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Five Steps to Simplify Budgeting

Five Steps to Simplify Budgeting

February 26, 2024

A common goal for the new year is often getting on a budget. That is even more likely this year, since we have been experiencing historical inflation highs over the last couple of years. If one of your goals was to start a budget, this article is for you.

As a wealth manager, I collaborate with clients to build financial plans so we can apply appropriate risk to investments associated with specific goals. That is a sophisticated way of saying we plan how to work toward our goals. In financial planning, I find the budgeting process to be the most common hold-up. What we really need for the planning process is an accurate cash flow analysis. The key to that analysis is a detailed breakdown of expenses. For those clients with budgets, this is a quick report. However, most people do not maintain a detailed budget so, they freeze at this step. We have ways around that, but it is important to understand how to create a budget and why you may want to do so. In this article, we break it down into five steps.

Before we get to the steps, it is worth noting that a detailed budget may not be right for everyone. For some people, breaking down finances into detailed categories and figuring out average spending is the equivalent of a root canal. If you fall into that category, detailed budgeting may not be a good fit for you. The steps should be modified to help you stay motivated. In each of these steps, I will provide my thoughts on how to make this work for you, as well.

The five steps to creating a budget are:

  • Step 1: Set goals. If you are just building a budget so you can save more money or because you are tired of stressing out about your bills, that is a great start, but you need to be more specific. The more specific you are about your goals, the easier it will be to identify whether you are saving enough or spending too much. Also, it will help you find the motivation to stick to your budget when you are tempted to stray.

Setting goals can be complex or simple. I like to use S.M.A.R.T. goals, because it helps me clearly visualize what I need to work toward. There are several versions of S.M.A.R.T. goals, but my favorite is:

S – specific (goal must be specific, not vague)

M – measurable (must be able to measure the goal in some way)

A – attainable (must be a realistic goal)

R – relevant (must be related to something important to you)

T – time-bound (must have a day/month/year/time/etc. goal to accomplish the goal)

There are a lot of books and courses on S.M.A.R.T. goals, and I am not going into more detail about it in this article. What I will point out is that the process can be overwhelming for some people and to varying degrees. If you are one of those people, modify each step so that it is not too demanding. For example, if you are having a hard time coming up with a specific day to set as a time-bound part of your goal, make it a month or a year. If you cannot get any more specific than, “I want to save more money,” then use that as your goal and try to save more money. For die-hard goal-setters, that sounds like blasphemy but, I have seen it work. If you cannot set goals because you freeze at this step, why not get something going by loosening up a little bit. You may get comfortable with this and adjust later. I think that is reasonable.

  • Step 2: Collect financial data. Now that you have a reason to set a budget, start collecting information about your income and expenses. One of the easiest ways to do this is to pull your bank statements for the last three to twelve months. You may also want to use your tax for the previous year.

The two parts of cash flow are income and expenses. Income should be easy to figure out. For financial planning, I prefer to use income before taxes. This allows me to estimate changes in income and taxes over future years. For budgeting however, you may want to use your take-home pay. An exception to this would be if you have a lot of payroll deductions for voluntary benefits. You should add the cost of these benefits in the expenses category and show that as income, as well. When budgeting, you may want to reconsider some of the voluntary benefits you are paying for.

For some people, income fluctuates based on sales or bonus pay. This can make budgeting more difficult, but not impossible. I recommend you think about your income from the previous year and consider whether it was typical. Adjust your income to be more realistic, based on your estimates. You can also take your last three years of income and find the average.

When estimating expenses, start by listing all your fixed expenses. These are the bills that are due regularly and the amount is consistent, like your mortgage, rent, car payment, etc. To make sure you do not miss any, look through your bank statements to identify them.

The remaining expenses are variable expenses, and you can manage these a couple of ways. The most accurate way is to categorize them using a budget template. You can find these online or reach out to me, and I will send you one. You should be better able to manage your budget over time when you have a limited number of categories to review.

You can also simply add up all your variable expenses and make that one big category. You can use this figure, along with your fixed expenses and income, to determine whether you have a surplus or deficit. We will cover that in another step.

  • Step 3: Analyze financial data. Taking the data you collected in Step 2, subtract all fixed and variable expenses from your income. The result will either be positive or negative. Theoretically, it should be zero because you are either saving or spending surplus cash or creating a liability by living on borrowed money.

If you have a surplus, congratulations! You are spending less than you are making. If you have a negative number, you may run out of money and not be able to achieve your goals. However, do not despair. Often, there are adjustments to make after running the first analysis.

If you started this exercise because you were worried about overspending, then your negative figure may be accurate, and you need to get control of your expenses as soon as possible. However, if you were just looking for ways to put more money aside for goals, then you may have overestimated in a few expense categories. Go back and trim some of the variable expenses where you think you may have overestimated.

  • Step 4: Define spending limits and adjust savings goals. In this step, you will look back at your goals to determine whether you are saving enough already. If you are saving enough for all your goals, then your budget is done. Move to Step 5. However, if you are not saving enough for all your goals, then you will want to define spending limits and adjust savings goals.

Start by prioritizing your goals. My preferred way of doing this is to start by prioritizing your values. If you have never gone through a values prioritization exercise, I highly recommend it. There are a lot of articles and books on this topic, so I will not go into a lot of detail here. Once you have your values listed and prioritized, you can do the same for your goals, based on your personal values.

You may feel overwhelmed by the prioritization process. If so, forget about prioritizing your values. However, you still need to go through it for your goals. You can use sticky notes, index cards, or an app that allows you to summarize each goal and move them around. Think about what you are trying to accomplish with each goal and whether the others are as important. Keep moving the cards or sticky notes around until you have a clearly prioritized list.

You need to prioritize your goals, because if your cash flow changes and you cannot accomplish all your goals, you can concentrate your efforts on your highest priority goals. That way, the goals you can accomplish are your most important ones.

If you do not have an emergency fund, you may want to consider this your first and highest priority. Financial emergencies can wreck your plans, but an emergency fund can help you get past those challenges and get back on track. How much should you have in your emergency fund? This can vary from person-to-person. While I am not a huge fan of rules-of-thumb, there are some you can adopt or modify to fit your needs, such as three to six months of expenses or income.

Once you have prioritized your goals, you will want to prioritize your expenses, so you can identify where you will be trimming your spending. Your essential expenses should be marked as such, and they are only reduced if necessary.

Discretionary spending is probably your lowest priority of spending, so these expenses are where we usually start making cuts. If you get a Starbucks latte every morning, consider reducing that to every other day or weekly. If you eat out for lunch every day, consider packing lunch on some days. Calculate the savings from these changes and whether they get you closer to accomplishing your goals.

You will want to go back and forth between reducing expenses and increasing savings toward your goals until you are able to achieve your goals. If you are not able to produce enough savings by reducing expenses, then you will need to either reduce or eliminate goals or increase your income.

  • Step 5: Monitor and review. With most good plans, monitoring and reviewing is an important step. You should have a system for keeping up with your spending and savings goals. Starting out, expect your budget to need adjustments. Review your progress monthly, quarterly, and annually so you can make those adjustments and stay on track.

You may find overspending in some categories while underspending in other categories. This should be expected because life can be chaotic. If the drift is small, that should be fine. However, if you find the drift large or consistent, you may want to adjust your budget.

Additionally, over time our goals can change. It is a good idea to reevaluate our goals on a regular basis. For some people, that means annually. For others, it may be semiannually. Either way, when you adjust goals make sure you go back to the budget to adjust.

There is a lot to consider when creating a budget, but I hope I was able to give you some room to breathe in each of the above steps. As a wealth manager, I must be detail-oriented and numbers-focused, but I also must consider how different personalities can be. I believe that budgeting can be helpful, but I also know that it can be overwhelming. Do not give up! If you find yourself sliding back, make a commitment to stop right now and get back on track. Anything you do to control your spending and increase your savings toward your financial goals is better than nothing. A wealth manager can also function as your coach in this area to help you get back on track. Either way, it is up to you to set a budget and stick with it.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult a qualified advisor prior to investing.