Monthly Archives: October 2016

Steps to Create an Effective Budget

Do you think budgets are a concept only for penny pinchers? If you have a high salary, you may not see the necessity of tracking every dollar you spend. But creating an effective budget can still be highly beneficial to your wallet—no matter how big or small.

Wealthy people are anomalies compared to most of the world. Unlike most of us, they have plenty of savings and no debt. A budget will help keep things that way. Remember this universal truth: the earlier you start budgeting and saving, the harder your money will work for you. Frivolous shopping purchases, regular restaurants visits, and frequently giving to family and friends all add up quickly.

I’m not saying you shouldn’t indulge in these things from time to time, but being mindful of your spending habits allows you to save and invest a larger chunk of your paycheck each month. That way, instead of your money mysteriously disappearing, it will multiply. (For more, see: How to Budget and Spend to Maximize Your Happiness.)

“Planning and controlling consumption are key factors underlying wealth accumulation,” wrote Thomas Stanley and William Danko in The Millionaire Next Door. “Operating a household without a budget is akin to operating a business without a plan, without goals, and without direction.” (For related reading, see: Top 3 Secrets to Financial Planning.)

If You’re Spending Less, You Can Invest More
By maintaining an effective budget, you’ll know exactly how much money you’re saving, and in turn, you can give your savings a chance to work for you. Maintaining a monthly budget and investing for the future will also provide you with a sense of security. As you probably already know, there are considerable tax advantages to putting extra funds in your 401(k) retirement account, IRA, or health savings account (HSA). There many other investment opportunities available, from guaranteed products like annuities and CDs, to different mutual fund or stock portfolios.

Your extra savings from budgeting could also be used to buy real estate or invest in other business ventures. Obviously, these options come with different levels of risk and should be carefully assessed before taking the plunge. But once you create a budget, you’ll see there is a myriad of things you can do with your extra funds.

With this in mind, let’s examine the best way to create a monthly budget so you can ensure your money is always working in your favor.

Getting Started On a Budget
Creating an effective budget can accomplish another beautiful thing: it will cause you to pay attention to the things on which you are spending your hard-earned money. By focusing on your individual expenditures each week or month with a budget calculator or budget planner, you’ll probably make better decisions about how you spend, save and invest. With all this in mind, here are some basic steps to follow:

Track your expenses. Go through your bank statements and write out every bill and monthly expense. You may have to average some of them, but that’s okay. This includes all your utility bills, your mortgage, car payment, home, car, and life insurance, child support, child care, student loans, cell phone, gym membership, credit card payments, prescriptions and other outstanding loan payments. It’s best to write these out in a budget planner spreadsheet so you can have everything in front of you.
Record other expenses you encounter throughout the year (excluding monthly expenses) and divide by 12. This includes things like property taxes, car repairs and oil changes, vet bills, glasses or contacts, tax preparation fees, medical expenses, charitable giving, vacation expenses and also camps and lessons for your children if you have them. Dividing the total amount you spend on these items annually by 12 will give you an average of what you need to set aside per month.
Add up how much you spend in various categories per month. Go through your bank statement again and write out approximately how much you spend each month on essentials. These include groceries, gas, clothing. Don’t forget extras like restaurants, parking fees, hair salon fees, gifts, traveling and entertainment. Analyze these amounts. Are you happy with how much you’re spending in each area? If not, set a budget or limit of what you believe is reasonable and attainable.
Record your total monthly income after taxes and subtract all of the above expenses. How does your bank account look now? Are you spending more than you make or is there a considerable amount left over to save? If not, it’s time to make some adjustments in your budget planner in order to create a more sensible plan.
Stay on track. After you create your budget, start regularly tracking your expenses and checking your bank account to see if you’re staying on track. This is the hardest part. You can either do this with your own spreadsheet or use a website that does it for you like Mint.com. Once you enter your credit and/or debit card information, Mint tracks all of your expenses in various categories and sends you alerts if you have overspent in certain areas.

The 50/30/20 Rule and Emergency Fund
First, I recommend creating an easy-access emergency fund savings account that contains at least six months of your monthly income. Next, I would implement the 50/30/20 rule—reserving 50% of your income for essentials like housing and food, 30% for lifestyle choices, and 20% toward financial priorities such as debt payments, retirement contributions, and savings.

As you get more comfortable with your monthly spending habits, this 50/30/20 ratio will change, eventually skewing toward saving more. Please remember, budgeting is often very trial-and-error. You may need to adjust it on a monthly basis until you get in a groove.

More Information About The Beauty of Budgeting

Can you name a Fortune 500 company that doesn’t have a budget? Don’t spend too much time thinking about it – there aren’t any. Successful businesses around the world have one thing in common: They budget their money. And they do it because it works.

But although making money and making a budget appear to go hand-in-hand, a 2013 Gallup poll found that only one in three Americans prepared a detailed written or computerized household budget. Things may be improving somewhat: A Bankrate.com survey in 2015 found a much higher number said they budgeted (36% on paper and 26% on a computer or smartphone app). On the other hand, another 18% didn’t budget and a matching number answered yes to keeping the information “all in your head.”

If you’re one of the non-budgeters (or sketchy budgeters) we’ll show you how to get a better idea of how you spend your money by putting together – and sticking to – a personal budget.
Get Over the Terminology
Part of America’s aversion to budgeting may be rooted in language. The word “budget” – much like the word “diet” – has negative connotations. Budgets and diets are viewed as restrictive reminders of things we cannot have. This is linguistic nonsense. A budget and a diet are both tools. If the tools are used properly, they lead to a desired outcome. Nobody dislikes the word “shovel”, even though the use of the shovel requires effort. People use a shovel to dig a hole. They use a diet to develop a healthy body, and they use a budget to develop a fiscally responsible lifestyle. If it makes you feel better about the process, drop the word “budget” and call it a “spending plan”. Instead of viewing the plan as restrictive, think about the things it allows you to buy. After all, a budget is nothing more than a plan for how you will spend your money.

Start with Your Bills
Many people complain that they can’t create a budget because they don’t know exactly how much money they will earn in a given week. While it is true that workers earning an hourly wage or working on commission might not get the exact same dollar figure in each paycheck, the amount that you earn has much less to do with the basics of budgeting than the amount you spend. Instead of focusing on whether you earn enough each month, focus on your monthly spending. The question is simple: where does your money go?

Regardless of how much you earn or when you earn it, everybody has fixed expenses, such as the following:

Mortgage payments or rent
Transportation (car payment, gasoline, train or bus pass, etc.)
Utilities
Food
Insurance
Healthcare
If your recurring expenses don’t add up to the amount of your monthly income (and one would hope that they don’t), your next step should be to save the receipts from every purchase that you make next month and use them as the basis for creating additional categories or adjusting the numbers in the existing categories.

Beyond the Basics
Once you have the fixed expenses covered, it’s time to plan for the variables, such as the following:

Birthdays/holidays
Gym membership
Pet care
Haircut
Clothes
Vacation
Entertainment
These items are listed as variables for two reasons. The first reason is that these expenses vary from month to month. The second is that if you don’t have the money to cover these expenses, the expenses can be reduced or eliminated without too much difficulty. For example, if you’re out of money, the entertainment budget takes a hit and you stay home on Friday night, or you don’t buy those new shoes that you’ve been considering. Part of taking control of your money is learning how to exercise some discipline in your spending habits.

Look at Your Income
Now it’s time to take the theoretical aspects of budgeting and apply them to your life. Take a look at your monthly income. How much are you bringing in on your worst month? Compare that number to the amount that you are spending. Ideally, the income is larger than the output. If so, it’s time for a personal savings plan. In other words, don’t spend everything you earn – save some for yourself. If you are spending more than you are earning, it’s time to review your spending habits. When the expenditures are larger than the income, you have two choices: increase your income or cut the expenses.

Strategies to increase your income include getting a new higher paying job, getting a second job or finding a roommate to help you with expenses. Strategies to cut your expenses include eliminating impulse buys, which are a major expense for most people, and cutting out planned, but unnecessary, expenses. Keep in mind that simply cutting out that $3.00 cappuccino every morning can save you around $90 a month. The concept is really quite simple – if it’s not in your spending plan, don’t buy it.

SEE: Top 7 Most Common Financial Mistakes

Create Your Spending Plan
Nearly everyone wishes for more money at some point. That said, all but the wealthiest among us are essentially living on a fixed income. In other words, you bring in a certain amount of money each month, and when it’s gone, it’s gone. Accepting that reality is the key to living a happier, wealthier life. Keep in mind that your creditors don’t work for free, so spending money that you don’t actually have is also incredibly expensive. Fortunately, getting your finances on track isn’t that difficult, and while there are spreadsheets and software programs designed to make the budgeting process faster and easier, all you really need is a piece of paper, a pencil and the desire to live within (or even below) your means.
As a general rule, you should also plan to set aside enough money to cover at least three months’ worth of your expenses in case of an emergency. Once that money is put away, you won’t need to rely on your credit cards should you lose your job or experience unforeseen expenses. Like every other recurring item in your budget, the emergency fund is something you fund one month at a time until you reach your goal.

Tips To Stay On Track With Your Budget

At some point in time, you’ve likely made the decision to put aside excuses and start making sincere efforts to improve your financial situation. You probably made some form of budget for your monthly expenses and set some ambitious savings target, only to find the perfect excuse to spend outside your budget and/or pilfer your savings. Sometimes the reason for cheating on your budget is legitimate – emergencies happen – but a truly effective budget accounts for crises.

Even if your budgeting has not gone to plan, there is still plenty of time to get things back on track. Here are our top tips for effective budgeting and saving.

Reality Check
First, you need to determine whether your budget was realistic to begin with. Have you fallen down because it was unachievable, or are you simply spending more than you should be? Many people set a budget and savings plan without fully evaluating their current finances. If you have not met your saving objectives, then this is the exercise to go through, as it sets the record straight and lays the foundation for all your financial planning.

Gather every financial statement you can. This includes bank statements, investment accounts, recent utility bills and any information regarding a source of income or expense. Next, record all of your sources of income. This could be from employment, rent or shares. Record the total take-home pay as a monthly amount.

Create a list of all your monthly expenses. This may include your mortgage payment or rent, car payments, auto insurance, groceries, utilities, entertainment and dry cleaning. Use your bank statements to ensure that these figures are accurate. You then need to break this down into two columns – fixed and variable. Some expenses are the same each month and are essential spending to maintain your way of living. Then list your variable expenses. These expenses will change from month to month.

Finally, you need to total your monthly income and monthly expenses. I hope that your income is greater than your expenses, so you have the potential to save. This means you can look at what you are doing with this excess – if the money is not going into savings, then what are you spending it on? If your income is less than your expenses, then you need to make urgent cutbacks to avoid growing debt.

Cutbacks
Once you have examined your fixed expenses, it is time to look at your other expenditures. Are these areas where quick cutbacks be made? Whether you are budgeting to stop yourself from getting into debt or budgeting to put money into savings, cutbacks are the way to free up funds. For example, are you spending all of your disposable income on meals out? Your bank statements and credit card bills will show you where the areas of overspending are. Once you have identified these areas, you can take steps to curb your overspending.

Impulse Buys
Many people who fail to reach their savings goals are impulse buyers. In order to become an effective saver, you will need to address this behavior. Impulse buys eat into disposable income and can often mean wasted money. Never act on impulse when making purchases. If you see something you want, avoid buying it right away. Take a day to decide on the purchase. If the cost is significant, search for discount sites that may sell it for less money. Become.com and Pricegrabber.com are two sites that can help you hunt out a cheaper deal online.

Keep Track
Several months have passed by and your budgeting has slipped with time. To ensure that you stay updated for the rest of the year, keep daily logs of what you spend so you get a true picture of your spending habits. This will allow you to see if you are slipping into bad habits. If you do see a pattern – take action. Do not let months pass without addressing the issue.

If All Else Fails
We all use our plastic all the time. This makes it very tricky to get a feel for what you are spending. A way to combat this is to turn to cash. Every Sunday, take out your allotted spending money for the week, work out what your daily allowance is and remember that if you over/under spend one day, it will either give you more or less money later in the week. This is an effective way to understand your finances better.