How to Set Up Your First Successful Budget – Part I (Understanding and Research)

Since the beginning of time, mankind has understood that the spending power money holds must be controlled and channeled to appropriate uses if we are to (at the very least) survive, and (hopefully) achieve our lifetime financial goals. To do this, all of us need to create a budget.

Because of money’s finite qualities, each of us must make a choice, whether by chance of by plan, about where we spend our money every month.

It Takes Three to Tango?

This post is the first in a three-part series that will cover setting up and maintaining a successful budget. Follow along each week on your own for maximum success, and share your story in the comments! Although budgeting is a fairly simple process, it requires a certain degree of commitment and many steps to get to the desired outcome. It’s also beneficial to spend at least one week on each of the parts I’ll cover, so that you’re able to see results and make the necessary adjustments. The three parts of this series are:

• Part I – Understanding and Research (this post)
• Part II – Organizing and Setup
• Part III – Tracking and Review

Benefits of a Budget

Besides being able to brag to your friends about having set up a budget, you will do several things by going through this exercise:

• Force Decision-Making. It’s impossible to set up any type of balanced budget without deciding which portions of your spending are a priority to you.
• See Your Real Spending. The research process required to set up a budget allows insights into all of your spending habits.
• Align Your Goals. Through the tracking & reviewing process, a budget gives you the opportunity to align your financial goals with your spending. Taking that opportunity allows you to reap the biggest benefit of having a budget in the first place.

Types of Budgets

There are two basic types of budgets – the limit budget (your most typical, and frequently written about), and the envelope budget. Here is a brief outline of each:

• The Limit Method – The limit method is the standard budget you will hear and read about. It’s based on establishing spending limits in each of the categories you wish to track, and ensuring that those limits are respected throughout the month.
• The Envelope Method – The envelope method is a classic budgeting system that’s making a recent comeback. It’s based on dividing your income into pools or “envelopes” for the categories you wish to track, and spending from those envelopes during the month. The limit for spending exists when you “get to $0.”

If you’re interested in learning more about the envelope method, read my review of Mvelopes – a great budgeting software I use.

These two types of budgets are in essence opposite approaches to the same problem – spending more than we planned for in specific categories. However, the psychology is uniquely different, which is why I made the decision to personally use the envelope system for myself. If you’re starting a new budget for the first time, I encourage you to take at least a few months with each system and see what works better for you long-term.

In addition to the basic setup, you also have a choice about the level of detail you wish to have for your budget:

• Broad Budget – Many “vision-oriented” people who like to see things from the top down and review overall progress and alignment with goals will usually like a light and simple budget, low on categories and fluff.
• Detailed Budget – Detail-oriented folks, who like to dive into the “nitty-gritty” of things will enjoy a category-rich budget with lots of tracking tools and the ability to monitor specific progress and transaction details regularly.

Testing and selecting a level of detail for your budget is important and not always straight-forward. It may actually be the opposite of your normal personality type. It also varies with the type of budget you select. For example, I prefer a broad limit budget, but like the control of a detailed envelope budget. I would suggest taking a few months to determine these characteristics as well as see what works best for you.

Gathering Information

Before sitting down to develop any type of budget, it’s important to gather the necessary information that will inform your decisions and provide you with a rough starting point from which to begin. Take at least one week to collect the following before moving on to Part II:

• Typical monhthly income, usually as shown on your recent paystubs. Also think back over the last 12 months for other regular and dependable sources of income, such as investments, side business or hobby income, or cash from your Uncle that he sends each year. You’ll decide what to do with this income in Part II.
• Gather all of your regular bills and monthly subscription costs, including home payment (rent or mortgage), utilities, loan payments, magazine subscriptions, and anything else that’s a predictable monthly expense.
• Think back (or ideally, review your bank statements) for the last 12 months and note any regular expenses which occur every quarter or once a year.
• Finally, prepare a rough estimate of your varying monthly expenses. These include things like gasoline, groceries, and fun money. Ideally, your bank statement should be able to provide a general idea, and you can also take the average of the last several months. Don’t worry if you can’t estimate these costs precisely – we’ll deal with that in Part III.

Gathering this information is key to the next step, where you will set up your first budget.

Next Week – Part II (Setup and Planning)

Next Monday, you’ll learn how to organize all of the information you gathered and set up your new budget for maximum success. The following week, you’ll learn about tracking & revising your budget for temporary and permanent changes. Don’t miss it!