Creating an easy way to keep track of how much of each paycheck is getting allocated to each expense is key in creating a strong financial plan. Most people manage one or maybe two accounts: paycheck goes into the checking account, and then the month's bills are paid out of the checking. That's a hard way to manage expenses because you can't see at a glance how much of the money in checking needs to be saved for quarterly or annual expenses. A better way is to create money baskets. Money baskets are separate savings or checking accounts that hold money specifically earmarked for a particular financial goal.

Managing Fixed Expenses

Not all fixed expenses come due each month. Rent, mortgage, and loan payments come frequently enough that they are easy to remember. Quarterly and annual expenses are easier to forget until the bill comes in the mail. When this happens you find yourself saying, “This month would have been fine if it wasn't for that real estate tax bill that only happens once a year,” or something along those lines.

Set up an account that will be your fixed expense savings basket. When it comes to fixed expenses, there should be no surprises. A part of your paycheck needs to be allocated to your real estate taxes, insurance bills, mandatory auto inspections, school tuition, and car registrations. Divide all annual expenses by the number of paychecks you receive in a year and have your employer direct deposit the per-paycheck sum into your fixed expense basket account. For example, if real estate taxes are $3,000 per year and you get twenty-six paychecks (you're paid every other week), then $116 per paycheck ($3,000 divided by twenty-six) should go into the fixed expense account. The same simple math can be done for all other fixed expenses, and the combined amount of all will be part of the same direct deposit into the fixed expense savings basket.

If you become aware of a new fixed expense, figure the per-paycheck amount right away and start allocating it into your fixed expense money basket. You'll find it much easier to manage your month-to-month budget and to stick with an investment plan if you figure out how much of each paycheck is already committed to fixed expenses.

Planning for Variable Expenses

Variable expenses are difficult to plan for because they don't come with a regular bill. Fortunately, though, most people are truly creatures of habit and the expenses that might seem variable are somewhat predictable under close inspection.

Variable expenses are all those costs that are not fixed. These might include: utility payments, which tend to increase and decrease seasonally; entertainment expenses; fees for children's lessons or sports; clothing costs; and pet costs. The key to managing these expenses is to check your last twelve months of records — or three months at a minimum — and then estimate an average per-paycheck amount for each. These expenses may seem to fluctuate — e.g., higher electric bills during the winter if you heat with electricity — but if you total all your bills over the past twelve months and take an average, it will be clear how much you should allocate to the variable expense money basket. Entertainment and dining out may seem to fluctuate, and might rise during the holidays, but if you take an average of the total annual amount you spend, calculate a per-paycheck amount, and then deposit that into your variable expense money basket each payday, you won't be surprised.

Spread Out Long-Term Expenses

Establishing a long-term money basket for the things that you foresee but that won't occur for some time is the last step in managing your cash flow. Long-term expenses are much more easily handled if you can start planning for them well in advance. Take some time to list long-term expenses; a family vacation, a major home repair such as a new roof, or school tuition are common expenses that are too big for most people to pay from their regular paycheck, and instead are often paid by credit cards. Credit card interest significantly increases the final costs and reduces the resources you'll have available for future spending.

Wouldn't a vacation be more relaxing and exciting if you weren't thinking of the big credit card bills you were going to have when you got home? To take the stress out of vacation costs, and other long-term expenses, create long-term money baskets. Calculate the per-paycheck cost of each long-term expense as soon as you become aware of it. If you're not yet sure of the total cost, make an estimate. Start building individual money baskets right away. And if you miscalculate and save too much, reallocate that surplus to another money basket.