Guide to Create a Personal Budget with Financial Independence in Mind

The first step in any journey, is the hardest. But if you take that first step, and apply what you have learned from it, then retiring early, and happily, with less stress in your life is very much in your future. That first step is simple.  Just do a budget! 

Here are the steps to create a real budget. We are not talking about a budget that happens when you run out of money at the end of the month. We are talking about a budget which helps you navigate your way around life’s little and not-so -little surprises.

Identify where your money is going

1. You can also use technology to keep track of your expenses. There are hundreds of Cellphone Apps that can help you accomplish this like Mint and Every Dollar.
   Go get yourself a small notebook or writing pad. One that will fit in the breast pocket of your shirt, suit jacket or sport jacket. (If “you” are a couple then both of you need to do this.)
2. Keep a pen or pencil with it.
3. Every time you spend even one penny, write it down.
   • write down the date
   • write down what you spent the money on
   • write down how much you spent
   • write down if it was cash or credit card
   • do all that on one line, so write very small.
4. Do that for a month! 

At the end of the month you will notice that you have several things that are always the same; rent, insurance, gas, barber, entertainment, allowance – if you have kids, food, clothing, debt, car, etc.

Now go to your computer, open excel and make a spreadsheet. If you are not familiar with Excel, go to Walmart or an office store (OFFICE MAX, etc.) and get a budget book. One of the better ones is DOME: Simplified Home Budget Book. Buy it and record the purchase cost in your little book.

If you have gotten the budget book, record what you spent in the proper categories…. add them up and that is what you spent for one month. If you are using Excel put the date/day of the month across the top and the type of expenditure categories in the rows on the left side going down the page. Add each expenditure/row to the right, and at the bottom add the columns daily to get totals that match. Making sure your numbers are correct.

Tracking your financial habits, your savings, and your expenditures

One month of tracking your expenses is not enough to get a reasonable average. You should track three months of expenditures to help you work on your budget. Note that in this three-month period you will have some one-time expenditures: semi-annual car insurance or life insurance etc.

1. Take each month, average the type of expenditure in each column: food, gas, car, misc., clothes, sundries, what have you… these are your average monthly expenses.
2. You also need to track items like Taxes, Withholding and Retirement Savings.  These items are usually not shown on your checkbook or credit card statement, but rather on your  paycheck.  They are nevertheless part of your budget.You should add to your budget a row for  “Taxes,” “Short Term Savings.” and “Retirement Savings.”  Note how much your total paycheck is. Note that some money goes to State and Fed taxes, some to Social Security and some most likely to your benefits at work. Add those columns into your budget and record the amounts from each pay check.

Why take this extra step? Why write down what is already gone out of your paycheck?

1. 1. This way you realize that each dollar that comes to you goes somewhere and is important. It is after-all your money!
   2. This way you have a record of what was given you.

This way you realize how much other people take from you and how important what you are left with is! Spend it wisely!

Your Monthly Budget is Created

As long as you are able to pay your monthly expenses with your paycheck, and you are currently not in the red, this is the snapshot of what your monthly income and expenses are.  The next step is to look at each budget category and find out if these are acceptable amount of the expenses, and if they are helping achieve financial independence.

Now put the amounts you can spend, in each column/category at the start of the month in budget book or the excel spread sheet. Each time you buy something subtract the purchase, so you know how much is left over to spend for the month in that category.

1. You pay yourself first: Each month you put money into Short-Term Savings. Yes, put it in a bank. I prefer on-line banks they are still FDIC insured and pay more. Look up Capital One: EverBank, or ING.
2. Each month put money in your Long-Term Savings and retirement savings. If your employer has a 401-k use it. If you can, put in enough to cover the whole match he/she is giving you. Note, paying off debt is more important.
3. Each month total up the taxes you are paying and reflect on what you are getting for that. If that doesn’t make you want to vote and participate in the process… then I don’t know what will.
4. DO NOT go over the monthly amounts you have created in each column for each type of expense. If you must then that amount must come from another category.
5. Combine any money left over from categories to your Short Term savings to take control of your finances.

How to use your Short Term Savings to achieve Financial Independence

Many short term savings accounts, specially with online banks, allow you to have separate sub accounts or “buckets” that can help you define different short-term savings goals, here are a few:

1.  The first use of your short term savings should be an Emergency Fund.  The general rule is to have 3-6 months of your monthly expenses in a easily accessible account in case any emergency happens.  Financial experts like Dave Ramsey recommend to at least have $1,000 before going to the next step.
2. If you have expected household expenses like buying appliances, holiday shopping, unexpected travel, etc.  they should be part of your budget, these items can be bundled to “one-off” expenses  that should be covered with your short term savings.
3. If you have debt, like credit cards or loans, you should also use part of your short term savings to pay off debt.  YOU SHOULD NOT HAVE RECURRING DEBT.  As you embark in your personal finance quest, you should understand that Credit Cards should be paid off in full every month.  If you cannot pay off something at the end of the month, this probably means you can’t afford it.
4. Recognize that what you put into a retirement account or IRA or 401(k) is not to be touched. So, put in your retirement account only that which you feel comfortable allocating to your future. If you cannot use an entire Employer Match, so be it. Getting rid of debt (and not getting into debt again) is generally more important than putting money in a 401-k.

Review your budget at least once a year

Every so often you will need to adjust your budget. Do so. Don’t avoid it. Your life will change. You will take a vacation, get married, have a child etc. Any major event will change your life. So just like with life, change your budget.

This is start of the FIRE method of controlling your finances and putting yourself on the path to Financial Independence and Retiring Early!