Build A Better Budget Part 2 – Creating Categories

This is the second post in a series about how to build a better budget. You can check out the other posts here:

Build A Better Budget Part 1 – The Mindset
Build A Better Budget Part 2 – Creating Categories
Build A Better Budget Part 3 – Tracking Methods
Build A Better Budget Part 4 – Budgeting Software


Once you’ve established in your mind that a budget is a necessary project to undertake (as outlined in Part 1 of this series) it’s time to get down to business. Are you ready?

How To Get Started

An Excel spreadsheet, a notepad, a napkin, or whatever else you have available is all you need to get started. Your first task is data collection. Simply begin writing down 2 columns of information: your income and your expenses. Try to write down everything you can, even if it looks like a mess at first.

The key to this process is this: make sure every single dollar is listed on your sheet. If you usually grab $3 for a lottery ticket each week, write it down. If you’ve got a subscription to an online music service, write it down. Recurring payments, average grocery bills, etc. Whatever you can think of. It may help to look at a credit card statement during this process to remind you of places you spent money recently so that you don’t under-estimate your expenses.

Next, it’s time to group these items into logical categories. It may help to look at someone else’s budget online, or in some financial software, to give yourself an idea of how to start, but don’t be bound by someone else’s category list! Look at your income and expenses and decide how you’d like to group them together. It’s the only way to make a budget work for you.

Here’s a Budget Worksheet from Crown Financial I’ve found to be helpful for folks over the years, with some helpful guidelines on what some percentages might be of overall income (this gets into setting priorities for your money, so don’t worry about that part just yet).

As you go through this exercise you’ll begin to see your budget take shape before your eyes. Here are a couple of keys to think about as you finish categorizing things:

  1. Make sure that your monthly expenses don’t add up to more than your monthly income
  2. Make sure that your categories aren’t “wishful thinking”. If you’ve been averaging $50/month at Starbux over the last 6 months, then budgeting $20 isn’t going to help you right now. Start with the way things are, then make changes later.

Here’s an example of “someone else’s” budget:

Example of a budget category list

Example of a budget category list – Write it ALL down!

The budget you see above is based on monthly income and expenses. This budgeting method is easier for some, but for others (like me) an annual budget makes more sense. It could be weekly or bi-weekly too, it doesn’t matter as long as the method you choose lines up with how you naturally think about your money.

And one-off expenses will just have to be averaged out. Personally, I keep a “miscellaneous” category for those randoms that come up every not-so-often, like a parking ticket or some pictures we’d like to have printed. Lumped together and averaged out, they aren’t that many, so resist the urge to slap a huge dollar figure on a “catch-all” category, because your tendency will be to put all kinds of items in there. “Yeah I’ll play some golf tomorrow, I’ve got some miscellaneous dollars available I think…” That kind of setup isn’t going to do you any good.

A Tip From FI Pilgrim: Make categories as general as possible

I’ve found with beginners or folks re-creating a budget that it really helps to have as few categories as possible. See if you can blend a few categories together, or create some master categories that hold sub-categories. For example, don’t try to flesh out how much money you typically spend on breakfast, lunch, dinner, dining out, date nights… instead try to merge some of those together into “grocery” and “restaurants”. Later on, if you discover that you’re spending way more money than you would like to be in those categories, you could create sub-categories that help you track “Working lunches” or “Grocery for entertaining”, etc. Start with the easy, big picture categories, then refine them in scope as you go. There will be those areas where you want to get a better understanding over time, but be patient!

And for you married folks you may want to do what my wife and I do, which is to put some money into a couple of  “Allowance” funds for each of you. That way we each have a bit of money to spend on whatever we jolly well please and we don’t need to see eye-to-eye on it. My wife tends to save hers up (she’s awesome like that) while I spend mine pretty quickly (usually on golf-related expenses), but since it’s budgeted it doesn’t bother either one of us how the other spends theirs.

The Next Step

Once you have your expenses listed (and remember, everyone’s category list will be different), you’ll need to decide on two distinct sections to place those expense categories. Are they discretionary, meaning you can decide day-to-day whether you’d like to spend money from that category or not, or are they mandatory, meaning a fixed monthly amount, like a mortgage/loan payment or utility bill.

The benefit of separating them into these two sections is this: your month-to-month budget battles will likely be in your discretionary categories. Those are the areas where self control saves you money, so it’s easier to keep track of those if they are separated out. The mandatory categories are areas where you could put some thought into cutting expenses by switching services, paying off a loan, or canceling a service you don’t need. Those are larger wins, generally, but they don’t usually need to be monitored as closely.

The Devil Is In The Details

The biggest challenge when it comes to creating your categories is making sure that you have a category for everything. Nothing should be received or spent that doesn’t get assigned a category, otherwise the budget doesn’t work. If you stay under budget for the month, but have $100 in uncategorized expenses, that could mean you bounce a check or get an overdraft charge. Your budget didn’t help there! However, if that $100 is categorized (somewhere, somehow) then you have an accurate picture of your spending and where you’d like to improve or change things.

In Part 3 of this series we’ll look at some options you have available to you for tracking how you’re doing with your budget. It’s not as difficult as you might think, but there are a few “gotchas” with some of the methods that you’ll want to be aware of. Stay tuned!

Readers: please add any tips you have on how to create effective categories, so that we can learn from each other!


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