Budgeting basics

A budget is a work in progress. But having one is essential.

If you take a list of what you need with you when you go to the supermarket or the hardware store, you can shop more efficiently. And if you have a sense of what things cost and how much you are willing to spend, you’ll probably make better choices and save money too.

Using a budget can have similar positive results for your overall household and personal spending. It means you have a plan for how you’re going to spend the money you have coming in without spending more than you can afford.

What you spend

As the first step in budgeting, make a list of your expenses, dividing them into the following categories:

• Fixed monthly expenses, which include mortgage payment or rent, car payments, installment loan payments, including student loans, and insurance. If you pay for insurance quarterly or annually, convert the cost to a monthly amount. Do the same for property taxes if they’re not included in your mortgage payment.
• Variable monthly expenses, which include food, clothing, utilities, transportation, credit card charges, contributions, and medical expenses. These are just as important as fixed expenses, but you have a little more control over what you spend.
• Incidental expenses, which include everything else you spend. Some of this spending can be described as discretionary because what you’re buying is not essential. These purchases are sometimes described as wants rather than needs.

To document what you spend, you probably have checks or credit card receipts for some or all of your fixed and variable expenses. To figure out the rest, including incidentals, keep careful track of everything you buy with a debit card for a month or six weeks. Do the same with your cash purchases. What you discover may surprise you.

You can keep track of these expenditures in a small notebook or by finding an app for your mobile phone or other electronic device that you always have with you.

What you earn

The other half of the budget equation is figuring out your monthly income. List your salary or wages, alimony and child support if any, and other regular sources of income you have. You may have some savings or investment income, though you probably should be reinvesting that for future needs or goals. Some people have rental income, and people who are retired may have Social Security and pension income.

Where you stand

Next, compare what you’re spending each month with your income. If those amounts come out even, or if you have more income — even a little more — than what you’re spending, you have your finances under control. What making a budget can do for you is help you find ways to use your money more effectively, freeing up more to save and invest.

If your spending outpaces your income, you’ve either got to reduce your expenses or increase your income, or do both, to bring the two into balance. Otherwise you’ll find yourself in financial trouble because you won’t be able to pay your bills.

Making a spending plan

To revise your spending habits, especially if you regularly are short of the money you need to pay your bills, think about the answers to the following questions. It might help to write down your responses.

• Which expenses are essential and which ones have to go, at least for now?
• Can any of the essential expenses be reduced?
• What’s a realistic reduction for the ones that can be cut?

Next, project your spending for the next 12 months, subtracting what you estimate you can save based on what you’re spending now in each budget category. For example, unless you move, you probably can’t reduce the fixed amount that you’re spending on rent or mortgage. You have to make your car payments, too. But if your records show you’ve been spending an average of $500 on food each month, can you reduce that by 10%, or $50? Can you get your transportation costs down, or what you’re spending on utilities? Can you reduce your phone bill by getting rid of call waiting or being careful to use fewer minutes?

Keeping track

As the months go by, keep careful records and compare your actual expenses to what you budgeted. Remember that a budget is not carved in stone. It’s a working model. You should expect to keep refining it to make it work better.

Figure out how you can reduce your spending in a category where you’re running over the amount you anticipated. Or try to rearrange what you’ve allotted to various categories to reflect what’s really happening. For example, food may cost more than you planned but you may have figured out a way to spend less on transportation or electric bills.

You just want to be sure that you keep what you are spending in line with the total you have available to spend.

Finding ways to cut back

What’s the most effective way to realize the savings you believe you can produce?

The most personal and the most difficult part of budgeting is finding ways to reduce your spending. What works well for a relative or friend may not work for you, in part because spending is linked to personal priorities and responsibilities.

For example, if your housing costs eat up a large portion of your budget, you might be able to move to a less expensive home. But if you are happy where you are, you have good friends near by, and you can catch a bus to work just a block away, you may decide to economize some other way.

But most people, if they look, can find ways to spend less on certain things. Could you still have a good time if you cut your entertainment budget by 15% or more? If that seems extreme, try 10%. Could you carpool to work? Could you take your lunch instead of buying it every day?

Moving ahead

Budgeting isn’t a one-time exercise. It’s important to make monitoring your cash flow an ongoing process, by keeping records, either electronically or on paper, and making adjustments to your budget or spending.

It can be frustrating that following a budget doesn’t guarantee you’ll be able to afford everything you’d like to have, especially in the short term. But if you’re serious about living within your means and diligent about spending carefully, you’re much less likely to get caught in a serious financial trap.

On the brighter side, as you get your finances under control, you can start to make progress toward your goals, first by building an emergency fund to cover unexpected expenses you haven’t budgeted for and then by allocating a percentage of your income to savings and investment accounts.

This information is provided with the understanding that the authors and publishers are not engaged in rendering financial, accounting or legal advice, and they assume no legal responsibility for the completeness or accuracy of the contents. Some charts and graphs have been edited for illustrative purposes. The text is based on information available at time of publication. Readers should consult a financial professional about their own situation before acting on any information.