Your chances of becoming wealthy without budgeting are about the same as your chances of winning the lottery. Do you play the lottery by the way? Win it big yet? In any case, budgeting is fundamental in taking control of your finances and becoming wealthy.
Even the most complicated budgets are based on a simple idea. It can be summed up in an easy way: the envelope system. At the beginning of the month or when you get paid, you get yourself a packet full of envelopes and on each one you write the name of a different category for where the money will be spent. So there’s an envelope for groceries, going out to eat, gas, the phone bill, etc. In this way, as soon as you get paid, your money has already been allocated to where it needs to go. This is great because it means you won’t accidentally spend all of your money on delicious cake instead of saving some for your water bill. Water is just as important as cake after all.
I’m fairly certain that lots of people that do this only use envelopes for bills and then anything that’s left over they just leave as a big wad of cash in their wallets so they can easily blow the rest mindlessly on useless junk. The basic idea of the envelope system (the categories) is the basis for all budgeting. In it’s purest form it has lots of issues though. The main issues are that it uses all cash and having lots of envelopes to carry around is clumsy and bothersome. There should be an envelope for rare bills too, like taxes. So your “taxes” envelope is one that you’ll put money into once per month, and then only spend it when it’s time to pay taxes. It’s very clumsy.
Enter the 21st century of new-fangled gadgets and amazing inventions called “computers,” “bank accounts,” and “apps.” All of these fancy things let us get all of the benefits of a simple envelope system while getting rid of all of the clumsiness and adding some extra bonuses. Every single piece of budgeting software everywhere has categories. The rest of the stuff varies, but the idea is the same. You have to give your money a job BEFORE you spend it. Otherwise there’s no point in having a budget. So no matter how complicated your budgeting software may seem, the essential tool is the categories.
Categories let you
- see how much you have left to spend for monthly expenses like groceries and eating out until you get paid again.
- save little by little for non-recurring bills like taxes, vehicle maintenance, and Christmas presents.
- plan for upcoming large purchases like a new computer, a new car, a wedding, etc.
- prepare for unexpected emergencies.
The major benefits of budgeting come from the last three and they are easier to manage with an electronic system like YNAB or Mint. After a short learning curve you can easily add whichever categories you like and keep your money in the bank or use cash. It really can be that simple. It can be complicated too, if that’s the way you want it to be. We are talking about computer programs after all. So that’s it for the budget. What’s the difference at this point between normal people and wealthy ones? Normal people never move on to the other steps. Either that, or they’re doing their budget wrong.
Just in case, here are some signs you’re not using your budget correctly.
- when an unexpected expense arises you have to take money out of a category that you didn’t want to take it from.
- you’re able to pay your bills but you still don’t know where the rest of the money goes.
- you know where every penny goes and you still feel like you don’t have a choice about what to buy.
If you’re budgeting correctly there should be no true unexpected expenses. Why? Because you have an “unexpected expenses” category of course. And because you’ve included enough for vehicle repairs, large appliance malfunctions, job loss, etc. When you first start budgeting its normal to be surprised from time to time and to have to adjust how much you put into the recurring categories. If it’s still happening after 6 months though, you’re not doing it right and you probably just need to add more cushion somewhere.
If you’re able to pay your bills and you don’t know where the rest of the money goes, then you’re budgeting in a half-assed way because you’re not counting all of your money – you’re only counting some of it. Mint and YNAB can tell you exactly where every penny went when used correctly. If some of your money is magically disappearing every month then you need to enter every single expense, even the dollar you gave to your kid to fly to the moon on that rocket ship at the grocery store. Conversely, all of your money going to a mysterious category named “Miscellaneous” isn’t helpful – more details are better sometimes (and necessary).
If you know where every penny goes and still feel like you don’t have a choice about what to buy, you need to step back and have a look at where your money is going. This is one of those cases where those glib personal mantra sayings on Facebook may help. For example, “Some people live happy lives making half as much money as you do.” Or “Rich people stay rich by living like they’re broke. Broke people stay broke by living like they’re rich.” In other words, you are choosing to go out to eat, go on vacation, fuel your huge clown car, and send your kids to private school, instead of the other things you want to do. When it’s in your budget it’s easier to see those kinds of decisions, you then just have to admit it to yourself!
My personal experience was that I felt I had much more money when I started budgeting. It’s easy to see why – when you know where every penny goes you easily have more control over what you spend. When you can clearly see what’s left in each category you are automatically conscious that when you spend from one, it won’t be available for another. Thus every purchase is automatically prioritized. It lets you see how your money is working for you or against you. Once that’s clear, it’s easier to make better decisions and to be happy about them. Happy budgeting!