How to Budget Step 8 - Refining your Budget
Very few people have a balanced budget on the first try. This week, I’ll talk about how to refine your preliminary budget if it isn’t in balance. I have been very fortunate in that it has been a long time since I found it challenging to meet my financial goals. Also, I don’t know the specifics of any of your budgets, life-styles, or financial goals. So, in this post, I will identify the changes you can make to refine your budget at a high level and provide links to articles by other financial literacy bloggers that provide a whole host of ideas on the specifics. I hope that one or more of those articles will provide you with the ideas you need to successfully balance your budget.
The Bottom Line
The number on which you’ll want to focus is the Grand Total on the Budget tab. If it is close to zero (i.e., within a percent or two of your total income) and you have incorporated all of your financial goals, you are done. Otherwise, you’ll want to look at the section below that reflects your situation, i.e., whether the Grand Total is positive or negative, to learn how to refine your budget.
Your Budget Shows a Large Positive Balance
Congratulations! If the value in the Grand Total line of the Budget tab shows a large positive number, you have more income than you are spending and saving. You are among the fortunate few.Before spending your excess income, you might want to review your financial goals. Questions you could ask yourself include:
Do I have emergency savings of three to six months of expenses?
Are there other large purchases I’d like to make in the future?
Do I have enough savings to take maternity/paternity leave?
If you have children, am I saving for their education?
Have I studied the full costs of retirement and am I saving enough?
Have I contributed the maximum amounts to all of my tax-advantaged retirement savings accounts (IRAs and 401(k)s in the US, RRSPs, and TFSAs in Canada)?
Do I want to retire sooner (which would require more savings now)?
If you still have a positive balance after your review, you can consider increasing your discretionary expenses (possibly a newer car, a nice vacation, or the addition of a regular treat). Of course, there is never any harm in increasing your savings.
Your Budget Shows a Large Negative Balance
A large negative balance is much more common than a large positive balance. I wish I could give you a magic answer to resolve this situation, but there are really only three options.
Increase your income.
Decrease your expenses.
Borrow money either from a third party or by drawing down your savings.
Unless absolutely necessary, I suggest avoiding the third option. If your expenses exceed your income and you make up the difference by borrowing either from your savings or a third party, you are likely to have a worse problem next year. Unless either your income or expenses change, it can lead to a downward spiral.
Increase Your Income
Increasing your income can be a more effective way to balance your budget. However, it has its own challenges and often requires a significant investment of your time and/or money. Examples of ways to increase your income include:
Get a part-time job, but make sure it won’t jeopardize your primary job.
Work overtime if you are eligible.
Make sure you are earning a competitive wage by looking at relevant salary surveys. If you aren’t, ask your boss for a raise, such as described in this post, or look for another job in your field that pays more or offers more benefits.
Consider getting more education that will provide you with the opportunity to make more money in the future. Some employers will pay for some or all of your tuition if the additional education is related to your job. This choice is likely to cause more pain in the short term but can produce large benefits.
Sell things that you don’t need.
Start your own business. This option is one that I suggest you pursue only very cautiously if you already have a tight budget. Starting a business can be very expensive, which of course will put further pressure on your budget. Also, a large percentage of new businesses fail which means the owners lose money. According to Investopedia, 30% of businesses fail within two years of opening and 50% fail within five years. Of those that survive, one source indicates that many businesses don’t make money until the third year. If you want to start a side business, turning a hobby into a business is one of the most fun ways to do so. Here is an article with some suggestions on how to do so.
There are hundreds of articles about “side hustles.” I’ve provided a few examples. There are lots of pitfalls with side hustles, including many that might end up costing you money rather than making it. So, as with starting your own business, I suggest exercising caution if you decide to proceed with one or more of them.
Decrease Your Expenses
To be blunt, it is hard to decrease your expenses. Here are some tips on things to consider:
Separate your discretionary expenses from your required expenses. Required expenses include the cost of basic housing, a basic car, gas, groceries, medical care, insurance, and the like. Discretionary expenses are things you could live without, even if you don’t want to. Here are a few posts I’ve seen that provide ideas on how to cut back on discretionary expenses.
Review the amount you pay for your necessities to see if you can reduce any of these costs. Here are several posts that provide some ideas.
This post focuses specifically on your cell phone bill.
This post discusses your energy costs.
I really like this post as it covers one of my biggest areas of savings – cooking at home instead of in restaurants.
Figure out how much you are spending to pay off your debts, particularly if you have a lot of credit card debt. Research ways to refinance your debt to reduce the interest rate or, if necessary, lengthen the time to pay. For example, if you have something you can use as collateral, a collateralized loan will have a much lower interest rate than your credit cards. See my post on loans to understand the factors that affect the interest rate on a loan and the sensitivity of your monthly payments to changes in interest rates and term. This post has a lot of great information on repaying student loans. I also like this post which talks about refinancing student loans – are you ready for it and some options.
There are dozens (hunderds?) of blogs on FIRE (Financial Independence, Retire Early). These bloggers tend to post their personal stories about how they are living very frugally so they can retire very early. Although many of their approaches seem almost draconian, reading one or more of their posts might give you some ideas on how you can cut back on your expenses.
There are a few other expenses you can adjust to balance your budget, but I suggest you do them only after you have fine-tuned your budget and looked into refinancing your debt.
Reduce the amount you set aside for savings. Clearly, covering the basics, such as food and shelter, take priority over meeting your longer-term financial goals. Once you have covered those expenses, you’ll need to balance your short-term wants with your long-term goals. For example, you’ll need to decide whether you want to spend more today on entertainment or put more into your savings so you can have the retirement you desire. The idea of foregoing things today to the benefit of something you will get in the future is called delay of gratification. It is a difficult concept to implement in practice but is often a key to long-term financial success.
Avoid taking on too much more risk. For example, one way to save money on insurance (cars, homeowners/renters, or health) is to increase your deductible, lower your limit of liability, or, in the case of car insurance, not purchase physical damage coverage. As I discussed in my post on making financial decisions, these choices reduce your upfront cost but can have serious consequences in an adverse situation. If your budget is tight, you may not be able to afford to pay your full share of costs in the case of a serious accident, damage to your home, or serious illness.
Closing Thoughts
Working to refine your budget to bring it in balance can be a real challenge. If you can't do it on the second or third try, be patient with yourself. Learning to be financially responsible is often a long, challenging process.
