Categories: An Introduction
Now that we have learned the envelope analogy, let’s substitute the word “envelope“ for “categories”.
Let’s face it, we live in a digital age, and we will most likely not be paid in cash and neither will we be stuffing that cash into envelopes stashed underneath our beds. We will still treat these categories as metaphorical envelopes, and these categories will act as the foundation that allows any budget to hold meaning.
Categories, essentially, are what you would title your envelopes when you designate your hard-earned dollars towards a purpose. The importance of your categories lies in the fact that they will be the indicator for how you spend your money.
As you receive your paychecks, you will set aside money for different things. As you spend your money, you will be categorizing them appropriately. Over time, you will start to see which categories have the biggest spending. These are the areas where you can reel in your spending. Categories will also indicate whether you need to plan for a bigger budget or not.
Without proper categorization, your budgeting will be inaccurate and you will continue to ask yourself, “Where does my money go?”
If we do not know where our money goes, then we can never improve on our budgeting.
Therefore, I would like to focus most of our attention on setting up decent categories.
The Art of Making Categories
When we set up a budget, we need to choose how we categorize our spending wisely. Within the budget, categories are the most important part in figuring out where your money is actually going. The first exercise in setting up a budget is listing all the categories and sub-categories that define your lifestyle.
In general, I would recommend that all budgets begin with the following three main categories:
2. Financial Goals
Within each main category, start to brainstorm your sub-categories. Do this by thinking of things you spend your money on and determining which main category they fall under.
The toughest part is making sure that your sub-categories are neither too precise nor too vague. Here’s why:
Sub-categories that are too precise may lead to more work, since you will have additional categories that you need to keep track of. For example, having the following categories: Albertsons, Ralphs, Trader Joes and Whole Foods is too precise. How likely is it that you would go to each of these stores every month? Additionally, what information can you really glean from knowing that you spent $50 at Ralphs and $100 at Whole Foods? Not much. Instead, maybe group together all of your spending at these locations under “Groceries”. Knowing that you spent $300 in groceries is going to be more informative than knowing you spent $50 at Ralphs this month.
Likewise, categories can be way too vague. Having a sub-category titled “Food” does not give you much information at all. It doesn’t tell you if your spending is excessive when shopping for groceries, when dining out, or when celebrating birthdays and special events at restaurants. Knowing that you spent a lot on “food” last month does not specifically tell you where you can cut next month. Cutting on dining out may not help with the food budget, if it is the groceries that you are spending a lot of money on.
With this in mind, how is one to know if their category is just right? If this is the first time making a budget, the next lesson lists some categories to consider. Off course, these cater to a particular lifestyle and are only meant to give you inspiration. Everyone’s lifestyle is drastically different, and a category that might apply to us (auto-payment) may not exist in your life (in which case, Congrats!). Alter these categories as you see fit.
Category Ideas: Needs
Category Ideas for Needs:
· Auto insurance
· Auto Maintenance and Repair
· Auto Payment
· Auto Registration
· Cell Phone
· Business Related (Dentistry)
· Gas (for the car)
· Groceries (including household and personal necessities, such as deodorant, glass cleaner, etc.)
· Homeowner’s or Renter’s Insurance
· House Maintenance
· Medical Bills (including medical insurance)
· Mortgage or Rent
· Pet Expenses
· Utilities (including gas, electricity, and water bills)
Needs categories are the most important set of categories. These are the expenses that provide you with your basic necessities, which include housing and food. These are the things you are not willing to cut in order to maintain a level of comfortable living, as defined by you.
Now it’s your turn. Take a few moments to list your “Needs”.
Category Ideas: Financial Goals
Category Ideas for Financial Goals:
· Emergency Fund
· Student Loan Repayment
· Wedding Fund
· Buying a Home Fund
· Kid’s College Tuition Fund
Financial goals are the second most important thing to budget for. This is because these are the things that lead you towards the life you dream. Referencing your answers to the priorities questionnaire is most useful!
Go ahead! Jot down a few financial goals.
Category Ideas: Wants
Category Ideas for Wants:
· Dining Out
· Flexible Spending Bucket
· Home Improvements
· Gifts Received/ Personal Fun Money
· Personal Care
Wants categories are for the trivial things. These are not essential for your everyday living, neither are they essential for the future life you hope to lead. However, wants can still make us happy.
Go ahead and dream up your wants, in case you have extra income per month.
UP NEXT: PUTTING THE BUDGETING TOOL TOGETHER