Table of Contents
Get the audiobook
Join the Smart Penny Institute Insider's Club to get audiobook version of this guide for free. It's an exclusive gift for Insiders.
About this guide
To begin, I want you to know that budgets don’t work.
Budgets are boring and scary and tend to inspire guilt and shame. But this guide is about more than budgets alone. It’s about you and your relationship with money. Throughout this guide, I’ll attempt to remind you that, when used effectively, a budget is simply a tool for turning your financial life into solid gold.
While we’ll discuss practical budgeting methods and steps for creating an effective budget, the real purpose of this guide is to give you a mental framework for making lasting changes to your finances. By the end, you’ll be able to develop money habits based on your goals and passions, and you’ll be on track toward understanding all the complexities of your financial life.
While budgets alone are boring, it’s not boring at all to save enough money to travel the world, become completely debt free, or finally achieve financial independence. A better financial life is in your grasp, and it begins by gaining control of your money habits.
In this guide, we’ll cover:
- The mental barriers that make budgeting difficult and how to overcome them
- The characteristics of an effective budget
- Common budgeting myths and the truths behind them
- A look at popular budgeting techniques
- A basic roadmap for building a budgeting habit
- Additional budgeting resources
To help frame these topics, this guide is divided into three parts: Mindset, Strategies, and Roadmap.
The Mindset section is where we’ll spend most of our time, and you’re encouraged to read this section in its entirety. Budgeting is a lifestyle change, and like any change in lifestyle, it requires the appropriate mindset to ensure that the changes stick. We’ll dive deep into the emotional baggage that gets in the way of taking control of your finances, break down some of the false assumptions about budgeting, and start to understand what makes a budget truly effective. With a healthy mindset around your finances, creating a budget will no longer be intimidating; instead, you’ll see it simply for what it is: one of many tools for making positive changes to your financial life.
In the Strategies section, we’ll explore different methods of budgeting, from tracking every penny, to dividing up your finances into easily-manageable buckets, to relying on technology to do the work for us. Each method is effective for different reasons, and as we’ll soon discover, what matters most when using a budget is finding your preferred budgeting style.
In the Roadmap section, we’ll put all the pieces together and lay the groundwork for a budgeting habit that sticks. I’ll provide you with resources and tools to help, as well as ways of making budgeting something that becomes second nature rather than a constant source of frustration.
Have a question about the material in this guide? Have any feedback that could improve this guide? We’d love to hear from you. Email us at [email protected].
Part I: Mindset
When I was 15, I learned a tough lesson on how quickly money could slip through my fingers. As a reward for a streak of good grades, my parents gave me a $500 allowance. They deposited the money into a checking account in my name and handed over a debit card to go along with it. I’d never experienced having this amount of money all at once, especially without any restrictions.
Over the next few weeks, I spent money like any boy my age: on candy, video games, trips to the movies, and dinners out with friends. I remember feeling wealthy with my $500; I assumed it would last me for at least a few months.
Two weeks after receiving my allowance, I stopped by an ATM to check my balance. I was alarmed to find that I only had $7 remaining in my account. It had so easily slipped away from me, and I could barely remember where it all went.
Showing my balance to my parents infuriated them. To teach me a lesson, my mom insisted I learn to balance a checkbook. It didn’t take long for me to realize that I absolutely hated doing this. I dreaded the thought of physically writing down every single transaction and doing math. In my mind, it ruined the fun of having money, and I accepted that I would always be terrible with money if balancing a checkbook is what it took to have control over it.
For the next few years, I stuck with the routine of spending money blindly and hoping there were still funds in my account when I’d go to check my balance. I over-drafted my little checking account numerous times, much to the dismay of my parents.
It was early in my college years that my view of tracking my spending changed. In one of my classes called Business Skills for Life, our teacher described how monthly income and expenses would work out in the real world. For many of us, including myself, we had no concept of the income from a full-time job along with full scale adult expenses (I lived in a dorm room and my phone bill was paid by my parents).
The teacher wrote a figure on the board: $2,000 per month. “That’s a lot of money for one month, isn’t it?” he said. We agreed; I started to imagine everything I could do with that money each month (think of all the video games I could buy). But as I was dividing $2,000 by the average video game price, he began to tack on an assortment of average monthly expenses.
On the board below the $2,000 figure, he wrote out the following example numbers:
- Rent: $800
- Food: $300
- Phone bill: $80
- Utilities: $100
- Entertainment: $100
- Insurance: $100
- Car payment: $300
- Charitable giving: $200
- Remaining: $20
He then asked the class, “what will you do with your $20 each month?” For me, the lesson was clear: if there was any hope for me having a financially stable life, I needed to understand where my money would be going each month.
That afternoon when I got back to my dorm, I created my first budget in an Excel spreadsheet. At the top of the page, I entered my part-time monthly income, $480. Taking the lesson from class that day, I added expense categories. (I made sure to add the ones that were most important to me at the time: food, fuel, and video games.) This was my first budget, so I didn’t really know what I was doing. At that time, I didn’t even know why I was doing it other than acting out of fear—I knew that parents couldn’t bail me out of bank overdrafts forever.
Three years later, I came to understand my big “why” for budgeting. I married a great woman, and saddled her with $17,000 in my student loan debt. For us, budgeting wasn’t just a healthy exercise; it was a necessity. I took the lessons learned over those first few years of managing a budget and experimented with ways to make that budget more effective. It was this combination of an effective budget and a passionate goal of debt freedom that eventually led us to making our final debt payment one year after getting married.
These days, I budget religiously. I enjoy the control it gives me over my finances, I’ve become an avid investor, and most importantly, my wife and I found peace in our financial life.
As I learned earlier in life, money slips through our fingers quickly by default if we’re not watching it. No matter how much or how little money we have, we can take better control over it if we learn to manage it effectively.
Why Budgeting is So Difficult
If you’ve ever tried creating a budget, you know it can be a miserable process. It might require sorting through multiple bank accounts, credit card statements, and sometimes, emotional baggage. In my experience, my first few months of budgeting were unproductive and frustrating, but my breakthroughs came when I realized what was causing my grief.
You think budgeting is only about NOT spending
When most people think of budgeting, they imagine a restrictive process that takes all the fun out of making and spending money, like the effect that counting calories has on the food we eat—while it gives us insight and is a healthy practice, it’s also a major time commitment that turns most people off to eating healthier.
There’s a common myth about budgeting—that it’s about cutting back on what you love buying—and it’s simply not true.
First and foremost, budgeting isn’t about discovering what you can’t do with money—quite the opposite, in fact. When you budget, you get a clear view at what your money can do rather than making guesses. Because you get a clear view of your finances, you can make educated choices on what you want to spend your money on.
If most of your discretionary income goes to funding your love of books, keep buying books! Combine that love with a stable budget, and you can allocate more money towards books rather than let it slip away into wasteful spending.
Budgeting is intended for focusing on what’s important to you financially. It allows you to restrict the areas that bring you lesser joy so you can allocate to joyful spending.
Your budget doesn’t suit your personality
For the past five years, I’ve worked as a full-time web developer. I’ve built websites, written complex programming code, and attempted to solve difficult problems. I love digging into analytics, scanning graphs, and immersing myself in data. And because of this, I found success in budgeting by using a tool that allows me to track every penny of our expenses, move numbers around, and see graphs and charts that represent our financial health over time.
My wife, on the other hand, is highly creative, but doesn’t enjoy scanning charts of data or tinkering with numbers. She prefers big picture thinking; give her a target spending amount, and she’ll build smart money decisions around it. She does a fantastic job at planning our vacations and the spending to go along with them. Because of this, my wife works best when we discuss the high-level goals of our budget—what percentage of our money should go to savings, charity, investments, etc.; how many trips we’re able to take over the course of the year; or if we’re hitting our long-term target goals such as saving for a house.
It’s possible that you fit into one of those two categories; maybe not. The truth is everyone has a personality type when it comes to finances, and it’s likely that you’ve struggled with budgeting in the past because you haven’t learned to embrace your financial personality type. If you hate focusing on the gritty details of your money, don’t let anyone convince you that you should be tracking every penny; it’ll just lead to burnout and frustration. If, on the other hand, you love having full control over your financial life, don’t let anyone convince you to use an app that handles all your money for you.
Take dieting for example: there’s an approach that’s ideal for everyone: paleo, vegan, no-carb, slow-carb, vegetarian, or any of the many structured eating plans—they all lead to a generally healthy lifestyle. Comparing this to budgeting, no matter which of the five budgeting methods you gravitate towards (discussed later in this guide), they all lead to an improved financial life. The goal is to discover which method fits with your personality.
Budgeting reveals your priorities (for better or for worse)
As the successful entrepreneur Ramit Sethi once said, show me a person’s purchase history, and I’ll show you their priorities. How we spend our money defines what’s important to us.
The problem is that when we’re not tracking our spending habits, we can lose track of where our money is going each month. Perhaps we made a large purchase on a whim, only to regret that purchase days later. When we don’t recognize where our money is regularly going, we can lose the ability to live a financial life that closely aligns with our values and priorities.
This is because money can bring out the worst in people’s emotions. Some donate money because they feel guilty. Some live extravagant lives they can’t afford because they crave acceptance and praise from others. Some continuously drown in debt because they can’t separate their spending from their pain, depression, or feelings of inadequacy. This behavior isn’t conducive to people living their best lives according to their highest values.
But when we separate our money from our emotions, adopt a healthy habit of tracking our finances, and begin a practice of mindful spending, it gives us the ability to live a financial life according to our true priorities. We can buy the new house because it aligns with our investment or family goals; we can rid ourselves of debt because it’s not useful to fill our life with meaningless stuff; or we can give all our money away because we can, and we want to.
Budgeting not only reveals our priorities, it better enables us to live by them.
What You Gain from Budgeting
As we learned in the previous chapter, budgeting isn’t about what you can’t do with your money; it’s about discovering your financial potential and achieving it, month by month. The only true downside to budgeting is the time-cost associated with it, especially at first. But when we consider the benefits, they’re far-reaching and substantial.
Let’s examine two of the greatest benefits an effective budget can give you.
Imagine a life in which you have a complete understanding of what every penny that flows in and out of your life is doing. You know how much money you can spend on groceries late into the month. You’re fully aware of each subscription you’ve chosen to pay for. You can remember what you spent on clothing over the past 6 months. Because of this knowledge, you’re able to plan for a prosperous future, plan for emergencies, and live a financial life that’s light on unpleasant surprises. You can go to sleep free of money worries, fight about money less with your spouse or partner, and maybe even watch your net worth grow each month (and know why it’s growing).
This is the power of budgeting—it gives you superhuman awareness over your financial life.
My wife and I have kept an “every penny” budget (more on that later in the guide) for the past 3 years. With the data we carry from this money tracking, I can tell you random facts such as how many movies we saw in theaters in 2015 (40—we really love movies), which movies we saw, and which theaters we visited the most. I can also tell you how much we spent at each movie theater and which months saw our most frequent movie-going. According to our data, this culminated in a total of $891.53 spent on movie-going throughout 2015. Feel free to judge.
These are random bits of information that might be interesting to only my wife and me, but it illustrates the fact that long term budgeting will give you more lifestyle feedback that you’d know what to do with. You can re-evaluate your habits each year and plan future decisions based on real data.
As a more useful example, our data from 2015 also shows that we spent $1,717.63 on cell phones and cell service. In 2016, with this data in mind, we switched to a cheaper month-to-month phone plan mid-way through the year and bought a couple new phones to go along the new plan. In 2017, based on current trends at the time of this writing, we’ve estimated that we’ll only spend $592 on phone expenses for the entire year, a reduction of over $1,100 compared to 2015 totals.
As Peter Drucker says,
If you can’t measure it, you can’t improve it.
If you budget, you’re taking an active approach to measuring and improving your finances.
Since marrying my wife four years ago, we’ve encountered thousands of dollars in large, unexpected expenses. We’ve had countless car issues, each costing us hundreds of dollars to fix; we’ve made a move from the southeast all the way to the central coast of California, which cost us an estimated $11,000; we’ve had multiple expensive emergency room visits (all of which resulted in harmless diagnoses—very expensive scares).
After all of that, what’s our current financial situation look like? Surprisingly, since getting out of debt shortly after getting married, we’ve never fallen back into debt since the day of our final debt payment.
How did we do it? It turns out that when you budget properly, unexpected expenses aren’t so unexpected after all. We knew there would be emergencies from time to time, so we planned ahead. We budgeted for emergencies early on and were able to track the impact of those large expenses with our budget. From there, we could easily pivot our normal spending to accommodate the emergency expenses.
Having a healthy foundation in money management prepared us for those emergencies, and we don’t lose sleep over money these days. When you budget, you know what your money is doing, and you know what it’s capable of. A budget makes you the captain of your ship; it places you in the command center where you can navigate, plan, and adapt to the unexpected.
Characteristics of an Effective Budget
In the years since starting my first budget, not only have my wife and I been able to eliminate $17,000 in student loan debt, we’ve also increased our net worth by $80,000 since marrying four years ago, all with a standard middle class income—no fancy tricks, no big windfalls, just a disciplined approach to money management.
But before we could gain control over our money, we first needed to understand what makes budgeting effective in the first place.
If you don’t know what it’s like to use a budget that’s effective, you most certainly know what it’s like to use an ineffective one. This is what I experienced back when my mom pushed me to balance my checkbook with pen and paper. For me, this was an ineffective way to track my finances, and ultimately failed to change my spending habits.
If you dread budgeting or avoid it altogether, it’s likely that you’ve never been exposed to effective budgeting. When done properly, it involves a few key characteristics.
An effective budget supports a goal
Effective budgets are goal-oriented, even if that goal is years in the making.
While reading this, you might have a clear goal in mind. Maybe you want to finally get out of debt. Maybe you want save money to start a family. Maybe you want to start saving for your child’s education. Whatever the goal may be, you need to understand it so clearly that no amount of new shirt purchases, dinner dates, or video games can replace your desire to reach this goal. Budgeting for the sake of budgeting is destined for failure.
It should be said that a better financial life doesn’t come from getting more money alone; it comes from defining a clear “why” for making change. No book, speaker, nagging relative, or even this guide is going to convince you to build a healthier financial life if you don’t first establish a tangible goal for your finances.
The problem is that, beyond the goals I listed earlier, most of us don’t know what’s possible when we take steps to start a budget and improve our finances. It goes far beyond things like getting out of debt—what will you do when you’re debt free?
Let’s explore a few unconventional goal ideas that are entirely realistic and just require a more focused approach to money.
Goal: travel the world. Long term travel has never been more accessible and affordable for those living in the western world. In the book, Vagabonding: The Uncommon Guide to the Art of Long Term World Travel, author Rolf Potts describes how easy it can be to travel overseas for cheap. He writes,
For what it costs to fill your gas tank [in America], for example, you can take a train from one end of China to another. For the price of a home-delivered pepperoni pizza, you can eat great meals for a week in Brazil. And for a month’s rent in any major American city, you can spend a year in a beach hut in Indonesia.
Travel isn’t just for the ultra-wealthy. Anyone with a healthy grasp on their finances can become a world traveler.
Goal: “Retire” from the rat race. This doesn’t mean retire in the traditional sense. Imagine working your own hours, pursuing your passions, and spending each day doing exactly what’s most important to you. This isn’t just describing the successful entrepreneur; this can also describe the lifestyle of those who are financially independent. To see how this is possible, check out the story of the blogger known as Mr. Money Mustache.
Goal: Take jobs because you want to (rather than because you have to). When it comes to work, there’s the hungry, and there’s the starving—those that take any jobs because they simply can’t live without the income. This is a reality for more people than it should be; some struggle with being underpaid—a harsh reality—but even more often, people spend far beyond their means. This leads to a continuous cycle of working to pay for things that we can’t afford, then working more to pay off those purchases. A financially healthy life gives you the ability to choose work you love, though it may pay less, because you’re not tied to a voluntarily high cost of living.
Goal: Raise a family full time. Rather than taking off the standard leave associated with having a child, imagine taking off work for 6 months, a year, 5 years to dedicate all your time to raising a family. While this takes a focused approach to spending and saving, it’s certainly possible for those who’ve gained control of their finances. As an example of this, check out the blog of Go Curry Cracker.
Goal: Live the life you want to live. Financially free people are truly free to live according to their values and their preferred lifestyle, and there’s simply no better way to live.
If none of these goals excite you, that’s okay; just don’t miss the point being made. There’s more to your financial life than saving for an expensive new toy or saving for an old and gray retirement. If you set a long-term goal you’re passionate about, it makes budgeting far more effective and lasting.
An effective budget doesn’t make you feel guilty
One of the most common complaints I hear when it comes to budgeting is that people hate knowing how much they really spend in certain areas of their life. Unsurprisingly, I’ve heard that complaint most from people who also complain about their general financial struggles. Overspending is extremely easy when you’re not using a budget, so most people avoid the guilt that comes with tracking their spending habits.
I once worked with a guy who claimed that he’d hate to know how much he spent on medicine for his dog each month. He knew he was overspending, but he found it too scary to see just how much. For this reason, he avoided looking at the numbers, and this guilt alone was enough to prevent him from creating a budget.
When done properly, a budget doesn’t make you feel guilty. An effective budget allows you to build your spending around those areas that end up costing you the most money. If you’re not budgeting and you know there’s a major ongoing expense in your life, a budget will allow you to build your spending around that area or minimize it if it’s wrecking your finances.
Guilt is a terrible motivator for most people. If you learn to take steps to confront your spending and build your budget around the areas that are most important to you, your budget will undoubtedly be far more effective.
An effective budget changes your behavior
I once used a budgeting app that used what I consider to be “guilt-driven budgeting.” In my time using it, I found it difficult to make on-the-fly budget tweaks as the month went along, and I found that it didn’t make me want to cut back on my spending. At the end of the month, my screen would be filled with red bars indicating where I had overspent. Maybe next month, I’d tell myself.
I discovered that, for me, budgets should be more than reporting tools. I prefer to be actively engaged, and a budget shouldn’t just be an automated system that displays my spending. When I switched to the more hands-on budgeting tool, You Need a Budget, I was forced to input my spending manually, so spending money became a much more intentional experience. Over a short time period, I found that manually entering in my transactions had a dramatic impact on my financial decisions in all the right ways.
Also, an effective budget keeps your mind on the positive aspects of your finances, such as your long-term goals and your good financial decisions. When you’re dealing with positive financial experiences, your behavior will adapt to crave more. Checking your budget throughout the month might just become enjoyable.
An effective budget makes you excited about your finances
I’d like to get something out of the way if it hasn’t already been made clear—I love budgeting. For me, a long-time video gamer, it’s a game of resource management. Each dollar is a resource, and it’s enjoyable to move dollars around my budget to find the best ways to achieve our goals.
A properly maintained budget keeps you interested, and with the right mindset, can make you excited about achieving your financial goals. If you feel that maintaining your budget is work, it’s likely that you’re not budgeting in a way that’s best for you. Are you into more traditional methods such as spreadsheets? Do you enjoy using a simple pen and paper? Finding a tool you enjoy using makes all the difference.
An effective budget is flexible
It’s impossible to plan for everything. Life has a way of throwing flat tires and broken arms and many other wild expenses your way when you least expect them; the same can be said for those small monthly expenses that come out of nowhere. In times like these, your budget can’t survive being inflexible.
As Jesse Mecham of You Need a Budget describes it, you should be able to “roll with the punches” throughout the month—shift money around, take money out of less important categories, and most importantly, not lose your cool when unexpected expenses (or windfalls) come along.
As I’ve learned over my years of budgeting religiously, there will be bad spending months. But when you develop a budget that’s flexible, these months become mere bumps in the road rather than events that derail your finances.
If you treat budgeting like a crash diet—going all in and trying to make the perfect budget right away—you’ll burn out quickly. Rigid and hasty budgets lead to stress and guilt. If you’re completely new to budgeting, you’re guaranteed to make poor estimations for at least the first few months. You might assume you only spend $200 on groceries, only to find that you spend $600. This is normal; it takes time to understand your average spending habits. In fact, the goal of your first few months of budgeting should probably be spent simply recording your spending activity rather than estimating accurate spending.
Think of your budget like the driver’s seat of your car.
At any time, you can pump the brakes and scale back your spending. You could turn the wheel sharply and change course of your spending to head in a new direction. You can switch gears entirely. But as we all know from those early days of taking Driver’s Education, driving a car is a complex dance that requires most of our focus to perform safely. It’s difficult at first—am I doing this right? What If I make a wrong turn? What do these buttons do? —but over time, the act of driving, like budgeting, becomes second nature. We can perform that complex dance without issue and we know how to use all the car’s features to keep us going in the right direction. The same is true for budgeting.
Part II: Strategies
Now that we know the mindset we need for creating a budget that works, we’ll spend the following section looking at popular strategies for structuring a budget. It’s not necessary to fully embrace all of these strategies; this section is intended to give you an approach that you feel fits best with your personal preferences and comfort level.
The Every Penny Method
This method of budgeting is one of the most effective styles of tracking your finances. It’s fully hands-on, and introduces you to the idea of “giving every dollar a job” popularized by my favorite budgeting app, You Need a Budget. As you adopt this approach, you’ll gain a complete understanding of your finances.
Tracking every penny gives you pinpoint accuracy on your finances, and best of all, with many per-penny budgets, you have access to past data that can be used to forecast future decisions.
The downside of this method is that it involves a great deal of time to get started. It requires taking stock of each of your financial accounts and tracking each transaction flowing through those accounts. You’ll often be tracking each transaction manually, and while this may seem like an unproductive use of your time, it’ll also lead to more mindful spending and saving habits over the long term.
You might like this method if:
You enjoy tracking and analyzing data, and you’re a bit of a control freak. It’s also great for people who are somewhat tech savvy, as there are many apps and tools available online or on mobile devices that helps for this style of budgeting.
Tools for Every Penny budgeting:
- You Need a Budget (34-day free trial, then $50/year)
- My budgeting tool of choice
- Use this link to get your first month free after the initial 34-day trial
- EveryDollar (free, EveryDollar Plus available for $99/year)
The Automated Method
This method is usually accompanied by apps like Mint or Personal Capital. With these tools, you link your financial accounts, set categories for your expenses (groceries, dining out, bills, etc.), and set a maximum spending amount for those categories. The tool takes care of the rest. It uses the data from your financial accounts such as credit and debit card transactions, and automatically assigns them to a spending category, all while letting you know your spending progress towards those maximum spending amounts you set.
The benefit to this method is that it takes away much of the time commitment that comes with budgeting. You won’t need to enter in every single expense manually, which ensures you’ll never fall behind in your budget. It stays up to date with you.
The downside to this method is that it takes away most of the accountability and replaces it with guilt. When you overspend, it reminds you with warning messages and urgent emails. Leading up to the overspending, you might not have any indication of your spending progress unless you’re checking the progress within the app regularly.
You might like this method if:
You’re new to budgeting and you’d like to get started right away. It’s also great for the more tech-savvy folks, as this method requires using one of the many tools and apps used for tracking your spending. It also helps if you’re comfortable with giving a tool access to your financial data. While that may seem scary, these apps access your data in a “read-only” mode, so there’s no way to access your bank accounts directly if someone gains access to your account.
Tools for Automated Budgeting:
The Percentage Method
The Percentage method introduces the idea of dividing your finances into separate expense categories based on a percentage of your income.
Here’s an example:
- 50% goes to fixed expenses—rent, utilities, phone and cable bill.
- 30% goes to variable expenses such as groceries, dining out, or entertainment.
- 20% goes to savings.
This approach is open to different spending amounts—you might instead go with 60/20/20, 70/20/10, etc. The divisions you choose will depend on your cost of living and savings preferences.
The downside to this method is that it’s highly generalized and may be less effective for those with complex financial lives—those with large families or variable income from sources such as freelance or part-time work, for example.
You might like this method if:
Rather than tracking every detail, you’re more comfortable tracking the broad numbers of your budget. It also helps if your financial life isn’t too complicated—if you make a middle to upper-middle class income, you aren’t juggling variable income sources or amounts, and you don’t have a large family to keep track of financially, this method should work well for you.
Tools for Percentage Budgeting:
- Pen and Paper
The All Cash Method
Commonly referred to as the envelope system and popularized by Dave Ramsey, this system will show you exactly where each dollar goes.
This method involves using primarily cash for your monthly expenses, and settings aside that cash in envelopes/drawers/buckets that correspond with your usual spending categories. For example, if you typically spend $300 on groceries each month, you’ll set aside $300 in cash and place it into an envelope. You’ll do the same for your other budget categories such as dining out or entertainment—establish an envelope for each and fill them with the necessary cash at the beginning of the month. Throughout the month, you’ll withdraw money from those envelopes to cover your spending. And once you run out of cash, you’re out! This method is great for teaching you mindful spending habits.
The downside to this method is that you’ll carrying around larger amounts of cash more often, a potential issue since cash can be misplaced or stolen. Forgot your wallet on the subway? That might cost you a few weeks of grocery money.
You might like this method if
You’ve struggled with credit card usage in the past, you don’t trust debit cards, or you simply prefer using cash. This method makes your money real: you can take it out of the envelopes, stack it, count it, or sleep on it. And as the month progresses, you’ll watch the stack of cash shrink. It’s a much more tactile experience compared to seeing numbers on a screen.
Tools for All Cash Budgeting
- A stack of business envelopes
- Pen and Paper
- Spreadsheets (for budget planning)
This budgeting technique isn’t so much a budgeting strategy as it is an approach that can be applied to all the previous budgeting strategies.
Zero-based budgeting introduces the idea of setting your baseline spending at $0, and only allocating funds towards the expenses that are truly required. As an example, a common problem my wife and I saw in our “Every Penny” budget was that we were allocating money towards expenses that we expected to make rather than considering if we needed to make those expenses in the first place. Setting aside $400 for groceries each month meant, for us, that we had to spend $400 on groceries, rather than planning what we actually needed to spend for the month beforehand.
Zero-based budgeting is most effective when you’ve adopted healthy spending behaviors. When mixed with a habit of buying simply what you need rather than everything you want, this approach can lead to a surplus of savings each month, along with a happier, clutter-free lifestyle.
To apply this budgeting method, it can help to master one of the four other budgeting strategies—Every Penny, Automated, Cash-only, or Percentage—and, over time, learn what expenses bring you the most satisfaction, scale back on frivolous expenses that don’t, and learn to trust yourself and your spending habits.
No matter which budgeting strategy you choose, any form of money tracking can bring considerable benefits to your financial life—insight, security, and financial peace.
Part III: Roadmap
Now that we understand the mindset needed to begin budgeting with confidence, and we have a basic understanding of common budgeting strategies, it’s time we put our new knowledge into practice.
The upcoming chapter is optional. If you feel confident about what you’ve learned so far, and you’re ready to put pen to paper and begin your first budget, I wish you luck (email us if you have any questions)! But if you’re still feeling apprehensive about budgeting, I’d like to address your fears head on and outline a simple roadmap for building a healthy budgeting habit.
The 8 Steps to Budget Mastery
Step 1: Forgive yourself
Before you start budgeting, you need to do the most important thing of all when it comes to your finances: forgive yourself for any past financial mistakes. You might be living with large amounts of credit card debt, student loans, a poor credit score, or any number of other mishaps. But to move forward from here, I want you to adopt the following mantra:
I recognize the financial decisions that brought me to where I am today. For the successes, I am thankful, and for the mistakes, I choose to forgive myself. Starting now, I will make decisions that lead me to a healthier financial life.
Write it on your arms. Scribble it on the walls. Commit it to heart, and let’s get started.
Step 2: Find your goal
You might have a long term financial goal in mind such as buying a house, getting out of debt, saving for your kid’s college; maybe you want to spend more time with your family or travel the world. The more powerful the goal, the more likely it is that you’ll stick with new financial habits. As we discussed in the chapter on “Characteristics of an Effective Budget,” there are many unconventional goals that are possible when you’ve adopted healthier financial habits—early retirement, long term travel, or the ability to pursue careers you’re passionate about.
If your idea of a goal is still a bit cloudy, consider this quote from Lynne Twist, author of Soul of Money,
Money is so intricately interwoven with every other aspect of our lives that when we take a stand to make a difference with our life, it has an organizing effect on our relationship with money, and when we take a stand to make a difference with our money, it has an organizing effect on every other part of our life.
In other words, gaining control of your money just might help you in gaining control of other areas of your life. In my personal experience, my wife and I rarely argue over money thanks to our healthy finances. Also, when I’ve applied the data tracking approach I’ve taken with budgeting to my health, I’ve seen significant improvements in my dietary and exercise habits.
The goals you apply to budgeting are crucial to improving your money habits. Pick a goal you’re passionate about, and keep it with you as you move forward.
Step 3: How much do you make?
In my first job out of college, my annual salary was $31,000. I knew that I got paid on the first of each month, a notable difference from most other jobs I’ve had which paid me bi-monthly. I also knew how much money I could expect in my paycheck down to the penny. When I got married, my household income effectively doubled, which brought new considerations for how our money would be used.
When considering how much you make, maybe you feel like it’s not enough to make ends meet; maybe it’s more than you know what to do with. Regardless how you feel about the total, there’s no moving forward until you’ve committed this number to memory.
Step 4: What are your non-negotiable expenses?
Each month, I’m willing to bet that you pay rent or a mortgage. I’m also sure you pay some form of utilities, a phone bill, or maybe a car payment. Begin tracking your money by adding up these expenses that are crucial to maintaining your lifestyle, or your Non-Negotiable Expenses.
This might be the point where you experience your first feeling of shame or guilt. Some of these non-negotiables might be the result of those past financial mistakes we considered earlier, but since we’ve already forgiven ourselves for any past mistakes, we’ll no longer worry about those feelings that show up when we analyze our spending. I’m officially freeing you of your guilt and shame. This process is about moving forward, and it gets easier over time.
Open your favorite text editor or take out a sheet of paper and write down all the non-negotiable expenses you pay each month. This may include:
- Rent and/or mortgage
- Cable / Internet
- Car payments
- Credit card payments
- Charitable donations
- Medical bills
Add these expenses up, write down the total and assign a label to it: Non-Negotiable Expenses.
Step 5: What are you subscribing to?
I separate subscriptions from “fixed expenses” because often, we don’t even realize how many subscriptions we’ve signed up for at any given time. With many of the popular productivity and lifestyle tools based on a subscription model these days, it can be easy for these expenses to add up quickly. But the great thing about subscriptions is that most of them can be canceled at any time.
Write down all the subscriptions you’re currently aware of paying for. You might need to search through old credit card or bank statements to see if there are any surprise memberships that you may have forgotten about.
Subscriptions may include:
- Streaming services like Netflix or Hulu
- Club memberships
- Gym memberships
- Web hosting plans
- Phone apps with a subscription plan
- Storage companies or apps
Add them up, write down the total, and assign the label: Subscriptions.
During this step, if you realize that you don’t need some of the subscriptions you’ve written down, feel free to cancel them right away. Every time you cancel an unwanted subscription, you essentially give yourself a pay raise. High five!
For most people, fixed expenses and subscriptions make up a large portion of their spending. Just by recording these expenses, you’ve made incredible progress. If you’re feeling a bit drained after seeing where your money is going each month, it’s okay! This is a natural feeling, so we’re going to take some time to address it.
Step 6: Relax!
Grab a drink. Kick back and relax. I want you to know that you’ve done some incredibly difficult work up to this point. You’ve successfully overcome the scariest part of budgeting, and you’re now aware of where most of your money is going each month. Most of the fear of budgeting comes from what’s already been done—the things we’ve already paid for that we might regret.
I also want you to know that, no matter what you’ve discovered in steps 4 and 5, it’s okay. As a reminder, budgeting isn’t about what you’ve done in the past. It’s about giving you the power to take control of your future. If you wanted, you could remove a few of those fixed expenses or continue cutting subscriptions to free up a bit more cash each month. As you’ve probably now discovered by performing the previous steps, you’re in control.
Step 7: Understand your daily spending habits
Now that you’re aware of the expenses you’ve accrued in the past—subscriptions and fixed expenses such as bills and credit card payments—it’s time to face the biggest money monster of all: your daily expenses. This could include dining out, groceries, morning lattes, video games, or any number of other expenses you make regularly.
Most these expenses are done out of habit, built up over most of our lives. Some of us are compulsive spenders, constantly tempted by shiny new toys. Some of us buy things due to peer pressure or addictions. For these reasons, this is one of the most difficult areas to take control of in your financial life. Your daily expenses make the difference between living in constant money stress or becoming financially independent. Seriously.
To help you gain control of your daily spending habits, consider the Pick 3 Rule. Choose 3 spending categories that you enjoy where you can direct most of your spending, and choose 3 problem spending categories where you can start cutting back on your spending.
As a personal example, I enjoy spending my money on books, video games, and music; but I’ve found that I usually regret spending money on dining out, candy, and cappuccinos. When tempted to make one of those problem expenses, I remind myself that it’s not going to make me happy; instead, I direct that money towards one of the areas that I enjoy.
Over the next month, take note of each of the daily expenses you make. If it’s too much work at first to record how much you spent on those purchases, that’s okay; another suggestion is to simply record what you purchased. At the end of the month, reflect on how many of those daily purchases you made; do you remember buying those things? Did they make you happy?
The goal of this step is awareness. You should become aware of all those little purchases you made throughout the month. You should reflect on which of those purchases made you happy, and which ones you regret. Pick 3 that you enjoy, and pick 3 that you don’t. Write down what you’ve learned, and prepare to take the final step.
Step 8: Embrace your budget strategy
Now that you’ve strengthened your awareness around the money that comes in each month and where it goes, it’s time to choose your budgeting strategy. Refer to Part II: Strategies for a closer look at the common budgeting methods.
As discussed earlier in this guide, choose a strategy that you feel best suits your personality. Do you enjoy tinkering with the numbers? Try an Every Penny budget. Do you prefer to focus on the broad money decisions? Go for a Percentage budget. No matter what you choose, make sure you enjoy it. Budgeting should be rewarding and become second nature over time.
And remember: your budget is simply a tool to improve your finances. It shouldn’t stress you out. It shouldn’t make you feel guilty. You’re in control, and you now have everything you need to budget effectively.
Now that you know how to plan and execute an effective budget, it’s time to take control of your finances and achieve your goals.
To recap, it begins by understanding all the amazing benefits that can come from budgeting, including superhuman financial awareness and a confident sense of security. It’s also important to understand what makes budgets effective in the first place. From there, you must choose a style of budgeting that fits with your personality. Each person’s mind works a bit differently, and budgets should cater to this. Next, find your roadmap that leads to long term changes; an effective approach is to introduce changes slowly, and build up to full awareness mode.
Lastly, know that when it comes to budgeting your personal finances, the ultimate goal is to become disciplined and knowledgeable enough in your financial decisions that you no longer need to use a budget. That’s right, in a budgeting guide, I’m telling you that one day, you should stop budgeting. The point is this: budgeting doesn’t just give you control, it teaches you control. It shows you where you spend your money so that you can understand why you spend it. And it may take some time, but one day, you can take this knowledge and live a financial life that’s truly free, even from budgets.
Until then, happy budgeting.
Our recommended budgeting tools
You Need a Budget (34-day free trial, then $50/year)
- My budgeting tool of choice
- Every Penny method
- Use this link to get your first month free after the initial trial
Personal Capital (free)
- Automated method
- Link your financial accounts to track your budget and net worth automatically
- Automated method
- Link your financial accounts to track a budget and net worth automatically
You may also like
EveryDollar (free, EveryDollar Plus available for $99/year)
- Every Penny method
Simple budget spreadsheet (free download)
- The first budget my wife and I used
- Includes our budget from July 2013 for sample data
Have a question about the material in this guide? Have any feedback that could improve this guide? We’d love to hear from you. Email us at [email protected].
Enjoy this guide?
Share it with your coolest friends.
Become a Smart Penny Institute Insider to get the audiobook version of this guide for free. It's an exclusive gift for Insiders.