How to Make a Budget and Set Your Finances on Autopilot

By PURSUIT of FIRE on in Save Money - Level 1

Budgeting often gets a bad reputation. It comes across as one of these boring activities that adults have to do. A task that seems to be set around what you can’t spend and can’t do with your money.

In reality, budgeting can actually help relieve a lot of stress over your finances. When done the right way, it will put your money to work for you on autopilot.

Step 1: Find out what you are spending your money on

The first step to stress free finances is to work out what you are spending your money on. I am not going to get you to guess here, if you do that you are likely to miss things.

I want you to log on to your online banking and download at least 2 months of transactions from your current account (checking account if you are in the US). Most banks will allow you to download transactions for a set period in csv or Excel format.

Once you have this I want you to open it up in Excel or some other spreadsheet software. Now I hope you aren’t a big spender because we are going to go through line by line and categorise what each line is.

You are looking to come up with categories like the following:

  • Income
  • Rent/Mortgage
  • Groceries (e.g your weekly shop or any top-up shops you do)
  • Utility (e.g. electricity, gas, water, sewage, broadband)
  • Council Tax
  • Insurance (e.g. car insurance, house insurance)
  • Car payment
  • Petrol
  • Take Away / Eating Out (e.g any meals you buy that you could have cooked yourself)
  • Going out
  • Luxury Subscriptions (e.g. Netflix, Cable, Dropbox, Spotify, Amazon Prime)
  • Clothing
  • Mobile Phone
  • Travel
  • Child Care
  • Savings

In a new column fill in what category the transaction falls into. There will likely be a few that you aren’t sure about. In which case, just add them to an Unknown category for now.

Your list will likely be different to mine but try and come up with some broad categories for your spending.

The first question you need to ask yourself is, “Am I spending more than I earn?“. If you are in debt then the answer is most likely a resounding yes.

You can use something like a Pivot table or SumIf to calculate how much you are spending in each category. This should give you a good idea as to where all your money is going and which areas you likely need to cut back on.

If this is the first time you are doing this exercise then this might come as a bit of a shock to you. The first time I did this exercise there was a large amount in the Take Away / Eating Out category, more than I would like to admit.

Step 2: What spending is fixed?

Out of all the money you have spent over the last couple of months there will likely be a few that are fixed. These cost you the same each month and either come out on the same date (e.g. rent, mortgage, subscriptions) or are of a regular frequency evey month (e.g. bus pass, train tickets).

The likely categories are:

  • Rent / Mortgage
  • Council Tax
  • Utilities
  • Travel Costs
  • Car payments
  • Mobile Phone
  • Insurance
  • Subscriptions

At the moment all of these things are going to come out of your account on a schedule or come out on a regular basis (such as a bus pass needed for work). These are the first expenses you should write down as part of your budget.

Even if you have a really good month and spend very little this money is going to come out of your account regardless, so you need to keep track of it.

While we are here it might be a good idea to look at some of those subscriptions and see if they are needed. Do you really need to be signed up for Sky, Netflix and Amazon Prime. How much TV can you watch at the same time anyway! Are you still paying £40 a month for your phone contract even though your mobile is already paid off?

Step 3: What spending is essential?

Once you remove the fixed outgoings in the last step you will likely be left with a mismatch of sometimes hard to categorise spending. This is where you really need to use the billing descriptors on your statement to work out what you spent.

In this step we are going to work out which bits of variable spending is actually essential. Don’t worry about the costs at the moment as we are going to try and get a weekly average for each of these.

Out of all the variable spending you should find very few essential items. The main ones will be:

  • Groceries - you need food to live so this is fairly essential.
  • Petrol - if you have to drive to work or do your shopping this is essential to.

I am going to leave out clothing for now. With the exception of children who outgrow their clothes ridiculously quickly, we don’t really need to buy clothes every month, so I wouldn’t count this as essential.

Next you want to divide the total spending in these categries by the number of weeks you downloaded from the bank. This will give you the average weekly spend in these categories.

Finally I want you to multiple this by 5. Now before you say it, I know there aren’t always 5 weeks in a month. The point here is we want to over budget. Worse case scenario there are 4 weeks in a month and you have money left over, shock horror! If you only budget for 4 weeks then you will always only just have enough or be short.

Step 4: What is left?

We have now taken account of the fixed costs and the essentials. The rest is either basic spending that doesn’t occur every month (e.g. clothing) or luxuries. Unless you are already fairly frugal you will likely find that a large portion of your income is going on take-aways, eating out and spending on other stuff you simply didn’t need.

Unfortunately consumerism is the Western way, it is the cultual norm to spend lots of money on crap we don’t need.

Step 5: Building a Budget

Now that we have all our ducks lined up, we can start putting all these numbers into our budget.

Income

We are going to add monthly income as the first line in our budget. If you are an employee with a regular salary then this bit is easy. If you are self employed and your income varies month to month then you will want to use either the average or the lowest amount you normally get as this figure.

Regular Fixed Expenses

Next we need to add all the regular fixed expenses we uncovered in step 2. These are the backbone of your budget and will likely make up a large proportion of your monthly spending. This is where you will see those large items such as rent and mortgage that can’t easily be changed.

Other spending

Here we need to add in the other spending, starting with the essentials first such as groceries and travel costs (for commuting). Then you can add in the other items you have left. As said before put in the average spend on the other items multiplied by 5 to get the monthly spend.

Savings

Hopefully, once you have done Income minus Expenses you are still left with some money at the end of the month. For a blog about Financial Independenc, savings is obviously quite a high priority on my list, and it should be on yours too.

Savings can be categorised into 2 categories:

  • Long Term Savings - Money that you are going to invest and have no plans on touching until you reach retirement. This is money you might put in a Stocks and Shares ISA or SIPP for example.
  • Short Term Savings - Money that you are planning on spending in the next few years but is saved for a particular goal. e.g. Holiday, Wedding.

Now long term savings are fairly self explanatory but I think the short term savings need to be covered in a bit more detail. Short term savings don’t need to be just for big ticket items like holidays or weddings. I also use savings for items I pay out on a yearly basis. This is my list of short term savings:

  • Emergency Fund - Unless you already have a large pot saved you need to be adding a bit every month into a savings fund.
  • Presents - There is nothing worse than getting to December and realising you have to find £400 to spend on presents. It is much better to save this money throughout the year so it is less of a shock come Christmas time. This also works for birthdays too.
  • Holiday - My parents used to put the holiday on the credit card and then pay it off over the year, with interest. I much prefer to save the money up front!
  • Car Insurance - you tend to get the best deals when you pay for your car insurance yearly. It tends to go down each year by a little so you can easily save up for it.
  • House - If you don’t have your own house yet than this could be money towards a deposit. When you do then you will likely need to spend money decorating it our buying furniture, appliances etc.
  • Children’s clothing - I have another savings account that I put money in for children’s clothing. My kids are growing so fast they outgrow their clothes every few months. Saving up money for clothes and shoes means you are less likely to need to dip into other savings to pay for them.
  • Season Ticket - I have to commute to London for work. There is a significant saving to be made on the yearly season ticket so I save up for this each month so I have enough when I need to pay for it.
  • New Car - You should always try and buy a new car in cash rather than with a car payment plan. These plans always have high interest and will result in you oweing more money than the car is worth.

Whether you put all of these pots of money into their own account or just one is up to you. I will cover what I do in a bit.

Guilt free spending

If you still have money left over after your expenses and savings then this is your guilt free spending money. You should put this in a seperate account away from where your expenses come out so you aren’t tempted to overspend.

This is your money to spend on whatever you like. It is effectively pocket money to yourself. Once it runs out that’s it you will have to deal without it until pay day. So you don’t need to cut out your Chinese take-away on a Friday night but it will be coming out of this account so it doesn’t interfere with your bills.

Step 7. Optimising your spending

If this is the first time you have created a budget you may find yourself in the situation of having a negative balance at the end. If that is the case then stop now and go back over your expenses and see if they are really necessary.

In some cases you may be able to just cancel subscriptions you don’t need to save yourself some money.

Other areas you may actually need to set a budget for that category and stick to it. I often find I overspend on groceries if I go to the store, especially if I go when I am hungry! Now we order our shopping online and then go and collect it. This way you can see what the cost is up front and remove items if you go over budget.

Where it get’s difficult is for items like car payments and rent. If you are renting then you could always move into a cheaper property when your lease is up. You are a bit stuck if you bought an expensive house that you couldn’t really afford. If you are serious about saving money then downsizing might be your only option.

In general you should always buy cars in cash rather than throwing money away on interest for car payments. If you have an expensive car that is costing you a lot each month then consider trading it in for a smaller model. Not only will the repayments be less but you will likely also save yourself money on petrol each month.

Step 8. Automate your finances

The last step in is to actually put your budget to work. What?! You though we were just going to create a spreadsheet and leave it there?

To truly automate your finances you are going to need a few more current accounts than you likely have now. If you want a new account quickly consider creating an account with one of the new challenger banks such as Monzo or Starling. You could have you new bank card within a week and it can all be done online.

Current Accounts

I have 3 current accounts that I use to automate everything:

  1. Expenses account - I have this as the joint account I share with my wife. This is the account all the main expenses come out of. All the direct debits are set up on this account and it is also used for grocery shopping.
  2. Salary account - I have my salary paid into a seperate account that doesn’t have any expenses associated with it. I then set up standing orders (automatic transfers) to transfer money from this account into the other current accounts and savings accounts.
  3. Guilt free account - I then pay my guilt free money into another account. This account doesn’t have any automatic expenses set up and is free to be spent as I see fit.

Savings Accounts

I used to have a savings account for each pot of money I was saving for. This is something you can do quite nicely with Monzo. I now just keep all my short term savings in one savings account that has a higher interest rate. I then use a spreadsheet to keep track of what money I have in each pot.

You can have as many savings accounts as you want but you will need at least 2, one for short term savings and one for long term savings. Your long term savings account should be your investment account.

Standing Orders (Automatic Transfers)

When dealing with standing orders you need to always be careful that you aren’t going to go into the red. I have made the mistake before of timing my standing orders wrong due to a bank holiday and then being charged for not having the money in my account.

To overcome this I now keep 1.5 months worth of outgoings in the expenses account and salary account. This acts as my own personal overdraft and stops me from getting overdraft charges.

I get paid on the last working day of the month, which means it is on a different date every month. To compensate this I have set up a transfer for earlier in the month so it is always on a fixed date (depending on the weekends).

This is my current schedule:

  • 24th - Transfer money into Joint account to cover expenses for the following month.
  • Last working day - Get salary paid by employer into salary account.
  • 2nd - Transfer money to savings accounts

The above set up is obviosuly reliant on you not living paycheck to paycheck and having at least a months expenses saved in your current account. If you don’t have that you can always swap the trasfer day and salary day around.

Each month I keep an eye on my expenses account and either top up or withdraw to make sure I keep my 1.5 month expenses buffer.

You may have heard the term “Pay yourself first”, in this example my savings are the first outgoings out of my monthly paycheck.

Hopefully there is enough information here to get your finances on track. We are getting near the end of the year so it is a good idea to start this now and be in the best shape financially in 2020.



AUTHOR BIO

Alex started Pursuit of FIRE in 2019 to try and help people reach financial independence. He has spent nearly a decade working as a software developer in the finance industry and now is looking towards early retirement so he can spend more time with his young family.