You start here whether your income comes from wages, commission, passive income, self-employment, or something else. I recommend reading this whole post before getting started.
First, look back at 2 months of spending across all methods (deductions straight from your paycheck, cash, debit card, Venmo, Paypal, credit card, etc.). Look for everything you spend money on regularly. For now, we are setting up your monthly budget so all of these are totals by month (so not by paycheck, we’ll handle that later). For now, we ignore income numbers entirely. Here is a list of possible outflow items, don’t worry about coming up with the numbers for each yet:
- Car Insurance
- Charitable Giving
- Health Insurance
- Life Insurance
- Child Care
- Eating Out
- Car payment
- Credit card payment
Once you have a comprehensive list, I want you to prioritize them all. List them in the order they are important to you from a perspective of survival, your goals, and what brings you joy. The way I think it helps to prioritize is to think in sequence through a few different perspectives:
- One good perspective to help you start – what if starting tomorrow you had no more income coming in (e.g., you got fired from your job)? What would you spend the money on first, then second, then third, etc. I recommend starting with whatever you need to buy in order to literally stay alive. This could include groceries, basic home utilities, and rent/mortgage.
- To get the next set of priorities it may help to think about what you would spend your money on if you had already covered the things needed to stay alive so now you need to spend money on things that allow you to find a new job. This may include such things as gas, car insurance, child care, etc.
- For the next set of priorities, consider that you earned a new job and it was at least equal in pay to before. So, now you would prioritize the remaining items.
To determine the amounts for each item there are going to be some that vary (e.g., groceries, entertainment). To get all the initial numbers you should look at your spending average over the past 2 months and use the max. At this point, use real numbers based on real history if you have it. Now isn’t the time to restrict or constrain the numbers. For those, I recommend using actual cash for the first month or two. Then you acknowledge pro-actively when you are going over your projected amount. You will want to get as many items at a fixed amount as possible. For example, you may want to call your utility companies to get on an averaging plan that is a set amount each month.
I encourage you to lump together discretionary items like entertainment, eating out, coffee shop visits, etc. Set a total for the month and literally set aside that total in cash before the month starts. Personally, I don’t mind how big that number is for you. Actually, I’d prefer it be a bigger number than you originally think as long as you can pay your mandatory expenses with your current income. If you set it too low you will not follow this budget, I guarantee it. If you have money that you set aside left over you can accrue it for the future and maybe even save for a bigger ticket discretionary item. If you regularly have leftovers though you should probably decrease the number if you don’t think it’s constraining to do so. I believe the number one reason people hate budgets is because it’s constraining and doesn’t allow for any fun to be had with your money. It’s money that you earned, enjoy it!
A few miscellaneous points: I do encourage you to include giving in the budget. For now, just ignore items that are very sporadic throughout the year and keep the budget as simple as possible; unless it’s a big ticket item that you should set aside for each month (e.g., renewing your car registration if it’s 4 months away may be needed if it’s $600 but maybe not if it’s only $40). When it comes to debt payments, for our purposes now, only list the minimum mandatory payment (so if you’re paying over that on your mortgage, car loan, credit card, etc. then don’t make the number that higher payment amount, just the minimum required). For now, do not including investing or saving. We will address paying down debt, saving, and investing in later posts.