How to Set Up a Budget | The Modest Millions Show

Today, we tackle how to set up a budget, the cornerstone of any personal finance plan. The household budget is where it all starts, and without a firm foundation in place, it’s easy for our long-term savings and retirement goals to slip from our grasp. That changes today when we work to conquer the household budget keep more of our hard-earned dollars. Budget nerds, unite!


IN THIS WEEK’S EPISODE

  • Budget essentials
  • How to track expenses, especially discretionary spending
  • Differentiating between needs, savings and wants
  • The 50/20/30 Budget
  • How to pay yourself first, every month
  • Quick overview of Betterment

HOW TO SET UP A BUDGET

Money goes in and money goes out. As long as you’re not in the hole, you’re good and you’ve got budgeting on lock, right? Not so much. Budgeting is more involved than just making sure that you pay your necessities, like paying your bills on time, making sure that the mortgage or rent is paid, utilities, daycare/school, you know the costs that are there every month. It’s easy enough to plan for those items. For the purposes of this conversation, let’s call these “needs.”

What I want to talk about is the small stuff. the costs that eat away at your money, the sand that falls through the cracks. Let’s call these the “wants.” Too often, our spending priorities get a little mixed up, and we end up spending money on our “wants” and “needs,” but we forget to set aside enough money for the items that will allow us to get ahead and reach our financial goals. Let’s call these “savings,” for now. They include savings, retirement accounts, investments, big-ticket items like vacations, landscaping, paying cash for a car and more.

It reminds me of a lesson I learned early in school. You were given a jar and a couple of big rocks, a handful of pebbles and a pile of sand. You had to figure out a way to get everything in the jar. You’d inevitably start by filling the jar with the sand, and then placing the rocks and pebbles in the jar, but it wouldn’t fit (kind of like overspending your budget). The only way for everything to fit in the jar (or to stay on budget) is to put the rocks and pebbles in first, and then pour in the sand so that it fills in the cracks and crevices.

This is very much like budgeting: needs (the rocks) and savings (the pebbles) go in first, and then the wants (the sand) goes in last to fill in whatever room is left.

Alright, at risk of budgeting a dead horse, I hope that sufficiently covers the importance of budgeting.

But how do you set up a budget?

In short, a budget is simply a way to track income and expenses and keep on a track. Having (and sticking to) a budget doesn’t inherently mean that you instantly become a cheapskate. You can if you want to, but it just allows you to set your priorities. If you want your budget to allow for higher-than-average housing, private school for the kids, hiring a housecleaner or splurging on entertainment, that’s fine, as long as the rest of the math adds up and still allows you to reach your savings goals each month.

Or, if you want to use a budget to trim and tighten your budget to the point where you do become a cheapskate, all the more power to you.

There are many different budget techniques, and a quick Google search will bring up several options. It doesn’t matter which one you pick as long as it works for you, so read about the budgets and their philosophies to make sure it aligns with your philosophies. For instance, you’re going to have a hard time sticking to an extreme savings budget (where you’re saving over 50-60% of your income) if you’re not willing to give up almost all of your discretionary spending or live extremely below your means.

For us, we use a variation of the popular 50/20/30 budget. We’ll go into more detail on that budget in a minute.

Before you can create a budget, you need to know where your money is coming from and where it’s going. Look back for at least the past three months to track all your income and expenses. Look at check card and credit card transactions, bank statements, pay stubs, etc. Why at least three months? It lets you get a good average for estimation purposes. Then, place all those expenses into itemized categories like gas, utilities, life insurance, etc. Map everything out in a spreadsheet with dates so you can project any budget shortfalls.

While you’re digging through your files, this will be a good time to look at any loans you might have (auto, personal loans, mortgage, lines of credit, etc.). Jot down the remaining balances, interest rates, estimated payoffs, monthly or minimum payments, etc. You’ll use this information later (we’ll talk about this in a future episode). For now, list this information in a separate sheet in your budget workbook for easy reference.

50/20/30 budget

First, this is based on net income, which means we’re looking at your take-home pay, after taxes, pre-tax deductions and social security has been taken out.

  • The first 50% of your budget goes towards necessities, including shelter, food, utilities, transportation, clothing – the things you need to get by day to day.
  • The next 20% of your budget goes to long-term savings and extra payments on any debt you may have. For example, this bucket would include contributions to your 401(k) or IRA, along with any accelerated debt payments you’re making to eliminate your debt obligations, which I HIGHLY recommend as a core savings strategy. This also includes other investment accounts, saving for big-ticket items like vacations, home improvement, buying a car with cash, beefing up your emergency fund.
  • The final 30% bucket is for your lifestyle choices. This includes things like entertainment, gym fees, hobbies, pets, eating out, cell-phone plans and cable packages. These are things you do not need to have to get by, They’re luxuries, however small.

For us, we’re more heavily weighted on housing expenses and childcare/education; that’s where we’ve decided to splurge. We’ve also taken a more aggressive approach recently to accelerating our debt payoff. I’ve also customized it a little bit to suit our situation, but the principles stay the same. As a result, ours is more like 65/25/10.

What trips people up is that too often the Needs and the Wants (even when they’re budgeted for), inevitably eat up the bank account and there isn’t enough left over at the end of the month for the Savings category of the budget. I don’t know what happens, but it seems that even with the strictest of budgets, something always comes up, I swear money simply evaporates throughout the month.

TOOLS

I’m putting the cart before the horse here since we haven’t talked about low-fee investing strategies, but in case you’re a couple chapters ahead and ready to mobilize, l highly suggest you check out Betterment. It’s a super slick investing platform that prides itself on its low-cost fee structure and tax-loss harvesting to deliver greater returns for its investors. This is one of the good parts of The Singularity and robots taking over the world, in that Betterment’s roboadvisors can really maximize returns for you. Since they don’t have all that overhead and manpower of investment advisors manually building portfolios mutual funds to try to squeeze every ounce of return out of an investment (which is nearly impossible to do, by the way), all while charging a pretty 1-1.5% fee to do so, you might be better off and yield a greater net return by seeking slightly above average and consistent returns (which are still pretty darn good!) with a minuscule fee. Take a gander and check out Betterment

PAY YOURSELF FIRST

You’ve probably heard the phrase, “Pay yourself first,” and in the case of personal finance, it’s really the one thing you can do to make sure you’re not falling behind in your long-term goals. Treat the 20% Savings bucket as a monthly expense, except it’s going right into your bank account. Just like how the mortgage or rent comes out on the first of the month, do the same for your savings “expense.”

For me, I like to forget about the money and have it at arm’s length.

As I’ve previously mentioned, for a long time, my income was variable, which meant it would fluctuate by thousands of dollars each month. Some months were pretty bare, other months were very flush. What we needed to do was standardize my income so that was a steady amount every month. At the same time, it also allowed us to keep our savings out of sight and out of mind.

To do this, we set up a second bank account in which all of our income and paychecks would be direct deposited into. We used Ally, an online bank with a smoking interest rate on their savings accounts as our primary account. Then, we’d set up bi-weekly deposits (similar to our pay cycles) in which we’d transfer just enough money into our checking account at our local credit union to cover the budgeted Needs and Wants for the month. Whatever was left over after each paycheck would be enough to fill our Savings bucket.

And voila, the money was never in our checking account for us to be tempted to spend it on an unbudgeted line item. If there was something outside the norm that we wanted to buy, we’d need to wait 2-3 business days for extra funds to transfer over from our Ally account, which really cut down on impulse purchases.

Or, talk to your employer about splitting up your paycheck direct deposit into two accounts. Ask them to direct 80% of your check into your primary checking account, and then 20% into an out of the way savings account, one that is at a separate bank from your checking account, to slow down the speed at which these funds can be transferred. This is another easy way to keep money out of sight and out of mind.

WRAP-UP

That’ll do it for this week’s episode. For a recap of the strategies, tools and links that we talked about today, check out the show notes and visit http://modestmillions.com/002.

Also, while you’re on the site, don’t forget to subscribe to receive email updates (you can do so at http://modestmillions.com/subscribe).

And please, if you like what we’re doing here and you find the information valuable, please, please, please help us spread the word and show your support by leaving us a five-star review on your whatever podcast platform you’re listening to us on. You can do so at http://modestmillions.com/review.

And I’d love to hear from you, so make sure to reach out with your feedback for me or for the show, topic ideas, personal anecdotes of your own journey or if you just want to say hi. You can always reach me at feedback[at]modestmillions[.]com.

Until then, remember to keep squirreling away now to earn millions later!

 

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