Budgeting is misunderstood by many people. Everyone has a budget. What you spend your money on is your budget. The difference with having a written budget is that you consciously choose what you spend your money. This allows you to feel more wealthy with the same income because you won’t waste your money on things you don’t care about. This leaves you with much much more money for the things that you actually value.
Determine What You Value
To create a budget, you will first want to write down everything that you value and how much it will cost. Remember to include necessities, entertainment, and irregular expenses. Many people will have housing, utilities, healthcare, transportation, food, vacations, eating out, hobbies, car maintenance, charity, retirement investments, taxes, and insurance.
Convert each expense to a monthly amount. If you buy a car every 5 years that costs $24,000, then you will want to save $400/month for your car in addition to monthly insurance, gas, and maintenance costs. If you spend $3 on coffee a day, you would multiply that by 30, so you would want to save $90/month for coffee.
The next step is to prioritize the items on this list. Give each item a number starting with 1 for the most important, 2 for the next most important, etc…
What Can You Afford?
Once you have this list, you will need to match it up with your income. Take your total monthly income and move down the list subtracting each amount until you run out of money. For example, if I make $1,000 a month and spend $400 on rent, I will have $600 left for my next priority. If I spend $150 on food, I will have $450 left for the next priority, etc..
Keep going down the list until you don’t have enough money for the next priority. This is your cut-off point. Don’t spend money on anything below your cut-off point. Otherwise, you will be taking away money from something you care more about and will be less fulfilled by your spending.
If you really want to spend on something that didn’t make the cut, then you will need to do one of three things: replace that item with something that is above your cut-off, reduce costs on expenses above the cut-off, or increase your income.
This will be a continual process of adjusting as you get more information and as your values and circumstances change. Expect expenses to come up that you forgot to include. Expect that your priorities will change when faced with the decision not to spend on something below your cut-off. The important thing is to be disciplined and always adjust your priorities so that you are never spending below your cut-off.
For example, you get in an accident and didn’t budget car repairs. Repairing your car is more important to you than going out to dinner 3 times a week, so you adjust your budget to stop going out to eat until the repair is paid for and you have reserves for an accident that may occur in the future. The point is that every time you spend money that wasn’t on your budget you need to move that thing up on your priorities and reduce your spending an equal amount from the priorities that were displaced. Every dollar needs to be accounted for.