Saturday, January 03, 2009

How to Make a Budget

With the New Year comes new resolutions and this year with the world in an economic downturn, there is no doubt that people will be resolving to better their financial situation. Whether your resolution is to save six months of living expenses, to pay off your credit cards, or to simply save more money, the first step you should take is to make a budget to guide you along your way. Here's how to get started.

1. Start a money journal.

For one month, track every penny that you spend. Make sure you track everything from your housing expenses to a pack of gum. There are many ways you can do this but the easiest way I find is to use Mint online. It is an online service similar to Quicken that tracks all of your accounts (savings, checking, loans, investments, etc) and compiles the information into one place. I use my credit card for every purchase I can, even the smallest transaction. That way I can not only track where my money is going but I earn cash back on everything (I use a Chase Freedom credit card).

If you're not comfortable using an online service, or if you are more partial to cash, you can always just keep a written journal of all of your spending.

2. Review

After you have tracked your expenses for 1 month, go back and look at where your money is going. Mint and other personal finance software have features that will automatically create trend reports to show you how much you spend in each category, but don't just stop there. Go through each and every purchase you made and circle anything that you think you could have done without. Notice if you are spending more than you thought in any one area such as dining, entertainment, clothing, etc.

3. Take inventory

Now that you know where your money is going, make a list of all of your essential fixed expenses. These are expenses that occur monthly and are about the same amount every month (rent/mortgage, auto insurance, car payment, taxes, student loans, etc). There may also be fixed expenses that are non-essential such as cable TV, Netflix, Tivo, and so on. List these in a separate column.

You'll also have variable expenses that will change depending on your consumption. These can also be essential and non-essential. Examples of essential variable expenses are water, electricity, gas, groceries and so on. List these as an average of your monthly expense. The non-essential variable expenses will be categories such as dining, entertainment, clothing, shopping, and so on. We'll get back to these later.

As an example, this is what you might end up with.

Essential Fixed Expenses:

Rent: $1,000
Student loans: $150
Auto Insurance: $120
Health insurance: $100
Prescriptions: $20

Total Essential Fixed Expenses: $1390

Non-Essential Fixed Expenses

Netflix: $22
Cell phone: $50

Total Non-Essential Fixed Expenses: $72

Essential Variable Expenses

Electricity: $35
Water: $20
Gas (Home): $25
Groceries: $150
Gas (Auto): $120

Total Essential Variable Expenses: $350

Total: $1812

4. Determine what you have and what you want to have

Let's say that in the above example your take home pay (after taxes) is $2,500. Subtract your total above (in the example $1812) and you are left with the money in your budget for everything else. In the example we are left with $688. The first thing you should divvy out your money to is your savings or money towards paying off debts.

Retirement savings (3%): $125
Emergency fund savings: $200
Down payment savings: $100

Now you are left with $263 to divide among the non-essential variable expenses.

Shopping (household, clothing, personal care) : $100
Entertainment and Dining: $113
Beauty (haircuts, grooming): $50

And voila! You have a budget. The hard part will be sticking to it, but I guarantee that it will be worth it and you will be on track to achieving your New Year's financial resolutions.

Happy saving!

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Mrs. Troy said...

It is nice to see you posting again - hope you had a good new year.

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Take care and good luck in fulfilling your goals

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Get out of debt said...

When doing your budget, don't forget the items that come up only occasionally - eg the annual insurance premium or emergency fund for plumbing disasters and so on. The reason people get into debt is that they don't budget for these and when the expenses come up they borrow to fund it. Work out a monthly amount to fund emergencies and put it in an instant access account so you can draw it when necessary.

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