Setting Up Budget Categories
A budget helps you identify how much money you're spending on various things, but it also can help you identify where you may have extra money to start investing.
One of the keys to creating and maintaining a budget is making it manageable. Once you buy into the value of a budget, it's very easy to get overly enthusiastic and create 30 different budget categories. The problem is maintaining all 30 throughout the month because there is some upkeep with any budget. It also doesn't make sense to have only one or two categories. So how detailed should it be? Here's an example that may help get you started.
This budget has one category - Expenses:
Hmmm. Looks like you overspent this month. Your budget was $2000, and the graph went right past that. This single item budget lets you know you were over budget, but that's about it. Where did you go over? Was it all the extra driving you did? Or your dinner out with friends? Who knows? Here's where categories help.
Here's the same $2000 budget, broken up into a few categories - Rent & Utilities, Cell Phone, Dining Out, and Auto expenses:
In this budget with even just 4 categories, you can easily see that you went WAY over on your Dining Out budget, and also a little over on your Cell Phone bill. The idea is once you start tracking things like this, you can adjust your behavior to fit within your budget. And once you're sticking to your budget, you can more easily determine how much extra money you have to invest!
So let's talk about what budget categories make the most sense. Read Dave Ramsey, Suze Orman, or any other finance guru, they all recommend pretty similar categories. Many overlap, and there's always a handful that they note will be unique to your situation. Your first attempt at it picking those categories won't be perfect, but that's no reason to wait to start. And you're not stuck with them forever. We typically review our budget categories every 3-6 months, and adjust as we see fit - that's both the category heading, and the amount of money budgeted to it. Over the years, we're changing those things less and less as we dial in the categories and amounts that work for us.
In addition to determining categories, we've also gone one step further to group our categories into 3 separate budgets - a joint budget, a Partner A budget, and a Partner B budget. These 3 budgets even relate to separate bank accounts too (not necessary but can be a great help in separating expenses).
Joint Budget
Our joint budget includes mostly non-negotiables and regular monthly expenses such as our rent payment and utility bills, groceries, insurance, and gas.
Here are our current budget categories for our JOINT ACCOUNT:
Auto Insurance
Gas for Cars
Gas/Electric Utility
Internet/Television
Cell Phones
Grocery
Charity
Gifts
House Misc
Rent/Mortgage
Pets/Vet/Petsitting
Travel
The motivation behind tracking these specific budget items is simple - we're tracking things that we want to keep an eye on or figure out how to optimize. For example, we were over our budget for a few months in a row at one point. We looked through and realized it was the cell phone bill. It was easy to catch because that budget line was just for the cell phone bill (similar to the graphic at the top of the blog post). We budgeted $165 and it was coming in at $192 ish. Having the cell phone listed as it's own budget line allowed us to quickly identify the problem and look into remedies, aka change carriers. The alternative to this would have been one big monthly budget number of, say $4550, and finding we spent $4577. Good luck combing through a few hundred transactions to find the extra $27 you spent somewhere.
Another example is Gas/Electric utility. It's great to separate out items like this that YOU, yourself can influence with your behavior! Try turning out the lights in your house when you leave a room. Not a new concept, but if you really focus on it for a month, you're likely to see a reduction in that bill. It's easy to see because it's its own budget item.
We also now separate some items that we used to co-mingle. We try to keep groceries and "house misc" separate. The house misc category includes things like paper towels, shampoo, TP, razors... When they were together as one budget line, we were always spending more than the budget, but it was really challenging to tell if it was because we bought the fancy steaks, hosted a BBQ, or bought the fancier toilet paper and paper towels that month. Separating food and home misc items was valuable for us, so we could dial in where our spending was getting off kilter. We can split these transactions digitally in the budget later if we buy them all together from the same store, but to make this even easier for us, at the checkout line, we'll often do two transactions. This makes it more obvious to us when we go to reconcile that one of those purchases was grocery, and the other was house misc.
Individual Budgets
Our personal budgets includes nice-to-have's, like entertainment and shopping and things specific to our individual hobbies - golf for example. Even if we had very little money allocated to our individual budgets, it's a nice feeling to know you get a dedicated amount each month to spend as YOU choose, and long term, will help you stick to your budgets overall because you know you've got some rewards for yourself built in there.
We consider this our FUN MONEY! Those budgets look like this:
Partner A
Restaurants
Lunch at Work
Health and Fitness/Massage
Entertainment
Shopping/Misc
Gifts
Partner B
Restaurants
Lunch at Work
Health and Fitness/Gym
Golf
Entertainment
Shopping/Misc
These budget categories change periodically, depending on what we want to watch in our own spending. We give ourselves the same amount of "fun money" each month and then individually decide how we spend it.
Restaurants and Lunch at Work are both in our personal budgets because they were budget items that were easily running away from us, and that we had different opinions on. The Partner B budget has a higher amount allocated to lunch out during the work week, because that's important to them, and something they like to do. The Partner A budget has a higher amount allocated to shopping and massage because that's important to them.
For restaurants, we usually take turns paying, or if one of us has splurged for the month on other things, the other person can cover an extra dinner or two out. We're liberal with sharing our "fun money" with one another, but it helps remind us that the cheapest option is to eat at home with the groceries we bought, and that if we eat out less, we have more money for entertainment/golf/massages, etc.
Budgeting Software/Methods
What do we use to track our budgets? We currently use the free online software Mint to do our budgeting - www.Mint.com. We've been through a myriad of Microsoft programs and home grown spreadsheets over the years too, but Mint does a nice enough job for us, is free, has a phone app, and is relatively easy to use.
Mint also can show you trends, allowing you to see where you're spending most of your money over time, or if there is one place you always spend your money. As an example, here is a screenshot from Mint showing a sample trend of spending. It's based on the "Partner A budget" only, and you can easily see where they spend most of their money (Food & Dining, nom nom nom):
Mint has a ton of additional functionality that we do not use but could be helpful to you. There are hints on ways to save money, setting goals, etc. This is valuable for when you start dialing in your budget and realize you have a little extra to play with. You can also add as many of your bank or investment accounts as you want, and it will track them. We just have loaded our checking accounts into Mint (no retirement accounts or emergency funds) for simplicity. The checking accounts are our day-to-day accounts that we monitor and use for our budgeting. The others are fairly static or are not accounts we pull money from for our spending. For beginners. we'd just recommend loading your primary checking account, making a couple of budget line items and start tracking them in Mint. You can always add complexity and additional accounts later.
There are also several other options besides using Mint of course. Some people we know (and when we were starting out) use home grown Excel spreadsheets, a piece of paper and a pen, or the envelope system (ala Dave Ramsey) to manage and monitor their budgets. Any of these methods will work. (And actually if you're struggling with the concept of budgeting to begin with, or know you're spending well over your actual income, it probably makes sense to start with the envelope system because it's visual - put cash in separate envelopes labeled with a category with the amount of money you get for that budget item for the month - when the cash is gone, you spent your budget!) Regardless of what method you choose, the key is sticking to a method that will work for you.
Get Started With Your Budget
So enough reading, let's take some action!
List out some obvious budget categories that you know you'll have. For example - auto insurance, rent/mortgage, groceries, daycare, etc.
Determine your method for tracking. Do you want to sign up for a Mint account online? Do you want to use cash and put it in envelopes? Do you want to write every transaction on paper and categorize? You can change your method down the road, but choose something you're comfortable starting with now.
Link your primary checking account (day-to-day spending) account to Mint (you can always add more accounts later), or if not using Mint, determine the easiest way you can monitor this account regularly - online banking maybe.
Pick dollar amounts for each budget item that are slightly HIGHER than you think they should be, and here's why - you need to be able to make/meet your budget, especially at the beginning. Nothing is less motivating than constantly blowing your budget every month and never seeing the light at the end of the tunnel. If you have a fixed price item like your rent/mortgage, sure, dial that in right away. But for groceries, gas, dining out, etc, aim a little high, so you can get a sense of your spending habits. Ideally your budget total is not more than your monthly take-home income, though to start, you may have some bad habits like that that you'll have to start to break. You can always (and should) dial each category back to an affordable, reasonable number over time, once you understand how to live within your budgets. But to get started, pick some numbers.
Start tracking your spending. You can do this on paper, in Excel, Mint, etc. If you've added your bank accounts or credit cards in Mint, this should be fairly easy. But like I noted earlier in the post, you need to maintain budgets to make them useful. So at least weekly (to start) and maybe daily if you're constantly spending money, log onto Mint and reconcile your transactions into the right categories. And stop spending when you've reached your limit!
At month end, review your spending for the month. Are there several transactions that you did not have a budget line for? (shown in Mint as Everything Else). How should you categorize those going forward? Having an enormous "Misc" or Miscellaneous account isn't always a good thing, because if it's always over budget, it's hard to see where you're actually spending your money. Was your budget too high for a couple of categories? We hope so given #4 above! Maybe dial those in $20 or even $5 and see if you fit in the budget again next month. Are you getting close to fitting within your take-home pay? That's ideal, and spending even less than that is what will allow you to reach financial freedom and retire early!
Review and maintain, review and maintain. We promise, at some point this gets fun!
Disclaimer: This article is intended to be a general resource only and is not intended to be nor does it constitute legal or professional advice. Any recommendations are based on personal, not professional, opinion only.