Most of us understand the basics of budgets and saving money. You list your expenses, then your income, and you're done, right? Wrong. Once you've completed step one, keep going. Ask yourself the kind of questions that will help you understand your debt, expenses, future purchases, and create a realistic and stress-free budget. Here are some questions that will help you get started.
Do I have "Good" Debt or "Bad" Debt? And what's the difference?
If you're in debt, your first priority is to get out of debt; saving can wait for now.
oGood Debt- your student loans, mortgage, real estate loans, business loans, etc. - is investment debt that creates value. Mortgages are typically considered good debt because it helps you maintain a strong credit history, the interest is tax deductible, and homes will generally appreciate over time.
oBad Debt - credit cards, store credit cards, etc. - is debt that doesn't raise your earning potential in the long run. You're financing today's happiness and overspending with no real benefit.
By now you've probably noticed that Auto Loans weren't listed as either "good" or "bad" debt and that's because they can be tricky. Vehicles are expensive and generally financing is necessary. Auto loans can be considered "bad" because the value of a new car depreciates once you drive it off the lot and when that happens you will most likely owe more on the car than it's worth. Also if you have less than fair credit, your interest rates can be very high. On the other hand an auto loan can be good if it's the vehicle you drive to work (which expands your employment and earnings potential), and if you've found a solid deal like a used, high-quality vehicle (which will depreciate much slower) instead of a shiny new, low-end model.
Are you planning to make any huge expenditures in the next 2-3 years? Make sure you budget for those so you have enough set aside when the time comes to sign the deed, the baby's delivered, or when you're putting a ring on it.
How much should I save?
The general rule of thumb is to save 10% of your paycheck, which is fine if you still live if the 60s, or plan on working until you're 80, which most of us are not. These days it's recommended that you save at least 20% of your income and allocating it in the following order:
1.Establish a rainy day fund that will see you through 3-6 months. Remember to factor in family support, unemployment insurance, etc. into your rainy day calculations.
2.Pay off your high-interest debts. The best investment you can make is reducing your liabilities. Think of it this way: you can perhaps get an 8% return in the stock market, though it's risky; paying off your credit card debt, on the other hand, is a guaranteed return of around 12%.
3.Max out your company's 401(k), if they offer it.
4.Max out your IRA contribution.
5.Consider a 529 savings account if you or a relative will incur educational expenses in the future.
6.Invest the rest in regularly taxed accounts.
Given the projections for Social Security and Medicare, we can't count on the same level of government support when we retire. Moreover, as we live longer, we require more money to fund our golden years. A 10% savings rate may have worked back in the old days, but now, 20% is the way to go.
How much should I spend?
So now you know how much to save, what should you do with the rest of your paycheck? Though your own calculations may vary, here's a good starting point for sketching out your budget:
25% to rent or mortgage payments
25% to non-housing necessities like basic food, insurance and health
25% to discretionary spending
20% to savings
5% to charity (more if you can spare it)
Building your Budget
Now it's time to go line-by-line and fill in the details. Most of the grunt work comes in filling in the discretionary and non-housing necessities columns which include things like basic foods (excluding restaurant food), transportation, insurances, medical visits, basic clothing, and other must-pay-for items.
If your absolute necessities dip into your discretionary spending, don't worry it's not the end of the world - just understand why this is the case and act accordingly. We'll cover ways to cut down on these costs but sometimes you'll need to chip away at the discretionary savings section in order to pay for the basics.
Now it's time to start writing it down. First, you don't need to pay money to save money. Start your budget off on the right foot by not wasting money on budgeting products when there are myriad free resources available. Mint is the 800-pound gorilla in the free budgeting world; LearnVest is another great tool but is considered more of an online coach with a focus on financial education with newsletters, "boot camp" programs, and actual Certified Financial Planners available to answer questions and perform free evaluations, etc.
And then there is always the simple spreadsheet. Consider using free office software like LibreOffice - they provide budget templates. It doesn't matter what you use, as long as it's written down somewhere, you're diligent about updating it, and you can track your progress.
Trips, Triggers, and Outsmarting Yourself
Okay, so you've got your budget set up, your expenses and income streams totted up in the right columns, and you're ready to go. It's time to start living up to the budget you've just written.
Set yourself up for success. Financial management is not a sprint, it's a marathon. Make sure that your budget isn't too aggressive, that you automate as much as possible, and you leave room for fun.
Don't be too aggressive. You've added up your monthly expenses; now it's time to allocate the rest. If your housing or necessities expenditures account for less than 25% each of your budget, allocate half the extra amount to savings and half to discretionary spending. Moreover, if you come in under budget in the necessities category, use the extra money to reward yourself for doing well. Pace yourself and don't go on an unsustainable cost-cutting frenzy.
Automate as much as possible. Enroll in automatic deductions for your company's 401(k), if offered, and set up an automatic transfer from your checking account to your IRA or another investment account. Use automatic bill payments for your credit card, utilities and whatever else you can from your checking account, preferably the day after your paycheck is deposited into the account. That way, you've already knocked off the basics and aren't tempted to spend what you never see.
Leave room for fun (and not so fun). It's important to have a rainy day fund for emergencies, but unexpected, fun expenses can also crop up. A summer full of weddings, an anniversary dinner, a gift for a special friend - these can all take an unexpected chunk out of your budget, so be sure to leave breathing room in the discretionary category.
The next step to sticking to your budget is to involve others. Science has shown peer pressure to be incredibly effective in everything from reducing obesity to quitting an addiction to working harder. Leveraging this social impact is a two-step process: Evaluating the ways your circle impacts your finances, and figuring out how to leverage it going forward.
Build the right community. Your default behavior is often what you perceive others to be doing; if your social circle has trouble living within their means, you will struggle to break the mold. If this is the case, consider finding other forms of social support: Join a communal savings group, or find a role model, whether or not you know her personally, and make an effort to emulate her actions.
Leverage your community. Now that you've built up a support network of people who will encourage the behavior you want encouraged, it's time to involve them in the process. Here are a few ideas to get started:
oA simple email list. Choose a list of 4-5 people you trust completely and are not involved in your day-to-day finances (so not your spouse) to be your check-in council. Tell them you'll send them an email every Sunday night that you stay under budget, and ask that if you don't email them, they contact you and ask why. If you get through a year under budget, do something nice for your council - can't go wrong with cookies.
oA savings group. Join an informal savings group that meets every week or so to simultaneously transfer money from a checking to investment account, write a check and use mobile deposit to put it in the bank, or otherwise have a shared, communal feeling of contribution.
oSocial sharing websites. Sites like StickK allow you to set goals, designate a referee and even put money on the line. These apps make it easy to share your progress with your social circle and get some skin in the game.
When it comes to impulse control, you are your own worst enemy. Your strategic-self tells you to contribute to your 401(k), to work out tomorrow, to eat more veggies. Your impulsive-self whispers, life is short so buy the shoes, sleeping totally burns calories, and you can't tell me what to do, strategic-self, I'm going to eat the Cheetos I found in the couch cushions and you can't stop me!
The way to succeed is to take as much power away from your impulsive-self as possible. Automatic deductions to your retirement and savings accounts are one way to do this; Christmas, vacation or wedding savings accounts are another. Beyond that, you need to know where you're most likely to overspend:
If you spend too muchThen you should
At the grocery storeUse Amazon Subscribe and Save or a similar service to automate as many purchases as possible and cut down on trips to the supermarket.
At restaurants, bars or mallsPay only with cash, and only bring as much money as you plan to spend on that excursion alone. If you'd rather not pay with cash, get a no-fee prepaid debit card, and load it from your bank account to avoid fees.
Impulse-buying onlineLoad your cart with all the goodies you like, and then wait at least 48 hours before actually buying.
Try linking your online account to a no-fee prepaid debit card, and load the card from your bank with your monthly online shopping budget.
If you really have trouble controlling the shopping impulse, install a script that will delay the loading of your designated sites by 5 minutes. This will give you cooling-off time and break the instant gratification connection.
really In any one category
Use a no-fee prepaid debit card dedicated solely to that spending category.
In the end, it's up to your strategic-self to stop your impulsive-self from making short-sighted decisions. This can mean making as many decisions as possible when you're cool-headed, and enlisting your community to provide support and feedback. You have the capacity to make your financial goals; just don't let yourself stand in the way.
Sources:4frontcu.com, NerdWallet.com, TIAA-CREC.org, Money.HowStuffWorks.com, Investopedia.com