Budgets: Not Sexy But Necessary

Let’s face it, budgets aren’t sexy, well maybe for some ?, but they are a necessary foundation of financial well-being.  Without a budget a person is more likely to overspend, get into debt, and never acquire any real wealth or savings to feel financially secure and independent.  That’s why it’s important for everyone to have at least a skeleton budget in place.  Read on below to see how to start a generic budget.

Starting a generic budget.  You should look back at least a month and write down all your expenses. Depending on your preferred method of spending, you can login to your credit card(s) website, gather receipts, etc.  But going back even farther will probably give you a more accurate picture of your expenses, since there are bound to be one time only expenses and shifts in your expenses month to month.  For example, you’ll probably spend more during the holidays or your (boy)friend’s birthday month.  Going forward, you can track your expenses manually or use a money management site like Mint.com.  I think Mint.com is a great tool in our day and age, but call me old school, I like to track my expenses manually, using excel or google docs.   For a nice comprehensive review on Mint, visit our brother site (literally and figuratively) here.  Tally up your expenses and place them into neat categories like rent or mortgage, car payments & insurance, childcare, groceries, etc. The purpose of tracking your expenses is to get a clear idea of how you spend your money.  This in turn allows you to identify overspending and look for ways to reduce your monthly expenses and create a savings.  How much savings do you need to carve out a month?  As mentioned before in my previous post here, you should be saving around 20% of your gross income.  Obviously this isn’t a hard and fast rule and it might change depending on many factors in your personal life, but its a good starting point for anyone who asks, how much should I be saving?  I say it never hurts to save more where ever you are in life, whether for retirement, a rainy day or some luxury splurge.

There are ways to further subdivide the budget like the popular 50/20/30 rule which says: no more than 50% of your take home pay should go to your necessities like housing and no more than 30% should go to entertainment or luxuries and 20% is for savings, but currently I don’t follow this rule.  I think it’s because when you have simple finances, it doesn’t really matter much what the rest of your money is doing as long as you’re saving at least 20% or more and not incurring any extra debt of course!  But if you’re the type that needs more guidelines on how to budget then definitely use it.  I’m sure it’s helpful for many people.

Pay yourself first budget.  A sort of reverse of first creating a budget and then carving out a savings is to “pay yourself first.”  This means before you pay anyone else, any bills, your landlord, Neiman Marcus, etc, you pay yourself first by setting aside 20% of your paycheck to savings and investing.  Once you’ve removed the amount you need to save monthly first, then it doesn’t exactly matter where the remaining money you have is being spent as long as you’re not spending money you don’t have (i.e. not being able to pay your credit card balances in full every month).

Let’s look at a simple case study (based on mostly true facts, but details have been changed to protect Sarah’s identity).

Sarah is a single professional woman making $100,000 yearly.

She should save 20% of her gross income which is $20,000/year or $1650-$1700/month.

To make things easier, Sarah could adjust her paycheck deductions to maximize her 401k contributions (for 2016 that’s $18,000) then she only has to worry about saving an additional $150/month from her take home pay.  By maximizing her 401K contributions, she’s already mostly paying herself first and saving on taxes.

This leaves $82,000 in taxable income.  Her federal marginal tax bracket is 25% and she might pay about $12,400 in federal taxes + any state taxes depending on where she lives.  If she lives in California like me, she might end up owing roughly $17,500 in taxes total.  Yikes.  This leaves her with approximately $64,500/year or $5380/month in net pay, which is still pretty good if your single.  From here she should be saving at least another $150/month, leaving approximately $5200/month for all additional expenses.

She tracks her spending and realizes she’s spending monthly:

budget

She probably spends a little more or a little less depending on the month, but pretty much she’s living paycheck to paycheck if she continues this pattern.  Sarah needs to cut about $200 out of her expenditures to save $150/month.  So, she examines her initial budget and decides to cut her cable since she wants to watch less Keeping Up with the Kardashians and exercise more anyways.  She cuts her grocery budget a bit by deciding she’ll shop less at Whole Foods buying organic everything.  She won’t buy that cute dress she saw on sale at Nordstrom or the Lululemon pants.  And she’ll try to eat out less during the week and one weekend night a month she’ll find a slightly cheaper entertainment choice.   I know this is an oversimplified example, but you get the idea.  On a side note, in Sarah’s situation, I think she should be trying to save more than 20%, possibly even trying to pay down her student loan, especially if it’s at a higher interest rate.  She could also be saving for a home purchase or a wedding fund??

I think it helps to do both at least initially and you can see they kind of go hand in hand.  It’s a great financial exercise to track your expenditures regularly, especially if you have a spending problem.  Because the research says willpower is a muscle, tracking your expenses regularly helps you spend less and lose weight too!  How awesome is that.  I used to meticulously track all my expenditures on an excel spreadsheet (didn’t lose any weight though) and deduct each expenditure from its designated category to ensure I wasn’t overspending for that month.  For example, if my monthly grocery budget is $300, at the beginning of each month I’d subtract my grocery expenses from $300.  This way towards the end of the month I’d know I only have $X left to spend in each category.  With excel its easy too because you can create mathematical formulas in the cell.
old budget

But now I have two kids, so we just “pay ourselves first” and spend the remainder.  I do however periodically review our expenses to check-up on our budget and see if we’re still headed towards our financial goals.

Don’t feel bad if you can’t get a perfect budget in place right away.  You might have to revise your budget several times and cut back your expenses slowly.  Cutting back your expenditures too dramatically might make you feel deprived and lead to a shopping binge on Amazon or something.  Just as I would approach losing weight, I don’t believe in dieting or starvation techniques, but rather lifestyle changes.  You want to make small but significant changes you can stick with in dieting and with your finances.  I know, I know easier said than done, but you gotta start somewhere and after minimizing your life, the next step should be creating a budget.

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