If you’re like most people, you know you can cover your monthly expenses, but you don’t truly know where your money’s going. Creating a budget is one of those things you tell yourself you’ll do ‘someday’ and by not doing it, there aren’t any immediate consequences. But the long-term consequences can be catastrophic.
Let’s look at a hypothetical example…
John Smith, currently 22 years old, created a budget and noticed he could cut his spending by $100/month. In doing so, he decided to take that $100/monthly and contribute it to a Roth IRA (Individual Retirement Account). He planned on doing this every month for the next 40 years and retire early at age 62. If we assume an 8% annual return, John’s $100 monthly investment would have grown to a whopping $310,868 over that 40-year period!
As you can see, creating a budget might be a time commitment, but it has the potential to be one of the biggest ROIs (Returns on Investment) you’ll find in life.
Now, let’s get started on the actual budget.
Step 1:
Determine where you’re going to keep your budget. You can find plenty of online resources and free budget templates with a quick Google search. There’s also free budgeting apps you can download (Mint, Acorns, Personal Capital).
Here’s a snippet of what a basic budget might look like, and you can get as detailed as you prefer. Keep your personal budget in whatever way is easiest for you.
Step 2:
Next, identify all of your income sources and also all of your expenses. To get an idea of income, I recommend looking at all the checking/savings and financial statements you can find. A lot of people have direct deposit set up for checks. You can also look back at paystubs with your employer, look at your checking account for cash deposits, etc. Use after-tax numbers in your income categories (use what you actually take home each month).
After you’ve determined your monthly income, the next step is to determine your expenses, or outflows each month. You can look through your checking account and credit cards statements here as well. Expenses will include rent, mortgage, car payments, car insurance, student loans, cell phone, utilities, cable/internet, even the sneaky ones like dry cleaning, haircuts, Netflix subscriptions, HBOGo, any iPhone or app subscriptions… I think you’ll be surprised if you really dig through all your expenses — you’ll probably uncover things you didn’t even realize you were paying for!
Then, what you’ll want to do is add up your income and add your expenses — you’ll have either a positive number or a negative number. If you end up with a positive number, great, you’re bringing in more money than you’re spending. If you’re running in the red or negative, it’s time to make some choices on how you want to reallocate. A suggestion is to go back and look at any discretionary items (things that you don’t necessarily have to have). This would include any subscriptions, maybe you’re eating out 4 times a week, maybe there’s a cheaper gym close to you (examine some of your wants and decide if you can go without).
Step 3:
50/30/20 Rule
As a rule of thumb, many agree on a 50/30/20 rule for spending within a personal budget. This is both practical and it also provides a high-level and flexible plan you can adjust for your own personal goals. 50% of money should be spent on needs and obligations, 30% on monthly wants, and 20% on savings and investments.
50%: Needs
Needs are those items in your spending that you absolutely cannot live without or are necessary to your survival and good credit standing. This would include rent, mortgages, car payments, groceries, insurance, minimum debt payments, etc. Half of your after-tax income should be spent on these items.
30%: Wants
These are items that are not absolutely essential, but make life more enjoyable. This would include eating out, entertainment, tickets to events, gym memberships, upgrading your phone, advanced cable package, and others.
20%: Savings
Try to allocate 20% of your take-home pay to your savings and investment accounts. This includes 401K or IRA contributions, emergency funds, savings accounts, accelerated payments on debt and others.
Step 4:
Discipline is everything when it comes to maintaining your personal budget. Feel free to use the above as a rough guideline, but ultimately your financial goals and situation are specific to you.
For example, if you want to pay off a student loan faster, eliminate $100/month from your “Wants” portion of your budget and add it to your “Savings” portion and retire the debt earlier. Again, tweak your budget and spending patterns each month to achieve your specific goals.
By having and maintaining a budget, you’re going to know exactly where you’re money’s going and you can stop worrying about whether or not you’re on track financially.
Create your budget, set your goals and maintain the course! You’ll find that your money will start to work FOR YOU rather than against you!
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