Budgeting may not sound exciting or fun, and in fact, it scares some people. One the other hand, it is the number one way to spend, save smartly, and to get a good handle on your finances. The good news is that budgeting doesn’t need to be complex. Keep reading for simple steps and insights into how to use a good budgeting tool - whether that’s free online software, an Excel spreadsheet, or good old-fashioned pencil and paper.
Before you ever start working with figures, set your goals. Establishing meaningful life goals, whether as an individual or together with your spouse, partner, or family is the first step in budgeting. You don't want to go through life as a rudderless ship, so make sure your financial strategy is taking you somewhere you want to end up. Your goals might include things such as buying a home in three years, planning for impending retirement, taking a vacation to Europe, or simply going for a walk every day. Write your goals down so that you can establish a plan (budget) to meet these goals. Yes, you may have to revise some of your goals along the way, but starting with them sets you on the road to budgeting success.
A monthly budget allows you to live within your means, and allows you to direct funds toward the goals set in step one. Based on these goals, your strategy should help you become free of liabilities (debt), accumulate assets, and use positive cash flow and assets to build a positive net worth.
1. First, determine your net monthly income. Include salary, tips, and child support. This is the amount you have coming in as “take-home pay,” after deductions for taxes, and other paycheck deductions such as health insurance and 401(k) contributions. If your income varies seasonally, work with your average low to be on the safe side.
2. Next, list ongoing, “fixed” monthly expenses such as rent/mortgage and auto payments. Include good estimate amounts for variable expenses that are “must-buys,” such as food, gas, and medicine. Also, set up categories for savings (prioritize building an emergency fund), entertainment, gifts, travel, other categories you spend money on, as well as unexpected expenses throughout the month. For expenses that occur annually or semi-annually - such as some insurance payments - take the total amount and divide by 12 to be able to allot a monthly amount in your budget.
3. Subtract your total expenses from monthly net income. This “bottom line” is your monthly cash flow.
4. If your bottom-line cash flow is negative or does not help you achieve your short- and long-term financial goals, find a way - difficult as it may be - to either increase your income or reduce your expenses.
Developing your budget is the first step toward an improved financial situation. Once you have established how much you plan to spend each month, the hardest part will be using your budget to stick to your plans. Take the following steps to stay on track:
1. At the beginning of every month, map out how you will spend your money in the upcoming month. Don’t forget to pay yourself first - that means heeding the category you made for savings and guarding it fiercely.
2. Track how much you spend by keeping a spending journal. You can also include columns in your budget for “actuals” where you write down your actual expenses in each category on a daily or weekly basis. Check how you are doing each week during the month so you can adjust either your goals or your spending if necessary. Make monitoring your financial health part of your routine.
3. Set up a simple financial system - make it a habit to deposit any cash or checks as they are received. Open all mail (including all bills) as soon as they arrive. Pay each bill immediately upon opening, or use a bill-paying filing system. That “system” may be a folder that resides on a certain spot on your desk, a basket on the kitchen counter, or an online calendar. Choose what works best for you, and then use it religiously.
Be sure to keep good records. You can keep copies of all your bills in manila envelopes, with one envelope for each main expense category. If you’re using an online tool, which requires you to link your bank and credit accounts to the online system, not all of your expenses will appear. You will need to manually enter cash purchases into the online system. (You’ll need to keep those receipts in good order whether you use an online system or not.)
One of the keys to establishing a solid financial situation is to eliminate debt - especially credit card debt. If you have credit card debt, use your budget to eliminate it. First, though, stop adding to the debt. The cash flow that is going into creditors' pockets should ultimately be going into your own savings account.
Instead of turning to plastic, withdraw cash for the week or month, or use a checkbook or debit card to make purchases. Being more conscious of spending will help rein in impulse purchases and reduce overall spending.
If you need to, put credit cards away in a safe place and delete card numbers from online shopping accounts. Cut up your credit cards, freeze them in a bowl of water, give them to your mother for safekeeping, or do whatever it takes to stop using them. However, think twice before closing long-standing accounts with a positive payment history; they positively impact your credit scores.
To use your budget to help you pay off debt, include a category for debt payment. Aim to pay more than the minimum each month - and pay as much as you can. If you cannot pay all of your debts down in a short period of time, choose either the “avalanche” or “snowball” method to proceed. Start by determining a fixed monthly amount you can pay toward your debt. This amount should be more than the combined minimum payments on all of your cards.
1. With the avalanche method, make minimum payments on credit cards with the lowest interest rates, and put all additional available funds to the card with the highest interest rate. Once that is paid off, put excess cash to the card with the second-highest rate, and so on until you are debt free. Include these payment amounts in your budget each month.
2. With the snowball method, pay the minimum on all debts. Apply any remaining funds from your overall allocated amount toward paying off the debt with the smallest balance. After you pay off that debt, continue paying the same monthly amount you started with. Follow the same strategy: Pay the minimum on all debts, but allocate all remaining funds toward your second-smallest debt. Working on debt elimination this way gives some people the most immediate satisfaction. Again, put all payment plans into the budget so you can plan around these the same way you will plan for other expenses.
Start considering savings a “bill” that must be paid, even if it is as little as $1 per day. Often, people find saving easier when they take advantage of direct deposit or automatic transfer to a savings account.
Three types of savings are essential.
1. First, an emergency fund. Start by considering what amount would send you to put an expense on a credit card. A $250 car repair bill? A $500 medical bill? Once you’ve accumulated that, ultimately aim to save enough to cover six to nine months of basic living expenses.
2. Second, plan for short-term savings to cover anticipated expenses, such as holiday gifts. Set something aside from each paycheck for these expenses, and you’ll be prepared when the bills come due.
3. Third, contribute to your retirement savings, whether through an employer or through an individual savings vehicle. Especially if your employer matches your retirement savings contributions, be sure to participate - otherwise, you’re essentially giving away part of your paycheck!
Budgeting can help you avoid this “don’t.” Sticking to a budget makes you much more aware of exactly what you have and what you can (and can’t) spend. Remember that the main reason most people fall into excessive debt is simple: they spend more than they earn. It’s easy to begin this habit. People think, “Oh, I’ll just buy this now and pay it off next time.” But it’s all too common for an unexpected car repair or a doctor’s bill to add more to a credit card bill. Then, if you can pay only a portion of the balance, interest and fees begin to accumulate. When debt becomes much too high, people might find themselves unable to make ends meet each month, charging groceries and utilities. Sticking to a strict monthly budget, and paying with available cash (or using a debit card tied to a checking account) will help you avoid getting stuck in this trap.
Don’t expect to change your spending habits overnight. Set reasonable goals you think you can achieve. If you are spending $100 on movies each month, for example, aim initially to cut it back to, say, $75 instead of something unreasonable like $10. If you find your initial goal too easy, set a harder goal for yourself next month. As you achieve your goals, you’ll begin to gain momentum. In turn, you’ll build the motivation you need to change your financial lifestyle and to keep it in good shape.
It’s true that there are different kinds of debt. Some types of debt are “healthy” in that they can provide reasonable ways to advance your life. These types can include mortgages, student loans, necessary medical bills, vehicle loans, and debt to finance a growing business. But do not persuade yourself that because a debt category is “healthy,” you can spend as much as you like in that area. Many recent graduates are burdened with tens or hundreds of thousands of dollars in student loans that will cripple their financial progress for decades. The recent housing crisis was fueled by homeowners who took on mortgage debt far beyond their means. And every day, cars are repossessed from buyers who couldn’t manage the payments. At best, you could lose income and property to these “healthy” debts; at worst, they could lead you into a spiral of financial despair. If a bill does not fit within your budget, find another way to manage.
Think about the real cost of an item paid for with a credit card when you cannot pay the entire bill off at the end of the month. Would you buy the item if you knew the real cost was not the price tag in the store, but the cost you pay including all the interest? Your $40 pair of jeans could actually cost you $80 if it takes you a few years to pay it off. To avoid unhealthy credit card debt, every time you make a credit card purchase, ask yourself, “Will I be able to pay the bill in full when it arrives?” If the answer is “no,” then don’t make the purchase. Remember, even when you’re sure you’re making a good choice, never commit to more debt than you can afford to pay each month.
Budgeting is the number one way to spend and save smartly, and to get out - and stay out - of debt. A budget, or a spending plan, is simply a way to intentionally spend and save money to meet your goals. It’s easy to feel intimidated by the idea of creating a budget, but once you become used to living with a budget, you’ll find a real sense of freedom in knowing that you control your money - it doesn’t control you.
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