While it may not be the most exciting activity in the world, building a budget is one of the most important pieces of getting your financial life on track, especially if you’re starting from a particularly precarious point. When I first realized I needed to improve my money situation, I was in debt and had no savings. Creating a budget was my first move in the right direction. I figured out what I was required to spend for my needs, and moved on to what I’d like to spend on my wants.
The state of my finances dictated I didn’t have anything left over for wants, and I was hardly meeting my needs with my income, so I had to make some sacrifices to reduce the cost of living. After a while, when I was earning more income, out of debt, and increasing my savings, I could loosen up my budget and afford some of the wants.
Budgets are seen as negative for two reasons:
- Typically, budgets are designed with the intent of restricting spending rather than allowing spending.
- Typically, sticking to a budget means not having flexibility.
When budgets are viewed as negative, people are less likely to follow them. Budgets should be approached as a positive — a recipe for spending that frees you, not limits you. One way to take that approach is to add in some flexibility.
Flexibility in budget categories
With budget categories, it’s easy to feel locked in. Budgets can cause stress, and stress can physically manifest itself in many harmful ways. Chances are you’re already stressed about money, so allowing yourself to be worried about making your budget could be harmful to your health. Yet, if you’re three weeks into the month and you’ve already spent all the money you have budgeted for that month’s food, having a strict budget can lead to negative feelings about that budget. You may consider this situation your fault, if you didn’t plan the month properly and could have spent less earlier, and guilt is yet another negative feeling related to the budget.
In reality, you’re not going to just stop spending on food if you’ve reached the end of that month’s funds. You’ll either borrow from another category’s spending or, if it’s available, turn to credit to feed your family for that last week or so. Either way, if your budget is strict, you may interpret this as a step backwards, and if it happens often, it could mentally derail your financial progress.
When designing and sticking to a budget, it’s important to keep in mind that it is acceptable to borrow from an unused category to cover unexpected expenses in another, even if it’s a result of poor planning. You can always do better the next time. If you do need to resort to credit, don’t fret; pay off the debt with excess money from next month’s budget. If, however, you start to see a pattern of spending beyond your budget in one category from month to month, it’s time to reevaluate your budget and decide if you need to change your spending, adjust your categories, or earn more income to compensate.
Flexibility in time
Most people budget from one month to the next. Every month, the budget resets and you’re given a clean slate. When you’ve reached the end of the month and haven’t spent your full budget in any particular category, you have a few good options. First of all, this is a great position to be in, because you’ve spent less than you’ve expected, and you’ve survived. You can use this as an opportunity to look at your spending, and if you think this is sustainable, adjust your budget going forward to represent the lower amount of spending.
The options you have for your surplus can go a long way to improving your financial condition. Let’s say, across three categories like food, clothing, and utilities, you spent $100 less than you expected. Most of the time, that $100 would just disappear, remaining in a checking account for another day. Here are a few ways to look at that $100 and turn it into something positive.
- Roll it forward. Apply the $100 to next month’s budget and let it be a cushion for your spending.
- Splurge. While not best for your financial growth, creating rewards for yourself for sticking to your budget is a good way to keep yourself motivated.
- Pay off debt. Adding $100 to your Debt Avalanche can save you money in interest.
- Save it. Use the $100 to add to or start a high yield savings account.
In our interview with J.D. Roth earlier this month, J.D. pointed out that year-based budgeting is more effective than month-based budgeting. I think that month-based budgeting is easier to keep track of, but when you look at your expenses on a month-to-month basis, you miss expenses that come up at certain times during the year. For example, when you design a budget, you’re not necessarily thinking about spending on gifts for your family, but if you create your budget based on what you spend in February, when December comes around you may find that you haven’t planned properly. Basing your budget on the expenses you need to cover across an entire year will help you think about what you might be forgetting on a month-to-month basis.
From there, you could take your annual budget and divide by twelve to determine your monthly spending, and when that happens, flexibility of time is necessary. You could calculate that your gift-giving budget amounts to $80 a month, but when it comes time to spend that money, most of it might be spent towards the end of the year. If you start spending $80 for gits each month because it’s in your budget, you won’t have anything left over when the December holidays come around. So annual budgeting takes a little more discipline to make sure you’re spending at the right time, and it emphasizes the point that what you don’t spend in one month can be added to the next month’s budget.
The more dire the situation is, the less flexibility you may have to work with, but some flexibility and the right approach could make budgeting much more effective. Aim for a positive approach with flexibility to move between categories rather than strictness and an approach based on money scarcity, and your budget will have a better chance of succeeding. With budgeting success, your financial condition will continue to improve, and at some point in the future after long periods of good habits and increased income, a budget will be less necessary for your future overall financial success and independence.