How to Budget

April 15, 2020

How to Determine Your Budget Categories in 5 Simple Steps

By Priya

April 15, 2020

I start my budget from scratch to make sure it’s relevant to my life and what’s important to me. This involves going through a simple process to determine the best budget categories for my life.

One of the biggest budgeting problems I see is when someone’s budget doesn’t really match their life. Many budgeting systems tell you what categories you need. However, using ‘ready-made’ budget categories is a bit of a shortcut.

It’s a great place to start if you’ve never budgeted before, but, it shouldn’t be a long term solution. To make the most out of your budget, you need to determine which budget categories are best for you.

Why you need personalised budget categories

I’ve tried to use many budgeting systems over the years, however, they were all wrong for me. I eventually just made my own system that combined all my accounting and finance experience. I tried to fit my life into the budget categories these budgeting systems told me to use.

Read more: 4 Reasons Why Budgeting is the Key to Financial Freedom

But they just didn’t fit with my life, my circumstances or my personality. As a result, I found myself getting distracted by things that didn’t matter. I wasn’t focusing on the things that did matter and it was harder to identify problem areas in my spending.

You’re budgeting towards financial freedom, so it’s time to really give your budget the power to change your life. As a result, it needs to reflect your life. Using budget categories that don’t fit with your life won’t give you any control over your finances. How can it? It doesn’t give you the insight and awareness you need to really understand your choices and make changes.

1. Track your spending, saving & income

First, you need to track all your money movements. That means tracking all your spending, saving, donating, investing and income transactions. Here are 5 ways to track your expenses to help you get started.

Read more: How to Use a Budget Calendar to Organise Your Finances

Tracking your transactions will give you eye-opening insight into where your money is actually going. It’ll show you how much you’re spending in each area of your life. Once you know where it’s going you can start to make changes that align with your financial goals.

Expert Tip

How long should you track expenses for?

I’d recommend tracking your expenses for at least 3 normal months. This will give you a more accurate picture of where your money is going. However, there are ways to speed up the process. You can review your bank and credit card statements for the last 3 months instead.

Furthermore, make a note of any infrequent bills and expenses that aren’t captured in the last 3 months of statements. These include things like annual subscription fees and premiums, quarterly taxes etc.

Read more: 7 Budgeting Myths You May Be Falling For

2. Separate your ‘problem areas’ into their own budget categories

Second, you’re going to start identifying your problem areas. You probably already know what these are. But if you don’t, reviewing 3 months of statements should make your problem areas very clear to you. For me, it’s retail therapy and comfort eating. These are issues I’ve known about and been dealing with for a long time.

But they might be something completely different for you, and that’s okay. In fact, that’s encouraged! Maybe you indulge in retail therapy like I do, or you have trouble cooking and eating at home. Your budget needs to reflect your life – not mine and not someone else’s.

Need help identifying your problem areas? Look for large or very frequent transactions and reflect on what they are or why they occurred. Chances are, it’s a spending habit you can’t quite control.

Read more: How to Meal Plan on a Budget

Read more: 6 Simple Tips for Controlling Your Spending

Areas where you can’t control your spending

Any area where you feel you can’t control your spending should be marked as a problem area. There’s no right or wrong area here, and certainly no judgement. You’ll only be harming yourself and your financially free future if you’re not being honest with yourself.

In order to achieve financial freedom, you need to understand your problem areas and make choices to change them. Therefore, including them as separate budget categories will help you track your behaviour and choices in those areas of your life. It’ll be easier to see what’s working, where things are going wrong and what you can do to fix it.

This is why I keep spending and eating out as separate budget categories in my budget. Because I can easily see what’s going on in those categories without distractions from any other expenses.

Read more: 10 Costs to Consider Before Buying Something Expensive

3. Group similar transactions together

Now that we’ve taken care of your problem areas, the third step in the process is to review all your remaining transactions. I love using highlighters as part of my budgeting process and it’ll make this next step much easier. If you have any highlighters or coloured pens sitting around, now’s the time to bring them to the party!

Using one colour at a time, start highlighting your statements. Your aim is to group all similar transactions together by highlighting them in the same colour. For example, highlight all of your grocery spending in orange, and all of your fuel in blue. As you go through your statements, you’ll begin to see common areas where you’re regularly spending money.

Expert Tip

Bills & Fixed Expenses

I don’t categorise my bills and fixed expenses the same way as my variable spending. Since they all have their own unique due dates, I keep them as separate lines in my budget. They’re not grouped with anything else. This allows me to easily see upcoming bills and whether a bill was higher than expected. In my budget, I highlight these transactions in grey. Similarly, I’d recommend keeping all debt & loan accounts as a separate category on their own as well. This will help you track your outstanding balances.

4. Create a category for each savings goal

Next, we’re going to create separate categories for each savings goal. Treat each of your savings goals like different piggybanks. There’s one for each goal. This makes it easier to see how much you’ve saved for each goal so far and how much more you need to save.

I recommend creating a separate goal and, therefore, savings category, for each large bill you might have during the year. For example, insurance premiums, car servicing and holidays. You should also have a separate category for your emergency fund savings as well as any investment accounts.

Read more: 7 Steps to a Debt-Free Travel Budget

5. Add new budget categories when needed

It’s important to keep your budget categories as consistent as possible. This will allow you to see trends in your spending habits and track your progress. However, that doesn’t mean you can’t add new budget categories when needed. One of the biggest mistakes I see people making with their budgets is that their budget doesn’t reflect their life. Your life changes, therefore, your budget should too.

To really make the most of your budget and take control of your finances, you need to determine the best budget categories for your life. This might take a little effort at first but it’s well worth it. Create separate categories for your problem areas, your savings goals and your regular expenses. Try to keep your categories consistent as much as possible as this will allow you to see trends and track your progress. However, if you need to add new budget categories over time then that’s totally fine.

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