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Why I hate budgeting by categories: how to budget the right way

 

If you want to be wealthy, retire early or just get a better handle on your finances, you’re going to need a budget.

 

There are only 3 steps to becoming wealthy:
  1. Save more money.
  2. Make more money.
  3. Invest the difference between how much you make and save.

 

That’s it! It’s actually that simple.

 

So, in order to crush the game of money, we need to develop good habits around saving more money.

 

Later, as you get raises and have more money to spend, these habits will (hopefully) remain strong and instead of inflating your lifestyle (spending more as you make more), you’ll instead invest the extra money you make and be closer to financial freedom.

 

My budgeting philosophy:

Many people have an elaborate budget. They give money to each category or type of expense they want to spend each month. I used to do this, too.

 

But for me, I think it’s the wrong way to look at budgeting.

 

Budgeting by category means that I give each category a specific amount to spend each month. So rent gets $1,400, restaurants get $300, clothing gets $50, etc…

 

Main Problem #1: First off, there’s no flexibility.

Sometimes, gas will be $120 vs your budgeted $80 because you took a road trip.

 

Or, you will have an unexpected $300 car repair.

 

All of the sudden, your category budgets are all out of whack and the next thing you know, you’re saying, “well, this is a throwaway month, I should just spend whatever and try harder next month.”

 

Main Problem #2: You take small wins and spend the money elsewhere.

The month is coming to a close and I see that I have spent $10 on clothing when I set a budget of $50. Sweet! I have $40 to spend on iPhone games.

 

So, now I’ve just taken a budgeting win and then lost it because I spended money I otherwise would not have spent.

 

When I used to budget by category, I found myself doing this all the time. Ultimately, it didn’t get me any closer to financial freedom each month.

 

Here’s how I budget instead.

I used to budget by categories. But I discovered these mistakes and ultimately lost sight of the main objective. Which is…”saving as much money as you can each month.”

 

Budgeting should not be like dieting, instead, it should become your lifestyle. When spending as little as possible each month becomes your habit, you no longer need to budget by categories because you try to keep all spending to a minimum.

 

For me, Instead of budgeting by categories, I budget by month. Each month, I give myself a target number to hit. The general rule that I’ve been using is “rent + $1,200.” Then I set a stretch goal of “rent + $1,000.”

 

So, because my rent and utilities comes out around $1,400 a month, my monthly budget goal is $2,600 and stretch goal is $2,400.

 

Why this is better for me:

When you are trying to create a habit or lifestyle, making the task as easy as possible is really important. I budget for the whole month because it’s easy to keep track of. I log onto Personal Capital a couple times a week and check one number – how much I’ve spent this month.

 

Let’s say it’s the middle of the month and I’ve already spent $2,200. Yikes, I need to slow down and not go out to eat too much for the remainder of the month. Yes, I do check my spending many times throughout the month, but that is another habit I’ve created for myself because I check all my finance info multiple times per month (spending, income, net worth, investments)..

 

I still look at each expense and category. But I don’t assign a target number to each category. I know I usually spend $200-250 on restaurants each month. If I want to spend $350, that’s fine, but I know I have to sacrifice somewhere else, because there’s only one number that matters, the total amount spent at the end of the month.

 

The potential downside:

All budgeting takes discipline. With more flexibility and less structure, this type of budgeting may require even more discipline. That said, I think a person is more likely to stick with it because it is less restrictive.

 

Ultimately, it takes the understanding that you are trying maximize your savings each month.

 

There is never the thought, “Oh, I’m $300 under budget this month, let’s go shopping!” You must approach spending consistently across the board. Splurge and treat yourself every once in awhile and on stuff that brings you happiness. But don’t go too crazy.

 

Start small and try to reduce your monthly budget by $100 every couple of months until you’ve really minimized your spending.

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