How to Build a Bulletproof Budget
Updated: Jul 21
The word "budget" often gives people the same shuttering feeling as "diet". It's seen as something you do to restrict your spending, similar to restricting what you eat while on a diet.
In actual fact, a budget should be seen as a tool to use that will ultimately give you more money to spend on things you truly value.
We've all been there before, and I feel you. We think we know what we spend each month and create a fictitious spending plan based on those numbers we have in our head. Truth is, we're usually way off, and not in the right direction.
With food consumption, we tend to underestimate the calories in any given meal, on average. The same thing goes for our finances. "I don't spend $300 a month on eating out!". Are you sure, Karen? Your bank account says otherwise.
In this article we'll break down the basics of building a budget and simple steps you can take to build a budget that fits your personal situation and circumstances. Let's dive in.
1. Get to know your net income
Steady income (generally your 9-5 workers)
Net income is the money you actually see hit your bank account each pay, after taxes and deductions are taken out. This is what nearly everyone refers to as "how much I got paid". We'll cover gross income at another time, but for now net income is what you should get familiar with.
Check your pay slip from your employer or even your bank statement to find what is regularly deposited into your account. Write this number down.
Inconsistent income (not a regular employee)
If you are a freelancer, sole trader, business owner, or anyone else that doesn't always have a steady stream of consistent income, that's ok. We can still build a budget to fit your situation, it just uses a few more assumptions and calculated forecasts.
Forecasting out an entire year of net earnings may be difficult or damn near impossible, depending on your occupation or industry so here are two options that can work:
Look back at your previous 3 months earnings. Were they consistent? Do you think it's reasonable to expect something similar for the next 3 months? If so, pick the lowest earning month and set that as your budget for the next 3 months. Review and adjust as needed each month.
Estimate earnings based on upcoming work. Maybe the previous 3 months won't be a good indication of what your future earnings will be, for whatever reason. If you're in this boat, forecast what you'd likely earn from any upcoming work. If you don't know, you're going to have to take your best guess. Aim for a few weeks at minimum, or ideally a month or two in advance. Break it into weekly chunks and review and adjust as needed every week.
2. Review your expenses
To understand where all your money goes, you have to keep an eye on it.
What get's measured, gets managed.
Remember that quote. It's absolutely true. If you don't track what comes out of your account, you don't have much hope of making change. A fact you might find surprising is that the majority of self-made millionaires create and use a budget every month. Yes, even the folks with a lot of money still use a budget to track their expenses!
Understanding your income is one piece of the puzzle, but knowing what you spend each month is arguably the most important part of building a successful budget that you'll stick to long term. If you're consistently spending more than you earn (i.e. living on credit cards), you're going to have to make some drastic changes to your spending habits once you know where your money is going.
Here are two ways to get an idea of what you regularly spend:
OPTION 1: Grab a copy of your last 3 months of bank statements (all of them). This even includes your credit card statements, not just your debit accounts. We want to know ALL of the expenses. This might be scary, but it's a must do.
Look for the value on the line that says "total withdrawals" on your debit accounts or "purchases & debits" on your credit cards. This is how much you've spent each month.
<< Debit account | Credit account >>
OPTION 2: Download an app (such as Mint, Pocketbook, Quicken, etc.) that syncs with your bank account. This is by far the quickest and easiest way to track your expenses. Install the app, connect to all of your spending accounts, including your credit cards, and it will spit out your total expenses for the last few months.
3. Categorize your spend
Now you know what comes into your accounts (net income) and what goes out in total each month (expenses), it's time to group your expenses "categories" so to better understand which areas of your life are consuming the most cash.
As with anything these days, you have a few options to get an understanding of what you've spent your money on. Regardless of what method you use to track, your expenses will have to be assigned into categories. Some folks like to use the broad categories of "needs, wants, savings", but that's too broad in my opinion. Every dollar has a purpose!
Create your categories If you have no idea what the categories should be, don't fret, I've created the table below to help get you started. The bold text is the category, with the indented text being the sub-category of each.
This table will help you if you choose to create a budget and track your expenses manually through excel or even on paper.
However, budgeting apps that sync to your accounts come with their own categories that are usually pretty good (very similar to what I've listed) and can save you the work of doing it your self.
Grab those statements (or your app) & give every expense a sub-category for the last 3 months
This step is going to be a bit tedious, especially if you're doing it the manual way and not using an app. I'm not gonna lie. It's boring, but it has to be done.
Using your statements or your app, give every expense a sub-category and tally up how much you spend each month for each. The reason we use 3 months is to get an average and minimize the chance of one month being an outlier. This will become your starting point for setting a realistic budget.
4. Examine your spend
By now you should have a good understanding of your spending habits and where the bulk of your money seems to go each month. Shocked by what you see? That's normal. Once we track, categorize and evaluate our spending patterns, it's eye-opening where we spend some of our cash.
You might have noticed your spend on "restaurants" is $300 a month, or "shopping" could be $250 a month. Whatever your numbers are, this is your starting point. If you regularly spend $300 on eating out each month, setting a budget for $50 a month is likely to fail, unless you're prepared to make some drastic changes.
This is a crucial step in understanding how you like to spend money. It will give you insight and allow you to set better, more realistic targets for each area of spend.
5. Set realistic targets
For each category/sub-category, recognize your regular spend and start by setting realistic targets. What's a realistic target? It depends on what behaviors you're willing to change.
See below for a few target setting examples:
You don't have to physically write down your action plans. Having it in your head is fine. Just make sure you've got some idea of how you are going to reach your newly set target.
Sometimes you'll see areas of spend that you can cut out completely, and that's great! More money to save, invest or pay off debt with.
Now that you've set targets for all your areas of spend, check to see that if your expenses will be lower than your net income. If they're not, revisit your targets and make some hard decisions on where to cut back. It's your only option. You will need to make some sacrifices to get ahead in this situation.
6. Implement, track & adjust as needed
Let me tell you now. You're not going to get it right the first time around. Some adjustments will be needed as you figure out all of your spending patterns. You can track using an app or pen and paper, it's up to you. Whatever you're more likely to stick to is the best solution for you.
Using an app
If you're using an app that auto-syncs with your accounts, be sure to check it at least every few days to make sure it's categorizing your spend correctly. You may have to make category adjustments to some expenses as the algorithm isn't always perfect.
Don't leave it too long between checking your app either. In doing this you run the risk of not knowing how much you've spent against your targets. That's why every few days is best as this will give you a chance to make adjustments so you don't overspend.
Not using an app
Using an app isn't the only option though. You can track with excel or even with a notepad. The same principles apply as using an app. Type/write each expense and give it a category and sub-category. Review every few days or once a week to ensure you're on track to meet your targets.
This isn't a set-and-forget process. You will have to tweak your budget from month to month in order for it to be relevant. What you plan to spend in January might be vastly different to what you plan to spend in June.
Set time aside at the end of each month to formally review your budget and how you've went, and set up the budget for the following month. Include your spouse or partner in on this process. It's crucial to success that you're both aligned.
What do I do with the money that will be left over?
Savings & debt reduction
Another important point is to factor additional debt repayments and savings into your budget targets. Try implementing "paying yourself first" where as soon as you get paid you shuttle your target savings & extra debt payment amounts away and only spend what's left. It's a game changer. Trust me.
It's always a good idea to build up an emergency fund, which can save your bacon in case something unexpected happens. In addition to your EF, it's a good idea to start saving for larger planned expenses such as appliance replacements, vacation fund, house deposit, etc., so you're prepared and avoid slipping back into debt.
If you've got high interest debt such as a credit card, personal loan, or car payments, you will want to make a debt reduction plan part of your budget. Paying off debt is the quickest way to give you more of your money back. Factor in extra repayments into your budget so you can knock your debt down faster.
Two popular methods or debt reduction are:
Snowball method - List your debts smallest to largest and throw all spare cash at the smallest until it's paid, then move to the next and the next until you've only got your mortgage left.
Avalanche method - List your debts from highest interest rate to lowest. Pay off the highest interest debt first and move onto the next until you're only left with your mortgage.
I know that's a whole whack of information slammed at you, but it's all the essentials, I promise! Let's have a quick recap of how to build your budget:
Know your net income. Figure it out or forecast what you expect to earn.
Keep a log of your expenses. Go back through your bank statements and see how much you spend.
Categorize your spend. Give all of your expenses a home and a room within the home (category and sub-category).
Examine your spend. Find out how much you spend where and on what.
Set realistic targets. Create spend goals for each sub-category of spend and have an action plan in mind for how you'll achieve your targets.
Implement, track & adjust. Start using your budget, keep an eye on what you're spending, course correct throughout the month to stay on track.
Don't beat yourself up if you've underestimated in one category and set an unrealistic target. Just reset the next month with something more reasonable and keep at it. This is an iterative process.
While meeting your category targets is good to do, the most important part is trying not to overspend on your OVERALL budget. If you overspend in one area, try to underspend in another. There may be some areas where you'll need to make concessions so as not to overspend on your total for the month. That's perfectly fine. We're all human and things pop up. Just adjust, do your best and stay consistent. You've got this!
If you want some help in building a budget of your own, give me a shout and I'll do my best to help you out and share some tips and tools I find to be useful.
Blake - FIRE with a family