Financial Planning – Step 2 – Determine Budget Categories and Sub-Categories
Now that you have established and found your motivation and WHY the next step is to identify your budget categories and sub-categories this stage goes hand in hand with tracking your spending.
This step answers, “How are you supposed to know how much to spend in each of your budget categories without any type of spending history“
1. Budget Categories and Tracking Your Spending
Before you can even think about which bank accounts to open or create a budget or write any numbers down. You need to know where you are spending your hard-earned money. Everything in this step is really important because tracking your spending and sub-dividing your spending into budget categories not only allows you to create a realistic budget but also provides you with the numbers to actually create your budget.
Without tracking your spending, you are basically moving blind and making decisions that will not help you financially. I know it might seem scary to reveal the truth about your spending behaviours. But, I assure you it is important that you actively track your spending.
First Comes AWARENESS and the comes PROGRESS
There are plenty of tools that you can use to track your spending and create budget categories. Your options are:
- Tracking your spending manually
- Tracking your spending using mobile apps
- Tracking your spending using Excel spreadsheets or Google Sheets, and finally
- Tracking your spending using inbuilt functions that are found within your specific banking apps or platforms
2. The Budget By PayCheck Method
In order to accurately track your spending, I suggest using the Budget Moms Budget By Paycheck Method. Her method goes beyond just adding numbers together. It forces you to really understand what your spending is telling you by using the “WHERE DID MY MONEY GO” worksheets. Even the process of adding the numbers together is really helpful because you start to become aware of how money comes in and out of your life.
I must mention that her method is manual, but I strongly suggest you go through it at least for 1-2 months. However, regardless of which tracking method you use, I suggest you are consistent and know that it will be hard and that there are no shortcuts.
One thing I love about tracking your spending is that it forces you to look at your reality. You can not hide or make excuses because you will be able to see exactly what you are doing with your money.
Finally, what I want you to remember is that everyone categorises their spending differently. Even the budget categories that you will create will be different. Meaning the rule of thumb to follow is that make sure you;
- Create budget categories that make sense to you and
- Are consistent with how you organise your categories and spending
3. Manually Tracking Your Spending – Highlighter Method
Once you are aware of where you are spending your money you can set up a plan to make sure you are spending your money intentionally. In order to do this, as I mentioned before I suggest you use the Budget Moms Budget By Paycheck Method. The Budget Mom encourages you to track all transactions (cash and electronic) manually so that you have total control over what category to assign. Tracking your spending this way also avoids double counting of transactions.
PS. TRACK every single amount going in and out of your various accounts.
The next step is to organise the information you have been writing down. Essentially, create your budget categories. I hope it is clear that in order to do this you first need to track your spending.
At this point, you have an expense tracker on paper with all your transactions. Using a highlighter you will go through your expense tracker and take note of similar transactions. For example, maybe you start with anything related to food and mark it using a green highlighter. You then move on to another group of transactions and highlight them using blue highlighter for eg transport and so on.
Once all transactions have been highlighted, you add up each colour. This exercise of tracking your spending manually tells you the following things.
- Exactly where your money went
- Your personalised budget categories
- The total of each category
- A starting point of amounts to put in your budget categories
Tracking your Expenses Manually is worth the TIME and WORK
In order to get started with tracking your spending, you should have completed the Actionable Tasks from Financial Planning – Step 1- Define your WHY and signed up for The Budget Moms Free Resource Library.
Once you have mastered tracking your spending manually. You can start tracking your expenses using mobile apps. I personally have used Money Manager since 2018. Since I have the paid version, I can create unlimited budget categories and subcategories and use the filter options to give me information about my spending over different periods.
4. Fixed, Variable and Periodic Expenses
We are almost at the halfway point. Now that you have all your transactions on an expense tracker or tracking app, either highlighted or combined for you. We are now going to organise our finances and spending much further. The budget categories are used to identify what you NEED to spend versus what you CHOOSE to spend. Essentially identifying your NEEDS vs WANTS.
But your spending can be broken into 3 main types of expenses:
- Fixed Expenses
- Your fixed expenses or bills are known and constant. They cost roughly the same each month and are paid on a regular basis on a predictable known date. Some examples of fixed expenses include
- Rent
- Electricity
- Water Bill
- Internet
- Debt Repayments
- Ground Rates
- Gym Membership
- All Subscription types
- Bank Account Maintenance Fees
- Insurance Payments
- Automatic Savings Contributions
- Automatic Investment Contributions
- Your fixed expenses or bills are known and constant. They cost roughly the same each month and are paid on a regular basis on a predictable known date. Some examples of fixed expenses include
- Variable Expenses
- On the other hand, variable expenses are unknown and mostly represent your daily spending decisions that can be influenced by so many things such as how often you eat out or what your hobbies and interests are. Typically, variable expenses are not essential and fall into the WANTS category. To complicate things even further, the amounts you spend can vary drastically from month to month. Therefore, the recommended way to budget for such expenses is to set the highest amount possible. Trust me, its better to have enough than to have less than you need for your expenses. Some examples of variable expenses include
- Food
- Beauty and Hair Treatments
- Clothing
- Hardware and Electronics
- Transportation
- Fun and Social
- Household
- On the other hand, variable expenses are unknown and mostly represent your daily spending decisions that can be influenced by so many things such as how often you eat out or what your hobbies and interests are. Typically, variable expenses are not essential and fall into the WANTS category. To complicate things even further, the amounts you spend can vary drastically from month to month. Therefore, the recommended way to budget for such expenses is to set the highest amount possible. Trust me, its better to have enough than to have less than you need for your expenses. Some examples of variable expenses include
- Periodic Expenses
- The final type of expense is periodic expenses. They are similar to fixed expenses because the cost is roughly the same or predictable. However, they only occur a handful of times a year. For example on a quarterly, bi-annually or annual basis. Since they only appear fewer times in a year. Most people will forget to add these costs to their financial plan because it is simple to overlook. To avoid this, there are a few things you can do such as adding reminders to a calendar or creating a sinking fund so that you have the money available when the bill is due. Some examples of periodic expenses include
- Car insurance and maintenance
- Car registration
- University and School Tuition
- Annual Subscription Renewals
- Vacation Spending
- Holiday Spending (Valentine’s, Thanksgiving, Christmas, and Birthdays)
- House Insurance
- Property Taxes
- The final type of expense is periodic expenses. They are similar to fixed expenses because the cost is roughly the same or predictable. However, they only occur a handful of times a year. For example on a quarterly, bi-annually or annual basis. Since they only appear fewer times in a year. Most people will forget to add these costs to their financial plan because it is simple to overlook. To avoid this, there are a few things you can do such as adding reminders to a calendar or creating a sinking fund so that you have the money available when the bill is due. Some examples of periodic expenses include
5. Determine Your Budget Categories
We are almost winding up with Step 2, so hang in there. The whole point of
- Manually tracking your expenses for a month
- Highlighting Expenses
- Categorising Expenses between Fixed or Variable
Is so that you start to create a system that makes sense to you and that you can maintain over a long period of time. It is not advisable to create 20-30 different budget categories when it will only make your work difficult in the long run. I started out with 23 budget categories and I am now down to 11. Regardless of how many budgeting categories you decide to keep. Make sure they make sense to you and are maintainable.
Another important thing to consider is how you break down your budget categories. For example, do you simply indicate FOOD in your expense tracker or break it down further into sub-categories such as groceries, meats & fish, restaurants, going out and beverages? The choice is really yours. If you are looking for specific individual data from your spending then you might decide to break it down into many sub-categories. Alternatively, you can use high-level categories if you do not need too much spending data. However, I recommend breaking down your categories first so that you have insight into your spending problem areas. Afterwards, you can simplify things and keep things simple.
Ultimately, your budget categories should reflect what is important to you and your priorities. Of course, these should be different from one individual to another.
6. Actionable Tasks
Now that you have understood the importance of tracking and how organising your expenses into budget categories will allow you to succeed in creating your Financial Plan. Here are your actionable tasks for Step 2.
Step 2- Determine Budget Categories and Sub-Categories
For the purpose of creating your Financial Plan and tracking your spending, I recommend getting the Money Manager App and also using the My Wealth Dashboard (Multi Year) by mwealthdiary. The mobile app will be used to enter your transactions on a daily basis since you can carry it with you. Secondly, the Wealth Dashboard will be used to consolidate all your transactions at the end of each week or every two weeks. Additionally, the dashboard has the added advantage of tracking other important financial numbers, such as your Savings Rate, Your FIRE number and also your Net Worth.
The following are the tasks that you need to complete. After you finish a task, you can tick it off just to help you keep track of what you have done and what else is pending.
At the end of this step, you should have successfully identified your Budget Categories. It might seem a little redundant but doing things manually and then using technology will help you appreciate the budgeting process in later stages.
Good Luck!
