​Five Simple Steps to Build a Budget for Financial Freedom

The key to ending your reliance on a W2 paycheck is more about knowing exactly how much you need each month and less about how much you are being paid. It is also about creating entrepreneurial solutions to solve new financial challenges. Monthly budgets have to cover all the traditional expenses like utility bills, groceries, mortgage, and property taxes, but also include some set asides for bigger ticket items like vacations, a new roof, and college savings for kids. The only way to accurately get a lock on this number is to start collecting accurate data. Below are five steps to building a sustainable budget for financial freedom. This is a two part post, the second post explains 12 Types of Passive Income to Fund Your Budget for Financial Independence

1. Set up a Method to Accurately Track Spending: Fortunately there are several online budget tools such as Mint that make it easy to track spending. The key to being successful is to be consistent and thorough in tracking all spending. So the easier it is to track the data the more likely you will be to stay with the plan.

2. Tracking Leads to Less Spending: People who track their spending are often surprised at how much money they burn through from unnecessary or impulsive purchases. Frequently eating meals out and $5 coffees are common culprits as well. The mere process of tracking spending leads many people to spend less as they become more conscious of each purchase. Another trick is to think about purchases in terms of how many hours of work they require at your after tax hourly rate. So you ask yourself is the item you are about to purchase worth four or six hours in the office?

3. Make Sustainable Cuts and Create Value: The key to reducing spending is to make sure that the cuts are sustainable. Your budget is not a short-term financial diet, it is a spending plan that you can live with for the long term. One strategy is to begin skipping certain items for a month and see if you still need them or if you can find a suitable, less expensive, replacement. The process is not only about letting things go it is about finding creative ways to create value:

- Calling your insurance company and their competitors can lead to finding the same coverage at a lower rate; raising your deductible can cut the cost of coverage;

- Being a volunteer firefighter for a certain number of hours each month can lead to earning tax credits in certain States;

- Having an energy audit can cut your energy bill as can installing new insulation or LED lighting;

- Bringing your lunch to work can save thousands in a year;

- The moving packet at the post office has a 10% discount coupon for major home improvement stores which is perfect when buying appliances;

- Merely delaying a major purchase by a few weeks may lead you to realize it is not necessary or a used option would suffice.

4. Lock In Your Monthly Income Goal: After several months, people may begin to see their spending fall into a regular pattern and they can set their specific monthly spending goal. The budget should also be building up reserves for anticipated big ticket expenses such as new tires for the car, a new HVAC system, or braces for the kids. Track any surprise expenses that emerge and add them to your list as future contingency spending that needs to be accounted for in the budget.

For example, after several months that you are spending $4,000 per month you can start to include inflation into your monthly expenses. Monthly income should climb by about 3% each year to give us the same purchasing power year after year. For our example we will need $4,000 per month this year and $4,120 ($4,000 x .03) per month next year and $4,243.60 ($4,120 x .03) per month in year three. This calculation can be done on a simple excel spreadsheet.

5. Adhere to the Budget, Entrepreneurial Solutions for New Expenses: After a year or two you should have a very accurate inflation adjusted monthly budget. Begin adhering strictly to this budget and measure how much of your budget is being covered from your passive income. If any surprise expenses emerge, don't rely on your regular W2 income to cover the costs, find a creative way to generate new income to address this emergency. An unanticipated $1,000 bill can be covered with a short term job at a retail store during the holidays or working part-time as a tax preparer during tax season. Or, even better, you can start a "business" shoveling driveways or mowing lawns with your kids to show them how to take an entrepreneurial approach to solving financial challenges and to allow them to share in the profits.

Make Progress Every Day In Building Passive Income:

Now that we know our monthly budget indexed for inflation, we can turn our sights on investing in multiple passive income streams to cover our monthly income goal. Your passive income should be increasing every month and it is important to track your net worth and passive monthly income, at least on a quarterly basis. For information on how to begin building your passive income portfolio please see my next post 12 Types of Passive Income to Fund Your Budget for Financial Independence which covers benefits and caveats of 12 different types of passive investments.

Best of luck as you start tracking your expenses and creating your budget goals,

*The above article is neither tax advice nor legal advice (because I skipped the bar exam and moved to Lebanon). Please consult an attorney or a tax professional for any related questions.