How to make budgeting a healthy financial habit you stick to.
We get it. In the past, budgeting was often time consuming, difficult, and a big hassle. But with the technology available now, that “big hassle” has become infinitely easier because digital platforms do all the hard stuff for you.
Still, even though you have a program to do the math, you need to know some basics to really build the effective budget you need. You can prioritize your obligations and expenses, and make real actionable plans to reach your financial goals. You can have a budget that really offers a good foundation for financial success.
Fact: Housing, transportation, food, insurance, and healthcare are the 5 largest expenses in the average budget.
Defining the elements of a budget
A budget always contains the following:
- Fixed expenses
- Flexible expenses
- Discretionary expenses
Income is obvious – it’s everything you have coming in. That includes things like wages from jobs, received alimony or child support, VA or other benefits, court settlement payouts.
Expenses are divided into three categories based on how they get paid and whether it’s a want or a need:
- Fixed expenses are needs that have a set cost that stays the same from month to month
- Flexible expenses are also needs, but they don’t have a set monthly cost
- Discretionary expenses are your wants
So what do you get out of defining your expenses? You can prioritize and plan effectively. You can also easily make cuts when you need to streamline your budget when you need to pay off debt or save up for something big.
Types of expenses versus budget categories
Now it’s important to recognize that “types of expenses” are different from “categories” that you assign to transactions. Transaction categories are more specific, while expense types are broad. And you need to define both to have an effective budget.
Think of your budget like an office building. Types of expenses would be the different floors of the building, while transaction categories are the rooms. So just like there can be a meeting room on every floor of an office, your housing costs can be spread out between all three types of expenses.
- Mortgage payments, HOA and insurance are all fixed expenses
- Electric bills, water bills and other utilities are flexible expenses
- Renovation and decorating expenses would be discretionary, because there isn’t a real, immediate need to have them done
Categorizing your transactions
When you start using a budgeting platform, it’s going to ask you to categorize your expenses. These programs learn from what you do, so you have to teach it how you think your spending should be divided.
Not everyone categorizes transactions the same way. So one person may put all of their food costs into one big category, while someone else would split up groceries and dining out. In general though, the more you categorize, the easier it is to structure your financial life.
Our experts recommend you try to categorize in a way that helps you split your expenses up. So using the housing example, mortgage payments should be a category, utility bills would be another category, and then home renovations should be another. That way, if you need to reduce your overall housing costs, you know where to cut.
Estimating cost on flexible and discretionary expenses
Fixed expenses are the only thing with a set cost every month, so how do you set the monthly cost for the other two types of expenses?
You take a three-month average.
Look back at the past three months of transactions and take an average in each category. This will give you a good baseline of where to set a monthly spending limit for that category. Setting monthly spending limits is important because it keeps you from overspending.
The good news: your platform does the calculating for you. Just categorize your transactions and the program tells you how much you’ve been spending.
Assessing your budget and making adjustments
Once you’ve done the initial legwork of entering your accounts and categorizing transactions on your budget platform, you can let your budget work. Since it’s a digital platform that constantly updates itself after every transaction you make, you just have to log on and see your progress.
Here are some tips for using your budget daily:
- Watch your spending limits versus your actual spending. If it’s mid-month and you’re already reaching a limit in a certain category, slow down.
- On the other hand, if you just can’t seem to stay on-budget in a spending category, you may need to adjust the spending limit. Just remember when you do that your total expenses need to be less than your income. So if you increase in one category, you may need to pull back in something else.
- Make saving money into an expense. It should actually be a fixed expense so you “pay yourself” appropriately every month.