A great way to make a household budget for 2024, financial planners say, is to look at how you spent money in 2023.

You might call it data-driven budgeting: Before you create a spending plan for this year, analyze how you allocated funds last year, to see where your money actually went.

“You need to figure out what happened in the past to have a roadmap going forward,” said Lili Vasileff, a certified financial planner in Greenwich, Connecticut.

Some financial experts term the exercise "backward budgeting," or "reverse budgeting."

(Confusingly, a quick internet search reveals another budgeting technique that bears those names. It’s based on the principle that you pay yourself first, assigning money to savings before you pay other expenses.)

'Data-driven budgeting' can be daunting: A budget app can help

Whatever you call it, data-driven budgeting is a daunting exercise. To do it right, you must pore over hundreds or thousands of expenses and assign them to categories: Streaming services. Take-out coffee. Meal deliveries. Out-of-pocket medical expenses. Housing costs. Veterinary bills.

A budget app can help. As NerdWallet explains, the purpose of budgeting software is to categorize and track spending and to show where your money is going.

Randy Bruns, a certified financial planner in Naperville, Illinois, used a budget app to track his spending last year. He and his wife felt that they were overspending, but they weren’t sure for what.

“We figured out we were spending a ridiculous amount going out to dinner,” he said. “It was absurd: Thousands of dollars a month, just going out to dinner. And we figured out that the big spike was in summer” when warm weather lures suburban Chicagoans out of their homes.

Many of us set budgets based on how much we would like to spend, with little regard for how much we actually spend. Such budgets might be termed aspirational or "forward" budgets.

An 'aspirational budget,' not based on actual spending, can swiftly fail

An aspirational budget can be great for ratcheting down expenses, experts say, by challenging you to spend less on things you don't really need. But it can also meet with swift failure.

“If you’re budgeting without looking at, let’s call it the historical data, you’re starting from a place that isn’t tethered to anything,” said Jonathan Duggan, a certified financial planner in Frederick, Maryland.

With an aspirational budget, Duggan said, “the danger to a financial plan isn’t that the spending is marginally off. The danger would be if you estimated a budget and you weren’t even in the right ballpark.”

Duggan recently examined his own spending and found that it varied dramatically from month to month.

“I have three cats,” he said. “I take them all to the vet basically one time a year, and so in December, there’s going to be a big vet bill coming up. I play a lot of golf in summertime, so my summer months are going to have a bigger recreational budget than my winter months.”

With clients, Duggan said, “what I tend to see is that most people’s spending is too lumpy to really get an accurate picture when one is only looking over a one-month period. What I mean by ‘lumpy’ is things like vacations, doctor’s visits.”

Duggan recommends that consumers review their spending over an entire year to capture the full picture.

“An ideal time to do this is either the end of the previous year or the start of a new one,” he said.

Melissa Cox, a certified financial planner in Dallas, said she is taking on more and more clients who “are not really sure where money goes.” She helps them comb through transaction records to better understand their monthly spending.

Some clients didn’t realize how much they were spending on Amazon impulse buys or Starbucks coffee. One woman had no idea she was shelling out $500 a month for in-app purchases in online games.

“A lot of the time, there’s going to be fat to trim,” Cox said. “Let’s maybe limit it to $200 in-app purchases for the first month. Maybe they realize they can make Starbucks at home.”

Tracking our spending has never been more important

Tracking our spending has never been more important, finance experts say, because so much of it plays out in automatic payments and one-click purchases, transactions we might barely notice.

“It was never easier to spend money without realizing it,” said Christopher Lyman, a certified financial planner in Newtown, Pennsylvania. “Every company wants you on an automated subscription, and there’s a reason why. It continues to draw money out of you without you realizing it.”

All of those auto-pays make it easy for people to lose track. One of Lyman’s clients estimated his spending at about $4,500 a month. Lyman ran some numbers and determined the client was spending nearly twice that much.

“Knowing how much you actually spend is very eye-opening for people,” he said.

Lyman sits down periodically to review his own spending. He stores his transaction records and monthly budget in Quicken, the personal finance app.

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The last time he reviewed the numbers, Lyman decided too much of his budget was going toward the supermarket. “We were spending $2,400, $2,600 a month just on groceries,” he said. “That’s not even dining out.”

His family resolved to “empty out our pantry, empty out our freezer.”

After that, he said, “we really just focused on one grocery store, signed up for the rewards program. We’ve cut our grocery bill essentially in half, just by being cognizant of what we’re buying. If this item’s 50% off because they’re clearing out the shelves, stock up. We just bought 20 bottles of olive oil.”

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