A 4-Group Budgeting System
Creating a budget is often viewed as a limiting activity. But the truth is that a budget, or knowing what you spend, allows you to answer life's biggest financial questions and can give you the confidence to take some pretty big and rewarding actions.
As much as budgeting is about knowing your "keep the lights on" expenses, it's also about empowering you to be intentional about your spending and giving you a true "guilt-free" spending number.
Importance of a Budget
The idea of creating a budget and tracking your spending can be overwhelming. But taking the steps to understand your spending will ultimately empower you to make some of the most important financial decisions of your life.
Knowing how much you spend is a critical component of a financial plan. Without a handle on your spending it is very challenging and even impossible to be confident in our projections.
Your expenses are a necessary variable in answering so many questions:
- How much should I save for retirement?
- What types of investment accounts should I use?
- Am I on track for retirement?
- How much should I keep in my emergency fund?
- How much life and disability insurance do I need?
In this post, we will walk through a 4-group budgeting system to give you confidence in answering these questions and more.
Budget Overview
This budget system breaks your spending into four categories: Fixed, Variable Needs, Flex, and Non-Monthly.
- Fixed expenses are monthly expenses that are exactly the same each month. Common expenses in this category include mortgage, rent, debt payments, phone, and internet bills.
- Variable Needs are monthly necessities that are roughly the same month-to-month. Common expenses in this category include groceries, utilities, gas, and home goods.
- Flex expenses are your discretionary purchases, or wants. Common flex spending includes dining out, shopping, and entertainment.
- Non-monthly items are large expenses or goals that may only occur once or a few times each year. Common non-monthly items include travel, out-of-pocket medical costs, home & auto maintenance, and annual or bi-annual insurance premiums.
Your Fixed and Variable Needs categories will help you understand your monthly "keep-the-lights on" expenses. Planning for your Non-Monthly items will account for those big expenses that can easily "blow up" a budget. And your Flex spending can be viewed as your "guilt-free" bucket and is best spent where you derive the greatest value.
Here is how to identify your budget categories and set initial amounts.
How to Set-up Your Budget
You may follow these three steps to set up your initial budget. But it should be acknowledged that budgeting is a process, not a one-time event. Your first budget will be wrong and life will change, leading to necessary tweaks and adjustments to your budget. What's most important is to get started.
Step 1: Create Your Budget Categories
Download and review your bank and credit card transactions over the last 3 months. Use this information to create your budget categories and assign them to a group (Fixed, Variable Needs, Flex, or Non-Monthly).
Step 2: Set Your Budget Amounts for Fixed, Variable Needs, and Flex Expenses
Fixed Expenses
Fixed expenses should be the easiest items to identify and assign a budget, as they are exactly the same each month. Identify the monthly amount of each of these expenses.
Below is an example of fixed monthly expenses.
Variable Needs
Your variable needs are not precisely the same each month, but typically average a similar amount. For example, your variable needs spending may look like the following.
As a starting point, consider averaging your last 3 months of spending in each category to use as your budget. For example, if you spent $1,100, $1,300, and $1,200 on groceries in the last 3 months, use $1,200 as your monthly grocery budget. You may refine this amount over time as you review your budget and get better data.
FLEX SPENDING
Your Flex spending is meant to be your discretionary purchases, or wants. This can be thought of as your "guilt-free" spending bucket.
The types of spending in this bucket can vary significantly from month to month. For example, some months you may spend heavily dining out, while in others you spend your "guilt-free" bucket on shopping. The screenshot below demonstrates the variation in Flex spending categories each month.
As a result of this varying spending, I recommend a different budgeting approach for this group. Instead of setting a budget at the category level, set a budget for the entire group.
As a starting point, consider taking an average of your last 3 months of expenses in this category and using that as your Flex group budget.
Step 3: Set Targets for Your Non-Monthly Expenses
Setting targets for your non-monthly spending categories is challenging due to the infrequency of spending and, for some categories, lack of control. For example, below may be what your non-monthly spending looks like over a year.
For these expenses, rough estimates are an acceptable starting point. Certain categories, like bi-annual insurance payments can be known precisely. Travel can be estimated based on your vacation plans. And while we can hope there won't be any big home, auto, or medical expenses, you may use historical spending or a safe estimate as an initial budget.
Once you have a full year's worth of data, budgeting for these items will be far easier. For example, you could use a previous year's actual spending to inform your current year budget like in the screenshot below.
Monitoring & Adjusting Your Budget
Your first budget will be wrong, but it is a monumental step in managing your finances. The next step is to review your budget on a regular basis and make updates as needed. Frequent updates are more likely in the early stages of your budgeting journey, but over time you will get more comfortable and accurate with your figures.
Early on you may review your budget monthly. Once you have built 3-6 months of good data, you can review your budget amounts and make necessary adjustments.
The fixed and variable needs categories should fall into line quickly, but it will take longer to understand your non-monthly spending.
A personal finance app is an incredily valuable tool to make tracking your spending easier, more engaging, and more actionable.
Using a Budgeting App
While you may track your budget by hand or in excel, budgeting apps, at the cost of about $100 per year, can save significant time, get both partners in a household more involved, and build excellent data.
For clients who do not already have a preferred budgeting app and/or method, we build this four-group budget in Monarch Money. (All the screenshots in this post have been taken from Monarch Money.)
A few excellent benefits of using an app like Monarch Money include:
Visibility for the Household
A shared budgeting app allows easy visibility of account balances and your budget.
Personalized to You
Depending upon your preferences, you can create your own categories and goals to align your budget with how you think about and spend your money.
Smart Categorization
With every transaction, you have the opportunity to create a "rule" to automatically categorize certain merchants in a specific category. Over time, you will find yourself doing less and less manual categorization.
Excellent Data for Your Financial Plan
Upon initial set-up, many historical transactions are pulled into Monarch. Over time, you build out more complete data to make informed decisions for your future.
With data like this, you can be confident in your financial plan's projections. For those working towards retirement, you can be confident in your expenses and know what is left over to save for your goals. For those nearing or in retirement, you can be confident in the cost of your lifestyle, the portfolio withdrawal that will be required to maintain that lifestyle, and the outlook for your plan.
Final Thoughts
As a financial advisor, it is extremely challenging to develop recommendations without confidence in our spending assumptions. While creating a budget may feel like a daunting and restrictive task, the knowledge is critical for good financial planning and empowers you to answer the most common and important questions.
When you know exactly where your money is going, you gain the clarity and confidence to make decisions that truly support your goals, whether that’s preparing for retirement, building your savings, or simply enjoying life without second-guessing every purchase. Tracking your spending isn’t about restriction; it’s about empowerment. With a clear understanding of your expenses, you can plan for life’s surprises, enjoy your discretionary spending guilt-free, and make meaningful progress toward the future you want.
To learn more about Kardinal Financial's financial planning services, visit the Contact page to schedule an introductory call.