How do I build a budget?

A budget is a relatively simple tool – you track money that you earn in the form of income, you track money you spend in the form of expenses, and you try to maintain a desired level of cash flow. Income minus expenses equals that cash flow, and if you do it right, hopefully that cash flow isn’t a negative number. But if it is, you either need to borrow, have an emergency fund set up to cover those extra expenses, or have enough positive cash flow in the future to offset your negative cash flow in the present. So how do you go about actually building a budget that works for you and your family?

There are three key concepts you need to focus on to build a successful budget:

          • It must be realistic.
          • It must be adaptable.
          • It must be process-oriented.

Those three items are concepts, not actions. And they’re specifically a list of concepts because there isn’t one right way to budget. There are plenty of systems out there, and some of those systems even work really well. I’m not here to sell you on the perfect budget system, because what works for one family or individual isn’t necessarily going to work for everyone else. In this way, budgeting is like cooking – everyone has to do it at some point (unless you eat out every night, which you need to account for in your budget), but different families cook different recipes in different ways on different schedules. I’m not going to make you eat spaghetti and meatballs if you prefer fish tacos. I’m going to make sure you are cooking those fish tacos in a way that works for you and is sustainable so you can make them again in the future.

The first item on the above list is that your budget must be realistic. I’m a golfer. I’m a bad golfer. My goal in any given round is to score under 100. At this point in my life, I accomplish that goal around 20 to 30 percent of the time. But it’s still a goal of mine that I’m trying to achieve whenever I play. Given that there are 18 holes in a golf course, this means I have to average approximately five and a half strokes per hole in order to end up with a score below 100. So let’s say that I go out and my attempt at the first nine holes doesn’t go particularly well – I shoot a 56, which happens more often than I’d like to admit. I then know that I have to shoot a 44 on the back nine in order to finish at 100 or lower. Mentally, every time I finish the front nine, I recalculate what I have to score in order to do this.

“Ok, I have to do this set of nine holes in just under five shots per hole. I can do this!”

Except most of the time, I can’t. It’s not realistic. How do I go from averaging almost six and a quarter shots per hole on the front nine to under five shots per hole on the back nine? And sure enough, I rarely end up making up that much ground, because it’s just not possible with the level of skill I currently possess with golf clubs.

Your budget has to be realistic.

If you live in New York City and you budget $800 for rent or a mortgage payment, you are nowhere near realistic. You could probably find a great place in Nashville on that budget or maybe a nice place in Topeka, but Manhattan generally doesn’t have a whole lot of places that are that cheap.

This is a somewhat egregious example, but let’s look at another one. I know that in order to buy the types of food I want to eat each week, I generally have to spend around $100 per week on food for our family. That’s the nature of the beast when you live in a high cost-of-living area like I do, and when you want to eat a good amount of fresh fruit and vegetables. Regardless of how often I bulk-buy oatmeal or rice and beans, or how often I’m able to find family-size packs of chicken breasts on sale, my costs are typically around $100 per week. So I’m not going to cheat on my budget and say that I can get it done with $80 per week, because it just won’t work in the long run. And that’ll just get discouraging and make me not want to continue budgeting.

The second concept on the list is that your budget has to be adaptable.

What I mean by that is that it has to adapt to the fact that your life is never static, at least not for extended periods of time. You might have a year or two where you have relative stability, but there are enough big shifts that happen that you need to have a budget that can adapt with those changes.

What types of big shifts am I talking about? Here’s a list:

      • Moving
      • Job change
      • Getting married
      • Having kids
      • Getting divorced
      • Losing a spouse
      • Kids going to college
      • Health problems
      • Work promotion

Anything that affects either the income or expense side of the ledger in a meaningful way can go on this list – otherwise I’d be writing it all day. But big decreases or increases in income and expenses happen. They don’t happen every year, but they happen enough that you will likely run into one of these big changes every few years. And so if you’ve built a budget that only works for your current situation, you are likely setting yourself up for some challenges when that situation inevitably changes.

The last piece on the list is that your budget has to be process-oriented.

This ties in somewhat with the above item, in that budgeting is not simply putting numbers down on a spreadsheet and then forgetting about it. It’s not even putting numbers down on a spreadsheet and then checking in once a month or once a year.

For example, let’s say that I go to check on my budget after the first three months of a year, and I notice that my grocery spending has gone up to $120 per week from $100 per week. How do I know what that means? There are a whole bunch of questions to ask just on an increase like this, and those need to be built into a regular review process of some type in order to answer them. What kinds of questions do you need to answer? Here’s a starting point:

      • Why has my spending in this category changed?
      • Is this a short-term fluctuation or a long-term shift?
      • Can I change my behavior to bring it back in line with my budget?
      • Do I need to shift my budget upwards?
      • How does that shift affect my other spending and saving?
      • Are there other places I should examine for additional savings?

Those are just starting points for how you should be reviewing your budget. And you don’t necessarily need to do this every week, month, or even every three months. For me, I have 12 budget categories, and I review one of them a month, so I rotate through them on a yearly basis. It helps to keep it manageable for me, but it also ensures that I’m taking a look at them on a regular basis. That same process might not work for you. Maybe you prefer to look at everything all at once, or more frequently than I do. That’s great! Budgeting doesn’t have to be done in any one way, so long as it’s being done in a way that helps you produce better results.

What defines better results from budgeting?

Having more of what you are intending to have, and less of what you are trying to avoid or don’t care about.

If you are really into cars and want to have extra money to spend on that hobby, then you want to build a budgeting process that gets you closer to that. If you are trying to save for three kids’ college educations, then you want to build a budget process that gets you closer to that. If you are trying to save money for retirement and you really just like seeing that account balance grow, then you want to build a budget process that gets you closer to that. And if you’re trying to avoid potential problem areas, like too much credit card spending or a need for payday loans, then you want to build a budget process that gets you closer to that. There isn’t any one goal, and that’s why there isn’t any one way to budget.

Be realistic, be adaptable, and build a process for review. Beyond that, you are looking for what works for your personality and your goals.