How to make a budget and stick to it

I still remember my first budget as if it were yesterday. It was two years after I graduated and got married. My husband and I were both earning a respectable salary, so we naturally assumed that we must be saving a good amount. When we sat down one fine Saturday morning to look into buying our first home, we got our first shock. We were actually saving nothing. After the initial shock wore off, I told my husband – “We will make a budget and stick to it, we should be fine“. And we did – the “budgeting” part, I even commented arrogantly – “ This is easy, I don’t know why people say budgeting is hard”. Ha! After a month came the next blow, we failed with the “sticking” part. I had drawn up a perfect budget. I failed. I modified it month after month. I kept failing month after month. I just didn’t understand what we were doing wrong. It took us more than 2 years to figure it out and another year to make a budget that we could stick to. So what is the secret recipe to a good budget? I don’t know the universal answer to that, but our process might give you some clues to help with your budget.

The first budget – Cracks in the foundation

Our first budget was really simple. I wrote down our gross income, found a budget spreadsheet online, filled all the fixed expenses and came with with an amount for all the variable expenses that I thought were reasonable.

Mistakes:

• I didn’t know where my money was going. Without knowing how much we were spending in groceries already, it is meaningless to say that from now on I will spend $200.
• I didn’t know where I wanted my money to go. I checked online and copied other people’s budget. I had no clue about their priorities, so it was all wrong.
• I was thinking short term. I never had any budget for once-a-year expenses like insurance premium or car maintenance. So even if we saved a little one month, it was wiped out when the big expense came.

Getting Organized

After many repeated failures, we collected 6 months worth of everything expense related – bills, credit card statements, check stubs and painfully categorized each one of the line items. First pass was generally broad with a few categories like housing, food, gas, health, shopping, entertainment and hobbies. We identified a few areas that we wanted to concentrate on, mostly discretionary areas like shopping, entertainment and hobbies. We also sub categorized food, because it was a little too high for what we “thought” we were spending. So food became grocery, restaurant, coffee shops, fast food and travel. For categories that we didn’t have problems with, like housing which basically included rent, insurance, utilities and occasional home improvement tools, we left it as a broad category. Make your organization as simple as you can and drill down to one/two problem areas. If you become good at this, you can come back and try to handle all the other categories one by one.

By the end of our organizing every single item had a category attached to it.

Know where your money goes

If there is one idea that absolutely changed my whole perspective on how I spend/save money, its this – know where your money goes. It is the simple mirror I needed to show me what my spending habits really were, not what I “thought” they were and based my budget on. The results were a revelation. It showed me that my once a week starbucks trip was actually happening 3 times a week… And my produce money was actually sitting in my closet as a shoe I bought when I visited a mall because I was “bored”. Finally after rearranging our expenses and just having the category-6month-3months-average/month sum of expenses in each category, we ended up here -

You can track this based on your past expenses like we did or if you are starting out fresh, just stash your receipts in a safe place and enter them by the end of the week. If your spending is all on credit cards, they would have 6 months worth of data or if you are using a personal finance software like Mint.com that would be very helpful in providing valuable insight as well.

Know where you want your money to go – Set goals

This was our second major mistake. We didn’t have any motivation to save. What do you think wins in this case? Boring bank statements or that double chocolate chip frapuccino? We set ourselves some SMART goals – long term, medium and short term. We didn’t want to save for the sake of saving. But when we put our dreams on paper, it got much better and gave us a sense of purpose and urgency to get everything in order. A SMART goal should be Specific, Measurable, Attainable, Relevant and Time-bound. For each goal, add as much detail as possible. How much will it cost? How much do you already have? What is the target date? Be as specific as possible and break down long term goals into smaller steps. Here is how our finished SMART goals looked like -

Tip: Learn more about how to create SMART financial goals, check this post – how I created my SMART financial goals.

Make priorities

Now that we knew where our money went and had a clear idea of where we wanted it to go, we had to go some heart-to-heart conversations between the two of us. What is important to us? I am not going to just listen to everyone and start cutting my “latte”. I would like to cut my expenses on things that don’t matter to me, that I don’t value much and channel that into things that really gives us pleasure or to our goals. So for every category, we ended up evaluating how important it was to us. Something like this -

Pick the low hanging fruits

After I had my priorities I brought down expenses that didn’t require a hard effort. I compared our plans to other plans and called the phone company. We were with T-Mobile for quite a few years, so I was able to get a plan that was better than what we had, but for a lower monthly cost as well. Cancelled the cable and signed up for a new internet service that charged a lower rate. Called up our insurance and raised my husband’s car deductible as it was an older car. I made sure I collected information about every possible discount we could get and used it. Basically – pick all the low hanging fruits. Without cutting any noticeable expenses, we now had a couple of hundred extra $ to play with every month. We didn’t have any credit card debt, if you did the credit card company would be #1 on my list of people to call. Negotiate your interest rate hard and bring it down.

Make some tough decisions

Now that we had cut as much as we could without making any effort, it was time for some sacrifices. Again, here we tried to substitute costlier options with cheaper alternatives that gave us the same pleasure – instead of buying books, we rented from the library; instead of going to the movies, we waited for the DVD; instead of going to restaurants 3 times a week, we made a romantic date to cook at home.

Attack one category at a time

This was one of the mistakes that took quite a while for us to figure out We were excited to have a plan and tried to do it all at once. Eat out less, not go to movies, don’t redecorate the house… Fail! Then we decided to just pay attention to what we spent on food. We have a mental envelope filled with our allowance for food. Just food. We had $500 for food. And $300 of that goes to just groceries. If we spent $100 on grocery for the first week, we have only $200 for the rest of the 3 weeks, so we knew we have to slow down. If we went to some exremely costly restaurant and blew $200 in one visit… No more restaurants that month. Surprisingly just paying attention to what we were spending on was enough to curb our small small expenses like coffee shops and late night ice cream runs.

Review

We had a financial date night at the end of every month. I know it sounds sooo unromantic. It was horrible the first few months. We ended up fighting a lot. I thought whatever I spent was reasonable and he should be saving. Yeah right! He thought so too… But after a few months, as our goals were the same, we understood each other. That was a good thing for our marriage too, not just our finances.

Automate, automate & automate!

This is the best thing we ever did for our finances. We automated everything. It might not be for everyone. But it worked for us. We came up with a Targeted spending plan where we paid our goals first. Before our pay check hit our bank checking account, we direct deposited the allotted money to each account. I have 8 direct deposits going out from each pay check. Out of that 7 are my goals (home down payment, vacation, education, our next car, irregular expenses, emergency funds, home decoration and parents retirement) and the final direct deposit is for our expenses. So each dollar has a purpose and a name attached to it. That would be our Targeted zero based budgeting system we finally settled on.

Simplify

After doing this a couple of months, we got a hang of it and it became natural to not go out every time we “felt” like it, less and less stuff just “came up”. We had anticipated irregular expenses and set aside some money every month for it. So we simplified out budget. All the fixed necessary expenses went into one pot and discretionary expenses in another pot. We only have a few problem areas we monitor actively using mint.com budget feature.

Keep rewards in sight

I like to do small “X-months-to-Hawaii” type calculations. If we slipped a little one month with our spending, based on our targeted zero based budgeting system, we have to take it out of savings, which means I have to decide from which goal I will take the money from. That would immediately tell me our lazy-late-night-pizza postponed my Hawaii vacation by one week. Sometimes it might be worth it, sometimes it won’t. The knowledge of how I am spending the money and what is at stake when I don’t follow my spending plan is very powerful. It helps us make informed decisions.

That would be our budgeting story. Finally after 3 years of struggling with this, finally budgeting nirvana!  For some people it comes naturally, we were not one of them. What about you? Did you have to struggle to make your first budget? Do you have one at all?

Tagged as: basics, budgeting, financial goals