Those of you who follow me on Anchor, or who listen to my Spanish-spoken podcast “Sobre la marcha” may have listened to a bunch of episodes about personal finance, You Need a Budget (YNAB) and budgets in general. In this post I want to share some notes with those of you that you haven’t listened to that, either because you don’t understand Spanish or because whatever reason.
Budgeting often has been misunderstood with expense tracking by the non-financial laypersons like me. Although they complement themselves and they are incomplete techniques without each other, they are completely different things. While expense tracking is something we do after having spent the money, budgeting is something we do before spending the money, and opens the door to financial control.
This is a dictionary definition of budget:
n. An itemized summary of estimated or intended expenditures for a given period along with proposals for financing them: submitted the annual budget to Congress.
Nothing to do with the actual tracking of expenses that have been already made. That would be expenses accounting or expenses tracking, and it´s something that makes a lot of sense to do in order to validate and refine the budget we make.
In order to make a budget, we work with all the income we have for a period of time. That money should last until the next time we get money, that is, until the next deposit. We assign lumps of that money to specific purposes (that are often called buckets or envelopes), in a prioritised order: first the bills that grant us the housing, water, energy, etc., then the groceries, transportation, and so on. The budget will only be done once all and every dollar is asigned to something, and it’s best to be very specific.
In order to live with the budget, we track the expenses deducting every expense from the bucket or envelope we have created in our budget, until the end of the budgeted period. There is no point on tracking expenses without a pre-existing budget, other than know how many dollars you have spent in shampoo at the end of the year (which gives you some questionable information, but not control).
A good habit is to look at the budget before spending, to prevent spending more than the available money for a given purpose. If we don’t want to have debts, we can’t go over the budget at the end of the period. If we exceed the budgeted amount, we must get some dollars from another bucket or envelope, and use those to cover the overspending.
When we are paid again, we should take a look to the budget and apply the lessons learned for the next period:
- We may have gone over the budgeted amount for a specific purpose. To solve this, we should vary the amounts we put into our buckets, for that not to happen again.
- We may have gone short of envelopes, that is, we may have ran into an expense that wasn’t predicted to fall into the existing budget structure, so we may have picked some money from one of the existing envelopes to cover that expense. For this not to happen again, we must set up additional buckets or envelopes, with the appropriate amount.
Budgeting is hard, and it’s a habit that we have to acquire. There are websites and apps that makes this activity not only easier, but also easier to incorporate to our lives. I use YNAB, for instance. Nevertheless, making a budget is not about using apps that we load on the phone, but about personal financial culture. It’s about embracing a problem and put it under control with a bit of realistic planning. You can use an excel sheet, a piece of paper, physical envelopes or several bank accounts (actual or virtual, as some banks begin to offer). The key is to budget, not how or with what means you do it.
Some final thoughts:
- The base of the budget is risk-free income, that is, income that we will have with no doubt, 100%. Budgeting with future income is impractical in the end, as we can be hit by life in so many ways, so it is better to budget only the money we already have in our bank account, as we receive it, either if we have a payroll or if we get paid by the bills we emit.
- Budgeting to loosely defined buckets, or having buckets with names like “savings” is not a good practice. Assing purposes even for savings is a good idea, because we always save for some reason: rainy days, retirement, a trip,…