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How to Budget for Life: Part 1

Knowing the ins and outs of setting up a personal budget is the first step to taking control of your finances and your future.

If you're reading this article you’re probably interested in making some changes in the way you handle your finances. Developing a budget is one of the best ways to get you started. Why? By understanding how much money you have, you are in a much better position to make informed decisions about where that money needs to go.

Think of a budget as a house's foundation. It is the base on which a strong financial plan is built. Without it, your entire financial structure can become unsteady. So read on to learn more about:

One of the main reasons why you'll want to set up a budget is to reach your short and long-term financial goals. These goals cover major events in your life that you will want to take into account when developing a financial plan. Always had your eye on a house with a big backyard? Want to save for your children's postsecondary education? Looking forward to an early retirement? It's doubtful that any of these things can happen if you go through life spending money indiscriminately, without a plan.

Budgeting is about looking at the big picture, deciding where your priorities are and making a few short-term, changes to reach your goals.

Manage wants and needs

The first step in developing a budget is understanding the difference between wants and needs. When you're grocery shopping, how often do you reach for a box of cookies or a magazine at the counter even if they're not on your list?

Make a promise to yourself that the next time you're thinking of buying anything, ask yourself: Do I need this? Or do I just want it? You'll be surprised how often you'll put it back on the shelf or walk away. Besides, we all know what happens to most impulse purchases. They end up collecting dust somewhere in the house after a few weeks.

Making small changes

It's amazing how often most of us visit an ABM, take out $60 and a day later can't remember where all that money went. Usually that's because we spend the money on the little things — a candy bar here, a coffee there. But it's these little expenses that add up.

These are perfect purchases to start determining the differences between wants and needs. By forgoing that third or fourth cup of coffee, you could be saving yourself more than just caffeine jitters. Let's show you how:

2 cups of coffee per day = $3
5 days per week = $15
50 weeks per year = $750
5 years = $3,750

Over five years, you could save yourself enough money to pay off credit card debts or pay down your mortgage sooner. Of course this money could grow significantly if you decided to invest it.

The reality of budgeting

As you see from the coffee example, making small life changes to meet your budget does not have to be difficult. Discipline and planning for the future make excellent partners. It's simply a matter of remembering why you're saving and not spending in the first place. Like everything else in life, moderation is the key.

Then there is also the issue of cash flow. It always feels good to know you have enough money on hand, but everyone experiences peaks and valleys in their cash flow. The important idea to keep in mind, however, is to make sure your cash flow is working for you.

For example, if you’ve paid off your car and suddenly have extra money on hand at the end of each month, save it, invest it or use it to pay down your debt. But don’t roll it into your cash flow without considering your alternatives. Most people tend to spend the money they have, but if that money is out of sight, it's out of mind and the extra money is now working for you.

Before we start, please remember: Budgets are not about blame, shame, or deprivation. You are simply increasing your consciousness of how you spend money and developing a guideline so you can reach your financial goals. And of course self-discipline is also important.

Step one: Categorize your expenses and income

In this first step, you'll want to set up income and expense categories to track everything you make and everything you buy. These categories might include anything from mortgage payments to childcare or even eating out. Make sure the categories you write down or print out are detailed enough so they can give you adequate ideas about your spending habits.

Step two: Calculate your income

Take a look at your T4 slip from last year to understand your take home pay after taxes. If your pay changes from month to month, try to figure out the average. Note: Do not include surprise funds in this equation. If you do not always get that bonus at the end of the month, don't include it. One sure way to damage a budget is to depend on money you might not have.

Calculate any other extra income such as interest income, bonds, dividends, child support, alimony, pension, and cash from a secondary job.

Step three: Calculate your fixed expenses

Collect your bills for the last two months. The idea here is to understand what your fixed expenses are. Fixed expenses are ones that happen regularly and are planned. There is also one other advantage in knowing what you spend on utilities. You start to look at ways to save money in this area. After inspecting your bills you may be amazed how much of your income goes into insurance, hydro, cable, Internet and telephone services.

If you have other large expenses that come once a year, divide that number by twelve to calculate the monthly number. Don't forget your children's camp expenses, your gym fees, vet bills and medications.

Step four: Write it down

It's time to record what you spend. Some financial books tell you to simply estimate what you spend in each of the non-fixed or variable categories each month and then you'll be on your way to a finished budget. Yet we ask you to take a couple of months to write everything down for a reason: Most people severely underestimate how much money they actually spend on groceries or an evening out. Understanding the full picture is crucial to budgeting success.

Whether it’s dinner and movie, a new sweater, an unexpected car repair, or a gift for a relative or friend, collect the receipts and make it easy for yourself to accurately determine all of your variable expenses.

For the next month or two, try not to change your spending patterns. Just buy what you normally do and record it in your book. After a couple of months, add these monthly expenses and calculate them.

What's the difference?

Now it's time to take a look at the results. Add your monthly income and record it on a worksheet. Add all your expenses and record them too. Now look at the difference between the numbers to see how you're doing. If you have surplus money, you can still find ways to make your money work smarter. Set up a plan with your Scotiabank advisor so that money is automatically taken from your account to invest, for example a Pre-Authorized Contribution or recurring transfer.

If you're spending more money than you have, it's time to take a good look at what you're spending and why.

Points to keep in mind

Know your goals and plan for them
Small changes can have a big impact over time
Think twice about impulse purchase
Write it all down — categorize fixed versus variable expenses

Scotiabank's Money Finder Calculator can help you determine your surplus or deficit by month or by year.