If you want to have the money to realize your dreams – whether it’s getting rid of student debt, buying instead of renting or saving for retirement – you really do need to have a budget. Just spending as little as possible isn’t enough to take control of your financial life.
The best yearly budgets are well thought out and accurate, providing a realistic view of your finances for the next year. If you write down that you are going to spend $100 a month on groceries, for example, and you always exceed that by $500, your budget isn’t doing much good. A common problem that people face when making a budget is that they unrealistically trim certain expenses in order to be able to pay for others; for example, budgeting only $100 a month for groceries so you can have $500 a month for entertainment. The budget only works if it is realistic and if it is something that you can actually follow.
Once you make the commitment to create a yearly budget, you need to start with some fact-gathering.
Estimate Your Income
For most people, estimating income is easier than figuring out anticipated expenses. Your income should include all the money you can reasonably expect to earn or receive during the 12-month period, including:
- rents and royalties
- interest and dividends
- child support
- disability benefits
- Social Security
- retirement income
If you are unsure about your income – for example, if you are a contract laborer or a freelancer – it is better to underestimate and be pleasantly surprised when you have a surplus in your budget than to overestimate and be unable to pay a bill that comes due.
Research Past Spending
A realistic budget has to start with understanding how you spend money and what your biggest expenses are. Gather your past credit card statements, utility bills, check stubs, receipts and anything else that will help you figure out how much you spent last year (or ideally over the past several years). Put your spending in categories so you can get your arms around what costs you the most. This will let you make better projections about what you might spend in the coming year.
Estimate Future Expenses
Determining accurate expense projections is challenging, but not impossible. A yearly budget typically includes a number of fixed and variable expenses, as well as room for certain discretionary spending.
Fixed expenses. These tend to stay the same from month to month and are part of your way of living, such as your mortgage or rent payment, other debt payments (i.e. car, student loan and credit card), health insurance premiums and certain utility bills. Fixed expenses also include regular expenses that show up only once or twice a year, like homeowners’ insurance premiums, homeowners’ association dues, real estate taxes, vehicle taxes and vehicle insurance.
Variable expenses. Many expenditures may occur on a regular basis, but will vary in amount from month to month. For example, you may routinely purchase gasoline, but may use more during the summer months when you are vacationing. Similarly, your gas and electric utility bills arrive every month, but may vary greatly depending on the weather and how much heat or air conditioning you use during any particular month. When budgeting for a variable expense, you can estimate each month’s bill, or estimate the entire year’s expense and divide by 12 to come up with an average monthly estimate.
Variable expenses also include spending that does not occur on a regular or planned basis. You may not purchase new clothes every month, but may plan on buying the kids new outfits before starting school in the fall. Even though this is not a regular expense, you can still plan for it by putting it into the budget.
Other expenses. You may have noticed that some expenses could fall in either the fixed or variable category. When in doubt about whether a certain expense is fixed or variable, assign it to the category that makes the most sense to you. For example, you may be able to make a regular monthly contribution to a retirement account or savings account. You can call this a fixed expense. If, on the other hand, you plan on contributing different amounts throughout the year (perhaps you have a seasonal job), you can label this a variable expense. Where the expense is listed is far less important than making sure it appears somewhere on the budget and that you stick to it.
Discretionary spending. If you subtract your fixed and variable expenses from your total anticipated income and you have some money left over, then you will have room for discretionary spending in your budget. Discretionary purchases are things that you don’t really need, but that you would like to have. Examples of discretionary purchases include entertainment, dining out, music, vacations and other splurges.
Use this information to project what you will take in each year and how you plan to save and spend it.