Budgeting is a foundational requirement for financial success

What gets measured gets done — Peter Drucker

I often get asked “what is the first step someone can take to get on the road to financial success?”. Budgeting is the easy answer to that question. In order to be able to manage your money, it’s critical to know what you currently have and, importantly, how it changes over time. Budgeting is the way you get a handle on that second part — how your finances change over time. Even more importantly, it enables you to proactively and intelligently manage those changes in a way that realistically balances your finances with the lifestyle you want (or can afford).

When most people hear the word “budgeting”, their minds instantly go to one of two unpleasant things:

• Drudgery: It’s going to take many, many hours to pull together a budget. I’ll have to keep track of every dollar I earn and spend and then sit in front of a computer entering all that information into detailed spreadsheets. It will be so painful
• Punishment: Budgeting means that I have to restrict myself from any fun spending. It’s just a means of identifying and cutting out any discretionary expenditure which will make my life boring and empty

Rather than making the fears listed above come true, I suggest a more iterative and less severe form of budgeting which is easier to start and to stick with over time.

Step 1: Get started with an approximate budget

When you work on your budget, make it easy on yourself. Limit yourself to 45–60 minutes to pull together approximate amounts for the following five categories. I would recommend you stick with monthly timeframes as that aligns with many of life’s key expenses. For expenses which you need to pay on longer timeframes, such as auto insurance, prorate the expense per month (i.e., divide an annual expense by 12 to get the monthly expense):

• Income: This should be fairly easy for you to quantify the amount of money you have coming in each month
• Fixed Expenses: These are expenses you have to pay with relatively fixed amounts that you do not control in the short term. For example, rent, utilities, student loan payments
• Semi-discretionary Expenses: These are expenses you need to have for day-to-day life, but have some discretion on how much you spend. For example, food. You need to spend money on food, but can choose a different balance of how much you cook vs. eat out
• Savings and investments: Most people don’t think of this as an “expense”, but I fully recommend you include this category within your ongoing budgeting. Ideally, by saving some money each month through an automated system as I mentioned in a previous post (Why and How to Save), automated saving takes the onus away from you to actively “save”
• Fully-discretionary Expenses: As the name suggests, this is money that you don’t have to spend for day-to-day life but you enjoy. For example, that daily Starbucks or boba that you’ve gotten used to

In the first round, don’t worry too much if your numbers aren’t exact. You are trying right now to get an approximate sense of the money you have coming into your household and broad categories of where it’s going out. Now, hopefully, the income and four expense categories balance out. If they don’t, you need to accelerate the next steps in my process.

Step 2: Determine some small changes you can make in your budget without significantly impacting your quality of life

Once you’ve pulled together your approximate budget, determine if you’re happy with the balance of the first (income), fourth (savings) and second, third and fifth (expenses) line items. If you’re happy, then great. Jump to step three in my process. If you’re not happy, and most people will be in this situation, read on in step 2.

Now, you want to find ways to improve the balance between your income, savings and expenses. Take a few minutes to think through a couple of small changes you can make for that rebalance. This is the part where people start associating budgeting with punishment, but if you want to improve your finances, you do need to make an effort. In any case, everyone has some little expenses that they don’t need to make. For example, that second Starbucks you had last Tuesday wasn’t really necessary. Identify a couple of these low-impact expenditures you can drop without a major impact on your life and then ensure that you don’t make them over the next month.

It is critical that you keep this to a few and manageable items. If you try to change too many things at one time, you will feel like budgeting is a punishment and give up on it.

Step 3: Track progress and iterate

Before the month is complete, track your progress vs. the plans you made in the previous month. A simple way of doing this is to calculate the change in your assets (i.e., how much did your bank account and your cash holdings change). If the number was a positive change relative to what your budget had expected, then great. You’ve been successful in meeting your goals. If it was a negative change, then you need to identify additional expense cuts for the next month to bring yourself back on track.

Now, get started on your next month’s budget. The big trick here is to iterate by adding any positive changes from the previous month to your savings / investing line item. So, you now have a different baseline than you did before. If you’re happy with the new balance between income, savings/investment and expenditure, great. Make sure you keep to this budget going forward. If you’re still not happy, identify any additional changes you can make to further improve that balance without significantly impacting your quality-of-life. As part of these iterations, look at your fixed costs and see if they can be updated. For example, if your rent is really high and throwing off your budget, can you move to a lower-rent location? This way, over time, you’re not only impacting your discretionary expenses, but fixed and semi-discretionary ones as well. You can also increase your income by finding a new job or another way to earn some extra money.

Over time, as you continue iterating on your budget, you will reach a point where you are happy with the balance across income, savings/investing and expenditure. The goal from that point will be to maintain discipline and stay at that level. Of course, you will need to keep tabs of your budget and iterate as changes in your life (marriage, kids, etc.) will impact your ongoing expenses.

This completes today’s post on budgeting. The practical steps you can start taking from today’s post are:

• Start by building an approximate budget: This is a critical first step in managing your finances. Make it easy for yourself as you start this discipline
• Make small changes to your expenditures to bring yourself closer to your budget: Don’t change your life in one step as those changes won’t last. Make several easy changes per time period (i.e., monthly) to bring your cash outgoings more in line with your budget
• Track progress and iterate: See how close you’re getting to your actual budget. Update the next month’s budget by adding cash you’re freed up from expenses to the savings/investment line. Find other changes you can make in each successive time period

Thank you again for joining me on my journey to build financial literacy for young adults and their families. If you have found this post interesting and have friends and family who would benefit from it, please share it with them. If you are interested in reading more of my posts, please consider becoming a subscriber by clicking the button on the right. You can always access all the posts I have published on my author page at https://vocal.media/authors/sudhir-sahay. Additionally, if you have any questions on today’s topic or if there are any topics you’re interested in my broaching in future posts, please let me know. I can be reached at [email protected].