Creating a budget is the first essential step towards taking control of your finances. Many people find that they are spending more than they realize, while the lucky few bless themselves with saving more than they knew.
Envision Your Financial Future
Sometimes it can be hard to remember why you started budgeting until you think of all the things you can do once you have enough money saved. With money in the bank and control over your spending, you will have cash on hand for emergencies, money for your upcoming vacation, extra cash if you find a great deal, and the opportunity for a well-funded retirement.
Try Budgeting Tools
There are many programs and apps you can use to simplify the budgeting process. Quicken might be the most well-known budgeting software, but relatively new entrants like Mint, Mvelopes, and You Need a Budget (YNAB) have many fans as well. The pricing for each of these services varies widely, so compare features and costs to decide which is best for you. If you are comfortable with Excel, you can also create your own spreadsheet, relying on bank and credit card statements to fill in amounts and categories of income and expenses.
Consider Budgeting Types
There are two common budgeting methods: zero-based budgeting and the 50-30-20 rule. In zero-based budgeting, all income and expenses for a given period are accounted for in such a way that no money is left over. This does not mean you spend every dollar you earn each month; rather, it means you know exactly where every dollar went, whether it went into a retirement savings account, a credit card payment, or a checking account.
The 50-30-20 rule assumes you spend 50% of your monthly income on necessities, such as housing, utilities, food, and transportation; 30% on discretionary items, such as premium cable, concert tickets, and restaurant meals; and 20% on savings and debt repayment. This type of budgeting was popularized by U.S. Senator Elizabeth Warren and her daughter Amelia Warren Tyagi in their 2005 book “All Your Worth: The Ultimate Lifetime Money Plan.”
If you choose this type of budgeting, your goal will be to keep your spending on needs and wants within the specified ratios so that you can retain the remaining 20% to put into an individual retirement account (IRA) or pay more than the minimum on your credit card, for example.
Determine Your Monthly Income
If your only income comes from a steady job, calculating your monthly income is as simple as looking at your most recent paychecks. Calculate your net monthly income after taxes and other deductions. If you are self-employed, add your net profits from last year, then subtract estimated taxes and divide by 12. For more accuracy, add your earnings from the last three years and divide by 36.
Add any irregular or passive income, such as bonuses, commissions, dividends, rent, and interest. If you receive this income quarterly or annually, average it out to get a monthly estimate. This will help you design a steady budget that does not change every month.
Gather Your Monthly Expenses
When trying to get a handle on your monthly expenses, you may find it helpful to break them down into two categories.
Essential Expenses
Essential expenses are the bills you must pay every month, including:
- Rent or mortgage and utilities
- Car and home insurance
- Costs
- Healthcare
- Minimum payments on loans, such as student loans and credit cards
- Groceries, gasoline, and other semi-fixed expenses
- Short-term: Vacation, car repair fund
- Medium-term: Wedding, children’s education fund
- Long-term: Retirement
Divide the annual bill amount by 12 for any necessary expense that is paid annually, such as property taxes or vehicle registration fees. This will give you the monthly cost.
Optional Expenses
List optional expenses such as dining out, entertainment, vacations, electronics, and gifts. You can review last year’s credit and debit card statements to calculate your optional spending. Add everything up and divide by 12 to get the monthly average.
Total Monthly Expenses
Add all the monthly amounts and compare your total expenses to your total income. If you are spending more than you earn, you will need to make some changes. If you are earning more than you spend, you are in great shape.
Reducing Expenses
If you are spending more than you earn, your optional costs should be the first thing to cut back on and are the easiest. Prepare a lunch instead of eating out. Watch a movie at home instead of going to the theater. Cancel one of your subscriptions.
It’s hard to reduce fixed costs, but you can save hundreds by doing so. Request a reassessment of your home’s value if you think property taxes might be too high. Shop around for lower rates on your various insurance policies. Buy non-perishable items when they are on sale at the grocery store, and choose fresh produce based on the special discounts offered that week.
Prioritizing Savings
Once your income exceeds your expenses, decide which goals are most important to you. Your savings priorities should fall into three categories:
Divide your savings into separate accounts dedicated to each goal.
Creating a Savings Plan
Now you need to determine how much you should save each month to achieve those goals. A good rule of thumb is to save 15% of your income for retirement, so if you follow a 50-30-20 budget, that will leave you with 5% of your income to allocate towards additional debt repayment and short- and medium-term savings priorities.
Set specific amounts and timeframes (for example, $1000 and six months for a car repair fund), track your progress, and see if you need to drop or scale back a goal. For instance, you might be able to enjoy a lovely long weekend at a nearby beautiful resort instead of a 10-day vacation in France.
Comparing Spending to Budget
Each month, compare your actual income and expenses against your budgeted amounts. You will see areas where you are under and over your expectations. Assess and adjust so you can consistently meet your budget and steadily work toward your goals.
Source: https://www.thebalancemoney.com/create-your-first-budget-453625
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