEPING a budget. You can lead a horse to water, but you can’t make it drink. In order to KEEP a budget you must be well disciplined and you must WANT TO KEEP TO THE BUDGET. If you don’t have the desire, then you won’t have the discipline and if you don’t have the discipline, you won’t keep the budget AND if you can’t keep a budget then you won’t be retiring early, paying off student loans early, investing the best you possibly can or maximizing your life not just for today, but for the rest of your days. So, do you have the desire? Then let’s get to it and first learn how to build a realistic budget.
I’m a visual learner, so let me first show you my generic budget spreadsheet, which you can download for your own use here:
Budget Spreadsheet by The Modern Spartan
First off, please note a good budget is broken down monthly (not annually or weekly), as an annual budget might show everything nicely on a macro level, but if there are major life changes or life events, an annual budget will likely not be flexible enough or easy enough to follow. A weekly budget has the opposite problem of an annual budget; whereas a monthly budget allows to account for generally monthly payments like rent, car payments, etc.
To find out how much you can afford to invest in what assets or how much to put away for a $3,000 vacation or to find out how many months it will take to save up for a major expense like a house downpayment or wedding, you simply start with your take home pay or net income (income after taxes) and first subtract out all your necessary expenses. The cheaper you can keep down your essential expenses like rent / mortgage, vehicle expenses (car payments, insurance, tolls, gas, maintenance) and food; the more flexibility you will have with non-essential expenses in your life.
In our example above, let’s say we are making a budget for Jane who makes a salary of $50,000 annually, with no additional income. Depending on withholding levels, Jane will make around $3,500 per month after taxes. Don’t forget if Jane had additional income for commissions, bonuses, tips or subcontracted side work - she will need to set aside around 25% of that income for federal income taxes if these are classified as 1099 income rather than W2 income.
Where some people have trouble is when the categorize non-essential expenses as essential expenses. To keep it simple and to organize the most efficient life-style, only expenses necessary for survival of yourself and your family should be categorized as an essential expense. Obviously, you need a place to live therefore rent or mortgage payments should be considered an essential expense. It is possible to game these essential expenses in multiple ways like living with your parents as you get on your feet, househacking, living with roommates, or having multiple income streams in your family.
In Jane’s example, she’s a recent college graduate with a roommate, living in a city apartment. The apartment rent is $1,800 per month and it’s a two bedroom apartment; therefore her monthly rent expense is $900. If I were providing an example for myself I would have a mortgage and an HOA, since I live in a condo association - which is an additional recurring expense to watch out for, as you must pay it to live in certain places. Utilities are also an additional expense if they are not included in your rent, you need power to operate this day in age. You also need internet, a phone and good health (underrated) to live a good life! This is why I believe a gym membership is likely an essential expense, not only does being healthy help you live longer, but it makes you more productive, less likely to get sick, it makes you happier and it helps your energy levels and confidence.
Other necessary expenses include transportation expenses, whether it be a car to commute to work, city transportation, Uber / Lyft or a bicycle. They all cost money (some more than others) and these expenses can also be gamed. If you are trying to maximize your flexibility with non-essential expenses, you are definitely better able to do this if you drive a Toyota rather than a BMW or decide to ride a bike everywhere like Mr. Money Mustache.
Food, medicine, household cleaning goods and pet expenses are also considered essential expenses. You can game these too by shopping in a place like Trader Joe’s instead of Whole Foods, by cooking meals instead of going out to eat, by fasting intermittently and not eating out at restaurants. Also, pets and children are not cheap and if you have either it’s your responsibility to take care of their health needs, food, toys and other items.
One can argue as to whether clothing is an essential expense or not. Some jobs require you to wear a suit, tie, slacks, dress, skirts, etc. and these are not cheap - but more often than not, if you are healthy and diligent with your fitness, once you have a basic wardrobe, clothing expenses should not be much of a recurring problem. Personally, I spend less than $250 per year on clothes and I bring in more than six figures annually. A nice pair of gym shoes, a couple pairs of gym shorts and a shirt or two is enough for me. If you stay in shape and add to your wardrobe a little bit at a time, you should be set once you reach age 25 or so and most additional expenses are non-essential.
Having fun on the weekend (or whenever you have time off) is important for sanity and mental clarity, however unless you want to work until you are in your golden years, you need to control your spending. Three nights per week in the club or out at the nicest restaurants in your city won’t do you any favors long-term.
Most financial gurus will recommend having a cash nestegg somewhere between $10,000 or three months income in a savings account in case you have an emergency. My recommendation is to start by saving $100 per month - make it an automatic transfer from your checking account to your savings account and you won’t even think about it. Before you known it, you will have a nice little backup fund. If you get some extra money from a bonus or commission, it’s nice to set it aside in a high interest savings account (which matching inflation nowadays is lucky) or put it in a non-retirement index fund account on Vanguard matching the S&P 500 if you are a little more risk tolerant.
When it comes to investing and retirement savings you can find some starter tips, tricks and important lingo you need to know here. Also, there are plenty of great books to get you going like Rich Dad, Poor Dad, the Intelligent Investor and listening to podcasts like Jim Cramer’s Mad Money or The Motley Fool to keep learning. I have some quick notes on investing for those who don’t want to read the entire book here.
The three columns on the right of the spreadsheet are your registers (like a checkbook register) where you enter your expenses to help you track where you are at in the current month showing you how much room you have before you meet or surpass your budget. A key to helping make sure you don’t exceed your budget is to set autopayments where you can like rent, mortgage, car payments, etc. and to keep track of your credit card expenses. A side note, please don’t go into credit card debt - debt sucks. If you aren’t going to treat your credit card like a debit card, then you shouldn’t have a credit card.
In the end the key to building a budget and KEEPING a budget is to divide all of your expenses into essential or non-essential expenses. Cut non-essential expenses as much as you can and learn to game your essential expenses through househacking, carhacking, etc. Make sure your expenses are lower than your income to make sure you don’t go into debt, which is no fun and pick a budget you will actually follow. If you decide to leave no money for beer, having fun, eating out a couple times a month or going on vacation one or two times a year - you will go insane and won’t follow the budget. Like a good diet, you need to pick something that fits your personality, but don’t be afraid to push yourself to new boundaries. The most successful people I know were all frugal at a young age, worked hard and kept a strict budget - if you wait to invest, you will work until you die. The people who aren’t successful spend too much money on non-essential expenses like clothes, shoes, liesing expensive cars, living in too big of a house, going out to eat way too much at expensive restaurants or going out and spending all their money on bottle service at restaurants.
Decide how disciplined you are and want to be, decide when you would like to retire and follow your custom budget to match your desired lifestyle. Don’t lie to yourself and say, I’ll save more money later - it might not happen and the future is never clear. If you don’t start saving and investing now, then when?
SOURCES:
http://www.mrmoneymustache.com/2011/04/18/get-rich-with-bikes/