No matter what kind of money person you are: a saver, a spender, an investor or a gambler, you need a budget to ensure that you stay on track with your money. A budget is what underlies any successful money management plan, regardless of whether you live paycheck to paycheck or bring in over six figures.
Believe it or not, budgeting isn’t really about limiting your access to your money; it’s all about getting to know where your money goes. And yes, it’s about keeping things real when it comes to your spending and making sure that you have everything you need covered.
How to Create a Budget:
Creating a budget is really easy and is 100% free, unless you choose to purchase budgeting software. Doing so isn’t necessary and can be a bit on the expensive side, so unless you have no idea how to use Microsoft Excel or can’t find a piece of paper and a pencil, skip the expense and get ready to start budgeting.
• Step 1: Gather all your financial documents. This includes paycheck stubs, monthly bills, bank statements, receipts, etc. Get as much as you can together as each document will bring you closer to seeing the full picture of your financial situation.
• Step 2: Document your income. Write down the amounts of money you get from your job, as a contractor, from family members (if this is regular income), and any other source. Make sure that you use the net income numbers where applicable.
• Step 3: Create a list of monthly expense. Write down everything you can think of that you spend money out on every month. Be sure to include your “fixed” monthly expenses like rent and cable as well as “variable” expenses such as your utilities, groceries, etc.
• Step 4: Redistribute funds. This is an important step when it comes to budgeting. If you haven’t had a budget in a while, you may find the results of the above exercises a bit shocking. You may see that you are spending quite a bit on groceries while eating out most of the time or spending more than you thought on things like dry cleaning when you have a washer and dryer at home. Regardless of what you see on the paper in front of you, know that it is a temporary situation and now is the time to begin redistributing funds in order to make the best use out of your income.
While there are no hard and fast rules surrounding exactly what you should pay for certain things in your budget (i.e. 10% of your income on clothing, 5% on entertainment, etc.) there are certain thresholds you should keep in mind as you begin to redistribute. First of all, know that financial experts tend to think of expenses more in terms of their categories rather than as individual expenses. For example, housing expenses may include your rent or mortgage payment, cable, utilities, and other costs associated with maintaining your home.
Experts agree that 30% of your total, after tax income should be the limit on housing expenses, so for someone making $40,000 a year, this equates to $1,000 per month. Incidentals such as clothing, food, toiletries, and loans (other than a house or car loan), should eat up approximately 15% of your take home pay, or $500 a month for the person in the example above. If you find that you are spending more than allotted 15% on food, then look into online coupon services like Valpak to help reduce your spending.
Transportation is another large category and you should expect to spend 15% of your net income for your car payment, insurance, gas, oil changes and the like. This translates in to roughly $500 for the same person earning $40,000 per year.
The remaining 40% should go towards medical bills, savings, and, of course, the fun stuff.
• Step 5: Set Goals. Are you trying to pay off debt? Save money for a big purchase? Pay for a wedding or a college education? No matter what your financial goals are, you can achieve them through your budget. Put more of your “disposable cash” (the amount in the unallocated 40%) towards reaching your goals. If you find that you don’t have 40% left over at the end of the month, work towards changing your lifestyle so that your budget becomes balanced. Pay off unnecessary loans, downsize your apartment or house, or buy a used car rather than new in order to keep your category spending in line.
Getting your financial house in good order requires you to know how much money you make and where you spend it. The sooner you make a budget, the sooner you’ll be able to get on the road to financial freedom.