Why budget software is backwards
I spent the last 20 years trying to understand how to budget and continuously failing. I'd put together an excel spreadsheet, go through my bank statements and try to understand where all my money was going. I did this because my parents told me I should "have a budget" but they didn't tell me how to make one.
It turns out that my parents didn't budget very well, either. They practiced a technique I like to call "not spending too much" which is great in theory, but in practice looks like "sometimes spending too much."
With programs like Mint, YNAB, and Personal Capital, things got marginally better, but I never understood what they were trying to tell me. My finances were variable, my expenses inconsistent, and any little change seemed to throw any planning I had done out the window.
Eventually, through sheer luck, I realized that every budget I had ever heard of was trying to answer the wrong question. Budgets love to tell you how much you spent on tacos last month. The problem is that this month, you might buy even more tacos or no tacos at all. Budgeting your money for uncertain tacos isn't helpful, it's frustrating because this month was all about pizza.
Instead, you should be trying to answer a much more simple question:
Can I afford tacos today?
I've come up with a system that puts the answer to this question at the core of the whole budget. Every question you have about your budget can be answered with this simple answer and I'm going to show you how to do it.
Step 1: Determine your income
My income is very predictable. I've got a salaried job with a regular paycheck. Aside from occasional changes, my income stays the same every month.
For people who have variable income—freelancers, hourly workers, etc. you'll have to make a judgment call. You can use the average of your income for the last few months, provided you have some buffer, or you can go with your leanest month if you're worried about overspending.
Step 2: Determine your necessary expenses
When I say expenses, these are the things you pay every month. I have to pay rent, my cell phone bill, utilities, preschool tuition, and I subscribe to Google Music and Netflix. This is also where you'd put your car payment and minimum credit card payment.
Step 3: Find the difference.
When you take your income and subtract your expenses, you're left with spendable money. Groceries, gas, restaurants, clothes, every single thing that's not an expense comes out of the spendable amount.
Step 4: Come up with a weekly paycheck.
I'm terrible at planning for the future, so I plan my budget one week at a time.
Take your spendable amount from the 3rd step and divide it by 4.333. This will give you a weekly amount.
Every Monday, I transfer this amount of money into my spendable account. As long as I don't spend more than that in the week, I'm on budget.
Here's where things get interesting.
After a few weeks, you'll start noticing you either spend too much or have money left over.
Step 5: Come up with financial goals (this can happen a while later)
If you spend too much, take a look at your list of expenses. Can you reduce your monthly expenses? Can you spend less over the week? Can you make more money?
If you always have money left over, you should start paying off debt or saving. Do you have an emergency fund? Does your employer have a 401k? Have you opened an IRA?
Large Expenses and Windfalls:
Sometimes big things happen. I get a tax refund most years. While it's exciting to thing of that money as being a vacation fund, I like to use it to make my whole year better instead of just a month or two. I take my tax refund, divide it by 52, and increase my paycheck by that every week for the next year.
Budgets are a tool that you can use to gain information about your finances. It's up to you to decide what to do with them. They're not a way to make you feel bad about your money, but rather to help you realize that there are things you can do.