Thursday, May 1, 2014

Back to Basics: Budgeting 101

BUDGET – It’s really not a bad word. Unfortunately though, these six little letters can make the toughest among us cower. Resist your instinct, grit your teeth and read on.
paying bills

Budget is perceived to be a word of constraint, but it should rightly be considered a word of empowerment. A budget doesn’t limit the individual or the family, but rather the limitation comes from the amount of household income relative to objectives. A budget is a mechanism that helps you recognize this natural limitation and make better choices in light of it. Take some time this summer, find a quiet place to work and begin developing a budget. You’ll be surprised at just how liberating it can be.

Step 1: Develop a clear understanding of your needs, wants and priorities. Write a list of everything you need and want. Next, think about and prioritize your wants. There are no right answers here. While drinking a $5 latte on a per day basis is not more important than retirement to me, it does not make it wrong if this is a priority for you. Label each want with a number that corresponds to its level desirability. After you have prioritized your wants, calculate the cost of each want. Many of these costs are easy to calculate, but some require a greater level of expertise. Things like college and retirement costs often times require a more detailed calculation and professional help may be in order.

Step 2: Clearly understand your income. This is a fairly easy task. You should consider all sources of income, not just your employment income, but also any rental income, interest or dividend income, pensions, and social security. If you want to develop a monthly budget, make sure you list all income in terms of monthly income (There are 4.33 weeks in the average month).

Step 3: Assess and categorize your expenses. This is a little more difficult, but reviewing bank and credit card statements can make this process easier. For variable expenses, you may want to look back over a period of time to compute your average monthly expense. For annual or quarterly expenses, be sure to adjust them to reflect the monthly cost. You will then use the wants/needs list that you created in step one to categorize these expenses. Once this data is in front of you, take some time and review it. You might be surprised at the amount you are spending on groceries, eating out or filling up your tank. This is what we want to fix and where the fun begins.

Step 4: Create a budget. Obviously, you have to insert your needs first. You may want to take some time to consider each need and its associated cost to ensure that you are getting the best deal.

Step 5: Adhere to your budget. There are many systems out there and you have to find one that works for you. I would recommend taking a look at the envelope system of budgeting or some derivative. If you are more technology savvy, you may want to utilize or similar personal finance websites. The key is not how you stick to your plan, but that you do stick to your plan.
couple using to create budget

After assigning a price tag to each need item, subtract the total of those costs from your monthly income. This calculation will leave you with your discretionary income. You will want to parcel this money out to your wants based on your personal prioritization.

A good budget will help you understand where your money is going and help you make better decisions about how to manage your financial life.  Sites like help you quickly pinpoint weak spots in your spending and see how they add up.  For example ongoing debits like subscriptions and memberships can really start to add up, or extra curricular classes might start to resemble private education when totaled.  Creating, understanding and managing your budget will help you allocate your money towards things you really want and help you make decisions about cutting things that don't fit into your big picture plans.

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