Budgeting. It's a word that everyone knows. Who doesn't know what a budget is? But how many of us actually make a good monthly budget and stick to it? Most of us start out with good intentions, but then something unexpected comes up and blows our budget. Then we give up and go back to juggling our money and worrying about having too much month left at the end of the money. But if you want to make a budget to pay off your debts or start saving and investing, it's important to make a budget that works and is realistic.
So what's going wrong? Why is it so hard for most people to make a budget so they can live within their means? The simple truth is that most budgets don't work because they don't take irregular or changing costs into account. Everyone knows how much they pay for their rent or mortgage. Every month, it's the same amount. It's a no-brainer if your rent is $1,000 per month. The same is true for a lot of other fixed costs, like auto loan payments, insurance premiums, cable TV subscriptions, and so on. These costs are easy to plan for because the amounts don't change from month to month.
There are some costs that are the same every month, but there are also a lot of costs that change a little from month to month. We still have a pretty good idea of how much we spend each month, though. Our grocery bill is a good example. Most of us have a fairly clear picture of how much we spend each week at the supermarket. So, we can put a realistic number into our budget, which is still being worked on, and not be too far off. The amounts may go up or down a little each month, but we usually know what range we're working with. Phone bills, utility bills, and gas bills are also examples of this type (when prices are stable, that is).
The real reason budgets go over is because of irregular or variable costs. How much will it cost you to fix your car over the next year? What about bills for health care? Home maintenance costs? We seem to get bills for these kinds of costs out of the blue, which blows our budget. Before long, we'll have to use money for food to pay for a new set of tyres for our car, and our budget will fall apart.
So what should we do? This problem has no perfect solution. But we can get a close estimate by using the simple method of averaging over a few months. Start by getting your chequebook register, bank statements, and credit card statements from the last 12 months. Write down or enter into a spreadsheet how much you spent on each non-fixed expense. Put these costs into groups, such as cars, home repairs, clothes, etc. Don't try to make it too simple. You need a small number of useful categories. Then, keep writing down each of these costs under the right category for the whole year.
When you're done with this activity, you should have a good idea of how much you spend on these variable costs each year. For example, if you add up all the costs of fixing or maintaining your car for the year and get $1,200, you can divide that number by 12 to get an average of $100 per month. That's how much you need to put aside each month in your budget so you have enough money in case you need to fix your car. Again, this method isn't perfect because an expense may come up that costs more than what you thought it would, but at least it's better than guessing or, even worse, not including car maintenance in your budget.
The trick is to open a separate savings account to put these "extra" funds in. Let's say you put the "extra" $100 into savings for six months, and then you have to pay $400 to fix your car. You take the money out of your $600 savings account, which you set up specifically for this kind of expense. This way, you automatically set aside money to cover each type of unusual expense you had in the past year.
When people do this 12-month analysis of irregular expenses, they are usually shocked, and it becomes clear right away why their budget is always falling apart. This method gives you the self-control you need to realise that "extra" money is rarely really extra. If we think we can pay all of our bills and still have some cash left over, we usually spend it on something fun. But if we know we don't have any extra money because we haven't saved the extra $100 needed to keep our car running, we'll be less likely to spend it on pizza, beer, and movies.
The monthly average method is a good way to make a budget, especially if we use it the same way year after year. As time goes on, we learn more and more about what our real costs are, and we are no longer surprised by the occasional unexpected cost.
The best way to use this method is to set up a regular savings plan so that the money you set aside for unexpected costs is automatically taken out of your paycheck and sent to your savings account. If the money is taken out of your paycheck before you even see it, you will be less likely to skip this important part of budgeting, which will make it much more likely that your budget will work in the long run.
