Step 1: Forgive yourself
Before you start budgeting, you need to do the most important thing of all when it comes to your finances: forgive yourself for any past financial mistakes. You might be living with large amounts of credit card debt, student loans, a poor credit score, or any number of other mishaps. But to move forward from here, I want you to adopt the following mantra:
I recognize the financial decisions that brought me to where I am today. For the successes, I am thankful, and for the mistakes, I choose to forgive myself. Starting now, I will make decisions that lead me to a healthier financial life.
Write it on your arms. Scribble it on the walls. Commit it to heart, and let’s get started.
Step 2: Find your goal
You might have a long term financial goal in mind such as buying a house, getting out of debt, saving for your kid’s college; maybe you want to spend more time with your family or travel the world. The more powerful the goal, the more likely it is that you’ll stick with new financial habits.
If your idea of a goal is a bit cloudy, consider this quote from Lynne Twist, author of Soul of Money,
Money is so intricately interwoven with every other aspect of our lives that when we take a stand to make a difference with our life, it has an organizing effect on our relationship with money, and when we take a stand to make a difference with our money, it has an organizing effect on every other part of our life.
In other words, gaining control of your money just might help you in gaining control of other areas of your life. In my personal experience, my wife and I rarely argue over money thanks to our healthy finances. Also, when I’ve applied the data tracking approach I’ve taken with budgeting to my health, I’ve seen significant improvements in my dietary and exercise habits.
The goals you apply to budgeting are crucial to improving your money habits. Pick a goal you’re passionate about, and keep it with you as you move forward.
Step 3: How much do you make?
In my first job out of college, my annual salary was $31,000. I knew that I got paid on the first of each month, a notable difference from most other jobs I’ve had which paid me bi-monthly. I also knew how much money I could expect in my paycheck down to the penny. When I got married, my household income effectively doubled, which brought new considerations for how our money would be used.
When considering how much you make, maybe you feel like it’s not enough to make ends meet; maybe it’s more than you know what to do with. Regardless how you feel about the total, there’s no moving forward until you’ve committed this number to memory.
Step 4: What are your non-negotiable expenses?
Each month, I’m willing to bet that you pay rent or a mortgage. I’m also sure you pay some form of utilities, a phone bill, or maybe a car payment. Begin tracking your money by adding up these expenses that are crucial to maintaining your lifestyle, or your Non-Negotiable Expenses.
This might be the point where you experience your first feeling of shame or guilt. Some of these non-negotiables might be the result of those past financial mistakes we considered earlier, but since we’ve already forgiven ourselves for any past mistakes, we’ll no longer worry about those feelings that show up when we analyze our spending. I’m officially freeing you of your guilt and shame. This process is about moving forward, and it gets easier over time.
Open your favorite text editor or take out a sheet of paper and write down all the non-negotiable expenses you pay each month. This may include:
- Rent and/or mortgage
- Cable / Internet
- Car payments
- Credit card payments
- Charitable donations
- Medical bills
Add these expenses up, write down the total and assign a label to it: Non-Negotiable Expenses.
Step 5: What are you subscribing to?
I separate subscriptions from Non-Negotiable Expenses because often, we don’t even realize how many subscriptions we’ve signed up for at any given time. With many of the popular productivity and lifestyle tools based on a subscription model these days, it can be easy for these expenses to add up quickly. But the great thing about subscriptions is that most of them can be canceled at any time.
Write down all the subscriptions you’re currently aware of paying for. You might need to search through old credit card or bank statements to see if there are any surprise memberships that you may have forgotten about.
Subscriptions may include:
- Streaming services like Netflix or Hulu
- Club memberships
- Gym memberships
- Web hosting plans
- Phone apps with a subscription plan
- Storage companies or apps
Add them up, write down the total, and assign the label: Subscriptions.
During this step, if you realize that you don’t need some of the subscriptions you’ve written down, feel free to cancel them right away. Every time you cancel an unwanted subscription, you essentially give yourself a pay raise. High five!
For most people, fixed expenses and subscriptions make up a large portion of their spending. Just by recording these expenses, you’ve made incredible progress. If you’re feeling a bit drained after seeing where your money is going each month, it’s okay! This is a natural feeling, so we’re going to take some time to address it.
Step 6: Relax
Grab a drink. Kick back and relax. I want you to know that you’ve done some incredibly difficult work up to this point. You’ve successfully overcome the scariest part of budgeting, and you’re now aware of where most of your money is going each month. Most of the fear of budgeting comes from what’s already been done—the things we’ve already paid for that we might regret.
I also want you to know that, no matter what you’ve discovered in steps 4 and 5, it’s okay. As a reminder, budgeting isn’t about what you’ve done in the past. It’s about giving you the power to take control of your future. If you wanted, you could remove a few of those fixed expenses or continue cutting subscriptions to free up a bit more cash each month. As you’ve probably now discovered by performing the previous steps, you’re in control.
Step 7: Understand your daily spending habits
Now that you’re aware of the expenses you’ve accrued in the past—subscriptions and fixed expenses such as bills and credit card payments—it’s time to face the biggest money monster of all: your daily expenses. This could include dining out, groceries, morning lattes, video games, or any number of other expenses you make regularly.
Most these expenses are done out of habit, built up over most of our lives. Some of us are compulsive spenders, constantly tempted by shiny new toys. Some of us buy things due to peer pressure or addictions. For these reasons, this is one of the most difficult areas to take control of in your financial life. Your daily expenses make the difference between living in constant money stress or becoming financially independent. Seriously.
To help you gain control of your daily spending habits, consider the Pick 3 Rule. Choose 3 spending categories that you enjoy where you can direct most of your spending, and choose 3 problem spending categories where you can start cutting back on your spending.
As a personal example, I enjoy spending my money on books, video games, and music; but I’ve found that I usually regret spending money on dining out, candy, and cappuccinos. When tempted to make one of those problem expenses, I remind myself that it’s not going to make me happy; instead, I direct that money towards one of the areas that I enjoy.
Over the next month, take note of each of the daily expenses you make. If it’s too much work at first to record how much you spent on those purchases, that’s okay; another suggestion is to simply record what you purchased. At the end of the month, reflect on how many of those daily purchases you made; do you remember buying those things? Did they make you happy?
The goal of this step is awareness. You should become aware of all those little purchases you made throughout the month. You should reflect on which of those purchases made you happy, and which ones you regret. Pick 3 that you enjoy, and pick 3 that you don’t. Write down what you’ve learned, and prepare to take the final step.
Step 8: Embrace your budget strategy
Now that you’ve strengthened your awareness around the money that comes in each month and where it goes, it’s time to choose your budgeting strategy. Refer to Part II of our Complete Guide to Creating a Budget that Works for a closer look at the common budgeting methods. No matter what you choose, make sure you enjoy it. Budgeting should be rewarding and become second nature over time.
And remember: your budget is simply a tool to improve your finances. It shouldn’t stress you out. It shouldn’t make you feel guilty. You’re in control, and you now have everything you need to budget effectively.