Monday, March 19, 2007

Personal Finance: Budgeting

Without a budget, many of us just muddle through, trying to stay one step ahead of our bills, living paycheque to paycheque. If the word "budget" makes you squirm, think of it like this:

  • summarizing how you spend your income
  • creating guidelines for your spending

Thinking of a budget as a financial restriction is a sure way to set you up for failure. A budget is simply:

  • a tool to increase your consciousness of how and where you spend your money
  • a guideline to help you spend your money on the things that are most important to you

How do I start budgeting?
The first step is setting up income and expense categories to track. Basic categories such as housing, utilities, insurance, and food are a good place to start but we also each have expenses that are unique to our personal situation. The plan is to become more aware of where your money goes so you can be more aware about your spending decisions. You can use a budget program, a simple spreadsheet, or a piece of paper.

The next step is to start putting amounts into the fields of the spreadsheet or budgeting program you have decided to use. To get started, gather as many of your pay stubs, bills, and receipts as possible. Work out your average monthly gross income, including average salary, commission, bonuses, dividends, and interest.

Next, go through your bills and receipts for the last three months and list all your monthly expenses on a budget worksheet. Make your categories detailed enough to provide you with useful information about your spending habits, but not so detailed that you become bogged down in trivial details.

Now that you've listed estimates for your budgeted amounts, don't forget to record your cash expenditures. Write them down in a little notebook as you spend the cash or figure out something that works for you. You may be surprised at where your cash goes, especially if you make frequent ATM withdrawals. Some people use credit cards or debit cards to track all of their monthly expenses and carry very little cash.

The Truth Comes Out!

Now that you have successfully tracked your income and expenses, subtotal the income and expense categories and subtract the total expenses from the total income to arrive at your net income and now you know the amount of money you have left over for savings, emergency funds, etc. If the number is negative, your expenses are greater than your income. Don't be depressed because it’s likely your situation can be greatly improved by changing your spending behavior.

If you're fortunate enough to have a positive net income, be sure to transfer most of it to a savings or investment account at the end of each month because extra money left in your regular account has a way of getting spent.

Sticking with the Program

After you've tracked your actual spending for a month or two, you'll be better able to identify where you can make changes to start saving money. Consider it a process of self-discovery. Many people don't have a clear idea of where their money goes until they start tracking their spending, and then they are usually very surprised at how much they spend in certain categories over time. You can't control your money until you know how much you have and where it goes.

Once you've got the budgeting process in place, take an in-depth look at your largest spending categories, research new ways to reduce spending in specific categories, and set sensible goals. Don't overlook the smaller spending categories, either. Sometimes these are the easiest to make cuts in because the spending may be more discretionary, and small amounts can add up very quickly.

If you stick with tracking your income and expenses past the first month or two, you'll begin to see a pattern in your spending, and you'll be able to identify areas where you can painlessly save money that you can use to save. It may sound unlikely, but discovering ways to save becomes a challenge that can be very rewarding, especially as you see your savings grow. Following a budget can set you free from the burden of living paycheque to paycheque and the constant worry that you won't be able to get ahead financially.


mohican said...

Note: My wife and I use a simple MS Excel spreadsheet to track our income and expenses. It cost us nothing to buy and is customizable for our needs.

We have also decided to use our credit cards for all our monthly expenses. We did this for three reasons: 1) we get points / cash back on all our purchases; 2) we can more easily track our expenses; 3) we don't pay bank fees for cash withdrawals or debit purchases

If you decide that using your credit card is the best way to track your expenses, just ensure you have enough money to pay the bill in full every month.

the pope said...

Great post mohican, I wonder if you would be willing to share the excel template you use? I never know quite how far I should divide categories.

Jesse said...

A significant point is that money you save off the bottom line is already taxed.

re using credit card to track. I do this as much as possible. Getting a 1-2% dividend card or something similar makes a huge difference, as long as you treat the credit card as cash.

Jesse said...

Another point re credit cards, IF you have the discipline, is their payment terms are NET30. Over time this makes a difference too.

But the key is discipline.

mohican said...

"payment terms are NET30"

My wife and I were just talking about this the other day and discovered the added benefit of the continual float of $2000 / month of interest free credit from the credit card company works out to approximately $1000 of 'free' earnings over a 10 year period of investing that interest free float in a 4% dividend paying stock or mutual fund.

mohican said...

My expense/cash outflow categories on my personal budget are:

Car Expenses
Home Expenses/Utilities/Strata
Home Improvement/Maintenance
Work Related
Life/Health Insurance

Freako said...

"Great post mohican, I wonder if you would be willing to share the excel template you use? I never know quite how far I should divide categories. "

Mohican, Pope. I got a proposition of sorts for you. Been toying with an idea for a while. This great and to the point post cinched it for me. I will e-mail you what I had in mind (hopefully sooner than later).

Also, if you want to go the fancy route, software like Money and Quicken can automatically download your statements and even categorize the expense automatically. I had this up and running at least 6 years ago. The problem is that I stopped using it for some minor reason or other.

There is something for simplicity and the KISS formula. That is why I like Mohican's suggestion. You could also use a Google docs spreadsheet so that you can access from anywhere, and share with family members.

TQN said...

Great post and suggestion to those who do not practice this.
I use exel to budget my monthly spending and also, a bit further, forecast my cash flow for the next six months. That case, I dont expect any surprises.

littlemanrenter said...

My wife and I were just talking about this the other day and discovered the added benefit of the continual float of $2000 / month of interest free credit from the credit card company works out to approximately $1000 of 'free' earnings over a 10 year period of investing that interest free float in a 4% dividend paying stock or mutual fund.

Can you please provide more info/detail/example of this?


mohican said...

littlemanrenter - it works like this -

Every month we purchase everything with cash from the bank account. This includes the hydro, telephone, internet, groceries, and everything else. Lets say this adds up to $2000 / month. In this scenario the cash left the account immediately at the time of purchase and had no opportunity to earn interest/dividends/etc.

Let's say we switch to using a credit card for all purchases totalling $2000 / month and defer the cash expense for 30 days. We are now able to earn interest/dividends on that $2000 every single month that the credit card company lends us the money for free - until the bill is due. This essentially allows us to carry $2000 more in investments than we would otherwise be able to.

Earning 4% on $2000 compounded monthly over 10 years results in a $981 gain.

Does that make sense?

littlemanrenter said...

OH! You're just talking about the difference of deferring until the end of the monthy to pay and what you can do with the money instead.

The earlier post gave me the impression one might take an advance on the credit card, deposit that, earn interest, then pay back with it was actually due - and it sounded like it was interest free.

That would be nice, except I don't know any that do this and all charge interest immediately on cash withdrawals...

That aside, I do have switched to paying all bills with credit card (except for when I had hydro - they had the most convuluted system as opposed to anyone else)

Get the points, no worries on lateness or forgetting... just pay it off.

I also have an avion card but am thinking of switching to the gold as the avion charges $200 or $250 whereas gold does not, the only difference is the points on avion can be used for airfare... but it takes forever to get there anyways and I have 200,000 in Air Canada miles...

Lastly - having put myself into super-savings mode is wonderful though I would imagine many would roll their eyes.

I went from the Yaletown, own a new car, spend crap loads of money on stuff to cheap rental ($300), no car, sold what I don't need and spend very little.

Its contagious but also, I have more money, I am wiser on money (I look for ways to make it go further), my salary has increased (how thats related, I dunno), I've increased my skills through education and I am in excellent physical shape (cause I'd rather be at the gym than the $300 rental)

Granted, can't be done with a family but I would be a good 3/4 of people in Vancouver don't really know how much they're wasting in their spending...

Most of that is due to learnings gathered from these blogs BTW

betamax said...

There is something for simplicity and the KISS formula. That is why I like Mohican's suggestion.

I also used Quicken religiously, then stopped one day; it helped me save money, but became an onerous task to maintain. A spreadsheet with a few simple formulas works just as well.

Actually, I don't even refer to the spreadsheet much these days, as my wife and I (thanks to her good influence) have become so frugal that the budget essentially takes care of itself.

We spend sparingly on non-essentials but do not begrudge ourselves when it comes to buying quality (on sale, of course). By cutting out frivolous spending we've both been amazed at how quickly our savings have increased.

scoop said...


I've tried budgeting as you describe it - setting up category targets, tracking spending, and comparing spending after the fact.

The problem that I've always found with this is that there are no internal controls. I couldn't keep running balances for 20 categories in my head, so I wouldn't think about my budget when considering about spending another $10 on lunch (or whatever). So budgeting to me meant figuring out on a monthly basis how much I'd overspent.

I have a frugal friend who encouraged me to go the "cash" route, namely to withdraw in cash the amount you decide you will spend on all discretionary spending. When it's gone it's gone until the next paycheque. I liked the idea but hate using cash. So instead I opened a new no-fee bank account for this purpose. Each payday this spending account gets an infusion of a set amount, and I watch that amount decline as I spend.

I'm just a couple months in on this system but I'm definitely noticing a difference in my spending habits.

mohican said...

scoop - I think the general principle of tracking spending and keeping yourself within reasonable spending limits is fine as long as it works for you. I know people who use a similar system to yours and it seems to work good. My wife and I are too analytical for that to work for me. I need the detail and the charts!