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Take Control of Your Finances Part 5: Build a Better Budget

This article was written by in Money Management. 4 comments.


This is the next installment in a series at Consumerism Commentary about taking control of your finances. Please consider subscribing to the Consumerism Commentary RSS feed for updates.

It’s no secret that budgeting is a chore. Although this piece of personal finance carries an ugly reputation, even a simple form of budgeting will help you achieve more towards your goal of taking control of your finances. Despite the negativity surrounding budgets in the news — the economic slide is affecting corporate and government budgets and people are depressed everywhere — personal budgeting doesn’t have to be an ugly process.

Why develop a budget? The purpose of budgeting is not to force someone into spending less than a certain amount of money towards a particular category. A budget should be more like a guide. Yes, you can set aside money for a certain type of expense, but if you find you need more, you can “borrow” from another category or future time in which you expect to spend less. This borrowing, like debt, can get out of hand, so it should be limited as much as possible. Keep in mind that budgeting is flexible.

The best way to visualize a budget, particularly if you pay all your expenses with cash, is to use a system of envelopes. To simplify the visualization even further, let’s assume you receive your income on Day 1 of each month, and you must use that income throughout the month until your next paycheck on Day 1 of the following month. When you receive your income, you take the cash left after paying income taxes and place it into envelopes. On the outside of each envelope, write the name of a spending category.

You should have envelopes for rent or mortgage, insurance, food, and utilities. Also consider budgeting for transportation, household, debt repayments, entertainment, and charity. To get a good idea of where you spend your money, take a look at your expenses, which you track every month. Your most frequent spending categories should determine the labels for the envelopes. Use the data to determine the amount of income you require in each category each month. This is the amount of cash you should place in the envelope.

Do not neglect infrequent expenses. You may have certain obligations that are not paid monthly, like property taxes. If you pay $1,200 every six months for property taxes, consider your monthly budget to be one-sixth, or $200. Then left that money accumulate in the envelope for half a year until it is time to pay the bill.

Do you have an envelope for savings? You should. Consider setting this envelope apart from the others, perhaps in front so you will be reminded that it is one of the most important destinations for your cash. Everything not distributed to an expense envelope can be placed into the savings envelope. From here you can take as much as possible to the bank for deposit, invest some of it, and spend a small portion.

Now that you’ve set a budget based on your past or current spending, see if you can find a few places to cut back. Can you reduce your budget by 10%? You may find that this is not as hard as it seems, particularly if you have excess cash to spend on wants rather than needs. Start cutting back with your wants, but also look at your needs to see if they can be reduced. Once you’re familiar with using your budget, you can focus on the future rather than your past spending habits.

When you pay expenses by check, credit card, or debit card, you may find that it’s difficult to effectively use physical envelopes to manage your budget. Although placing cash into envelopes won’t work for everyone, the metaphor can be extended to software. Here are some of the popular choices:

  • Mvelopes is a website that lets you manage your personal finances online. The site focuses on your budget using a virtual envelope system similar to what I’ve described. Fee: $7.90 or more per month.
  • You Need a Budget is a tool you can download to help you organize your budget. Fee: $12 to $50 to download.
  • Intuit Quicken has a budgeting system included but many people find the feature difficult to use. Fee: $45 or more to download with this link (regularly $60 or more).
  • PearBudget is another web-based option that follows the envelope system. Fee: $3 per month.

If nothing else, use the $0.10 option: a pencil and paper. Writing down your budget will help you stick to it, whether you use paper or computer software. I started my first budget with a pencil and paper even though I was inclined towards computers. I was in a transition phase in my life, trying to get myself into financial shape for the first time. After working for a few years out of college, I left my low-paying, high-expense non-profit job and moved back in with family for about four months. I worked out a plan and a budget, found a new job, and by the time I moved out I was in control. Money was still tight, so I stuck close to my budget for a while.

As you see more financial success as a result of spending less and earning more, you may be tempted to move away from your budget. Despite other advice suggesting to always stick to a budget, it’s a good idea to focus less on the categorization and limitation of your expenses as the need decreases By the time you are sufficiently saving and investing money every month, the energy you spend working with a budget could probably be better spent on other activities. But it doesn’t hurt to check in with a budget once in a while. It has been suggested that more confident personal money managers will succeed better with an annual budget. Always keep tabs on your spending, and evaluate the trends, but don’t tie yourself down.

Budgeting, even in the early stages, should not be seen as a burden. Here are some tips to make budgeting easier.

Consider the 60% rule. I’m not a fan of rules, but sometimes a guideline can help get you started on the right path. As an individual, you can decide what’s right for you, but sometimes an example helps. The 60% rule suggests that the first 60% of your gross income (before income taxes are taken out) should be designated for your non-discretionary, essential expenses, like housing, food, clothing, and taxes. The rest of the income should be split with 10% going towards savings, 10% towards retirement, and the rest for “fun,” or your discretionary expenses.

Reward yourself for staying under budget. If your budget is realistic — not too difficult nor too easy to achieve — then you should reward yourself when you spend less than you plan. With your “fun” expenses, your spending may be variable month to month and difficult to predict. If you make a conscientious effort to spend less than you expected, perhaps by seeing fewer movies in the theater or cutting back on vacation plans, you have extra money left in your envelope (virtual or otherwise). First, move that excess money to savings. If you don’t perceive savings to be an intrinsic reward, treat yourself to something you’d like.

Use ING Direct’s subaccount feature. Since you can split money in ING Direct’s high-yield savings account into separate buckets, you can label these subaccounts to match your budgeting categories. this lets you earn a decent interest rate while keeping your money organized.

Pay yourself first. No matter what, make sure some of your excess income is diverted to your savings. If you set up direct deposit into your checking or savings account, this will require less work. Your savings envelope contains 100% of your income (minus income taxes) after you are paid, and from there you can distribute funds to your remaining envelopes.

Please share any budgeting advice or suggestions!

Photo credits: Bill in Ash Vegas, Jeff Keen

Updated September 16, 2011 and originally published November 20, 2008. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 4 comments… read them below or add one }

avatar Miranda

Great post! I have a sort of virtual envelopes system, although it’s not as advanced. I have my bill paying account, the emergency fund/long terms savings account, and the “fun” spending. Keeping it simple seems to work for us. (We also have retirement account savings automatically deducted each month.) I like automatic bill pay, and we schedule these bills in Quicken so that they also automatically come out of our personal finance software as well. Periodically, we have the software make a chart of what we’ve been spending, so that we can make sure we’re still on track.

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avatar Tom

Personally since I carry my cellphone/PDA with me all the time cash tracking is done on an Excel file on my cellphone/PDA. THen I enter them later on my Microsoft Money. MS Money handles all the credit cards/budgeting.

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avatar Andrew Chilton

Snap! I just wrote an article about the envelope system much like this one today too! Wow, we even used the same image.

I have found that the best way to budget for those infrequent expenses is to have a Freedom Fund. Generally this is somewhere (an account or an envelope) where you put a certain amount each month to cover for those months in which an infrequent expense occurs. It’s almost part of a yearly budget as opposed to a monthly budget.

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avatar Jimmy Liew

Great post. I previously fall into credit card trap. It took me 3 years to get out from the trap. I have used a lot of budgeting thing tools, not every tool works. I analyst and come out with one which works for me. It is exactly what you mention in the post. At least it works for me. :)

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