I remember the first time my wife and I really tried to make a budget. So many expenses were coming to mind it was difficult to prioritize which ones were most important. We messed up many things in that first month’s budget and felt really frustrated at our efforts.
It didn’t deter us however from trying again…and again…and again. We found that after several months of trial and error certain expenses always drifted to the surface first. It was apparent that we were drawn to some expenditures more readily than others because they represented fundamental needs for our family each month.
So what expenses go first when you make a budget? Then how do you determine what comes next? Today I’m going to outline our five-step thought process as we make a budget each month. Hopefully it will give you some direction as you try to figure out how your hard earned dollars will be allocated.
Process to Make a Budget
When you begin the process of putting a budget together, start with the highest priorities and work your way down. It should look something like this:
Budget Priority #1 – Necessities Above All
Put simply, you have to survive. Nothing else can happen in the budget before your basic needs are taken care of.
This shouldn’t be too big of a revelation but you’d be surprised how many people mismanage this step. They spend money on cable service but are behind on the mortgage. They shell out money for electronics and entertainment but have a difficult time keeping their children clothed.
There is nothing wrong with cable TV, or electronics or going out to the movies. But those are secondary items that do not deserve to be ranked high in the budget. People who make sure items like these are covered first in their budget are placing too high a priority on their importance.
Above all these necessities should be covered first when you make a budget. They are in no particular order because all five are needed for survival:
- Food. This includes all monies spent on groceries, eating out, the kid’s lunches at school and your daily trips to Starbucks. Anything you pay for and consume should be accounted for here.
- Clothing. You may not spend money here every month (I can go months without buying clothes) but you must at least give it consideration. Except on some beaches and in special colonies our society believes in covering the human form with fabric and will not look kindly on those who don’t.
- Shelter. A roof over your head brings safety, comfort and belonging. Wherever you lay your head at night is home. So prioritize the mortgage or rent payment check as one of the first that goes out the door.
- Utilities. What good is a home if the utilities are shut off? So pay the water, electricity, gas, and phone service (for us that’s just cell service as we have no home phone). Also include the trash bill here (unless you can drive it to the dump) so your house doesn’t become a wretched pigsty.
- Transportation. Being immobile would severely hamper our ability to get to work and earn a living. So plan on paying for the car payment, gasoline and vehicle maintenance. Or if you don’t own a car include money for some other form of public transportation.
These are the first five things you should be looking at in your monthly budget. Everything else should be set aside until these are covered.
Priority #1A – Giving
I thought about skipping this. However, I would not be giving a true representation of what my wife and I do with our budget. You may not feel giving to charity should be accorded this high a priority. I understand that sentiment and would not choose to critique your personal decision. if that’s the case, you can skip to step #2.
For us giving is ingrained in our minds and in our belief system that we should be giving regularly (monthly) to our local church. We set aside 10% of our income and place that “expenditure” at the top of our budget template. It serves a reminder that we have been given so much and should look for ways to give to those who bless us spiritually (the church) and to those who are less fortunate or have a need.
Budget Priority #2 – Insurances to the Rescue
I’ve dedicated a good portion of my blog space this year to writing about insurance. As a result of my research for all the various posts I’ve become convinced more than ever of the value insurance plays in our lives. I believe it’s truly vital…not an absolute necessity…but pretty darn close. That’s why it checks in on the second tier of expenses my wife and I look at when making our budget.
Without insurance we leave ourselves open to great risk. We are a bad, at-fault accident or a major health problem away from bankruptcy. That’s not overstating the dangers considering the high cost of healthcare or the litigious nature of our culture. Insurances serve to rescue us from potential financial ruin.
So, after taking care of our necessities, we budget for the following insurances each month:
-Health Insurance (A Beginner’s Guide to the Health Insurance and the Affordable Care Act)
-Car Insurance (on two vehicles) (A Comprehensive Look at Auto Insurance and Why You Need It)
-Homeowner’s Insurance (What Do I Need to Know About Homeowner’s Insurance?)
-Life Insurance (for both of us) (The Most Important Things You Need to Know About Life Insurance)
-Disability Insurance (on my wife only) (The Big Reason You Need Disability Insurance)
If you are interested, I’ve written a detailed post about each type of insurance (except the last one…which is coming soon). I look at the specifics of each type of insurance, what to look for and how to save money on each one. Click on the article titles I’ve provided above to be redirected to that article.
Budget Priority #3 – A Debt-Free Existence
The third priority when you make a budget should be to allocate funds to pay off other debts that are unrelated to the mortgage or the car payment. We dealt with each of those in step #1 when we set aside money for shelter and transportation.
The two things that would most likely fall into this category would be school loans and credit card debt. But you could also be dealing with a home equity or other type of loan that needs to be paid back. Any debt that falls outside the car or mortgage payment should be funded here.
I labeled #3 as “Debt-Free Existence” because that is what we are striving for. We can’t let debts languish month after month or year after year by only paying the minimums when the bill comes. Our goal should be to get rid of debt as quickly as possible using a debt payoff method.
The good news is once the debt is gone you can skip this step entirely. Speaking from my own experience of becoming entirely debt free, it’s a pleasure to not deal with this each and every month.
Budget Priority #4 – Hitting the Hassle Expenses
The fourth area to prioritize is what I call “hassle expenses.” I refer to them this way because they are not necessities but life would be more challenging in some ways if we didn’t account for them.
Some monthly expenses we budget for in this step include our cable television service, Internet access, and our home security system.
As you can see we don’t NEED all of those things. A home security system is clearly an optional expense. You could find Internet access in a plethora of Wi-fi hotspots around town (restaurants, libraries, etc). In fact, we went without cable TV service for about 3 years while we were paying off our mortgage early.
But a) we can afford them, b) they make life more manageable and c) they add to our life enjoyment.
In this category, I would also include budgeting for any home maintenance expenditures that are not compromising the integrity of the home. (Some home maintenance might be considered a necessity – like a leaking roof or faucet – and would need to be dealt with in Step #1 – Shelter.) We want to deal with home maintenance issues eventually because they nag at us and give us the sense our home is falling apart (even though it’s not). They may also lead to bigger repair issues if not taken care of in a timely fashion.
Two other big hassle expenses we prioritize in step four are handling savings and retirement. I consider these hassle expenses because…well, think about what life would be like if you had no savings. Or if you had nothing invested for retirement.
With no savings you’d continually be going into debt to handle life’s emergencies. Without money for retirement you could end up working until your 80 and then relying on the little you’ll receive from Social Security. Both of those scenarios need to be prevented by funding them in your monthly budget.
You need to fund savings until you have 3-6 months of cash saved in a bank account that you can access immediately. Once you have that amount saved you can skip funding it in the budget unless it drops below your comfort threshold.
Investing for retirement should never end, at least not during your working life. Budget for that each month so your investments grow over time and you’ll have money to live out your later years with dignity.
Budget Priority #5 – The Continuum of Value
The final items we look at as we make a budget are all optional expenses. Some we encounter every month while others are more sporadic and we don’t know if/when they are coming. Even if they occur periodically though we still account for them as if we might have to deal with them.
Step #5 has been termed “The Continuum of Value” because what items you put here will be different than ours based on what optional expenses you value. Some will be more important than others. The expenses you see as less of a priority are often the ones that get dropped out of the monthly budget first when you find yourself with less discretionary income for one reason or another.
Once we have all other expenses accounted for in steps 1-4 these are the optional expenses we fund in order of importance:
- Child related expenses
- Personal care (think hygiene/sanitary/cleaning items)
- Pet care
- Gifts (for birthdays, special occasions, etc.)
- Entertainment (movies, Netflix, MLB subscription, etc.)
- Home Décor/Furnishings
Items 1-6 on the list we fund money for and spend in almost each and every month. Items 7-10 happen less frequently and are the ones we would bump out of the budget first if we ran short on money in any given month.
You can see how these are based on what we value most, as we put kid expenses at the very top. With four children in the house “Child Related Expenses” easily becomes our third most expensive budget category behind food and health insurance.
But that may not be what’s important for you. That’s why everything in step #5 is based on what you value at that time of your life. Your priorities will change over time. Indeed, in about 12 years child related expenses will not exist in our monthly budget as all as our kids will be out of the home.
Final Thoughts On How to Make a Budget
How to make a budget can be an overwhelming challenge for a beginner. It was confusing for us initially to know where to start. It took us a few months of practice to get our priorities in place but we eventually settled into knowing how and where to allocate our dollars. Now, after doing it successfully for so many years, our budget planning takes about 10 minutes each month (because everything essentially stays about the same).
When you make a budget always remember to fund the necessities first and then protect yourself from financial risk by keeping your insurances current. After that prioritizing the budget expenditures becomes an issue of the financial stage of life you are in and what you value.
Questions: What priorities do you put first when you make a budget? Have you ever let a necessity slide in order to fund/pay for something else? What other “hassle expenses” would you consider important? What optional expenses do you value the most right now?