Create a monthly spending plan

Most Mondays, we post a question from a reader and an answer from Dan Danford. We've skipped a few Mondays due to vacations, but we're back on our regular schedule as of today. Please let us know if you have a question of your own. Post it in the comments section.

QUESTION: I am in the process of setting up a family budget. We are a two-income family with three kids all 5 and under. Our expenses include day care, a mortgage, a second mortgage, and then routine bills (electricity, cable, gas, water, trash, insurance). Can you describe a basic process for how to start doing this and what needs to be in it? How detailed should it be? What should I do with savings?

ANSWER FROM DAN DANFORD: I prefer the term "spending plan" instead of budget. Budget has a lot of negative connotations, and most of us rebel at constraints. A monthly spending plan sounds and works better for most of us.

The process can be very simple. Create a list of recurring expenses. If certain things only come up once or twice a year (insurance or taxes, maybe), divide them out into a monthly amount. Or, better yet, set them up to pay monthly - it might cost a bit more, but the convenience may be worth it. Now, armed with this list, compare to your monthly income. The difference - either a shortfall or surplus - requires more attention.

Monthly deficits require a second look at your expenses. Where can you make adjustments to eliminate the shortfall? Usually, there are some discretionary expenses that can be shifted downward. Entertainment, maybe, or clothing. Lower car payments or rent. As I said earlier, this is a spending plan, so adjust your future spending to fall within your income.

If you have the luxury of surplus (and that is a luxury today!), stash the extra into a bank, credit union, or money market account. Dave Ramsey suggests a $1,000 emergency fund (as a start) and I'd shoot for three to six months of expenses. There will always be emergencies, and it's a genuine blessing to have cash on hand when they come. In fact, that's one measure of financial success in my book! After you've accumulated three to six months of savings, you can start looking at other investments. Like Ramsey, I suggest no-load mutual funds with a bent towards growth. But, until you have an emergency reserve, that's putting the cart before the horse.

In The Millionaire Next Door (Tom Stanley), he notes that few millionaires use budgets. That seems counterintuitive, right? What he found, though, is that they know the important stuff anyway, even without a formal budget. The most important data from a spending plan is how much you spend on things on an ongoing basis. That's the key. If you know what you spend and make good choices, family results are good. The reason why many advisors suggest a plan is because most folks don't keep track of what they spend. That's why they have financial problems.