Making a budget is the most important step you can take to get out of credit card debt faster, yet the high percentage of people with high debt shows how few seem to realize that.
What exactly is budgeting? At its simplest, it’s a ledger detailing the spending decisions you intend to make. It estimates how much money will come in during the months ahead and it allocates enough money to cover expenditures such as food, housing, transportation and insurance. A good budget also includes allocations for regular savings.
Yet few take the time to draft a budget. A Gallup poll showed only 32 percent of Americans have a budget each month. Even fewer, 30 percent, have a long-term financial plan. Instead, they rely on guesswork or a wish list of things they’d like to buy.
If that’s how you manage money, things won’t go well. Before long, your expenses easily outstrip your earnings leading to a financial meltdown.
First let’s dump the misconceptions about budgeting. It isn’t about self-denial, though a solid plan usually contains an element of that. Rather, it’s about outlining your near-term financial future. Remember writing term papers in school and the teacher telling you to make an outline before you began writing?
A budget is like that – a plan for where your money will go before you earn it.
Budgets won’t protect you from disasters, but they can help you avoid them. Unexpected car troubles or a big medical bill can disrupt even great plans, but a good budget can mute the impact. Part of your budget will allocate savings to help you build an emergency fund.
When you get ready to budget, remember to be honest. Self-deception is the worst thing you can bring to the process. Budgets only include money you realistically expect to receive. They don’t include unforeseen windfalls like chance inheritances or winning the lotto.
Budgets have various purposes. They can help you save for a specific goal, like buying a car or a house. They also can help you pay down debt or build a nest egg. When you start the process, decide what the objective is and write it down. It’s easier to reach your goal when you’re reminded of it every month.
To start, resolve to live within you means. Consider Rachel, 26, who is single and takes home $3,500 a month. Her rent is $1,200 a month and she spends $300 a month for groceries. She enjoys eating out, flying to visit her parents several times a year, going to clubs and concerts and maintaining social media accounts. Expenses also include a car, a puppy and a gym membership. And, oh, $300 a month student loan payments.
Rachel outflows average $3,600 a month. The $100 monthly shortfall now goes on her credit card, and the growing interest payments on her credit card is eating up more income every month.
What should she do?
Step one is taking a sheet of paper and drawing a line down the middle. Income is on the left; expenses on the right. She needs to devise a plan that balances the two and, hopefully, leaves a couple hundred dollars untouched for an emergency fund. It’s not easy, but it can be done. Here’s how:
When it comes to a budget, take-home income is the only income that matters. Forget about pre-tax earnings. Your take-home pay is what you can spend or save. Here’s how to determine what your monthly take-home income is:
If you are paid a consistent salary ever other week, multiply your take-home pay for one paycheck by the number of paychecks in a year: 26. Then divide this number by 12 to get your monthly income.
Take your weekly pay and multiply it by the number of weeks in a year: 52. Divide this number by 12 to get your monthly income.
If your pay fluctuates based off of tips, varying hours and/or commissions, you can still calculate an estimated monthly income by adding up 3 months worth of income and then dividing by 3.
When calculating income, also include other income like social security, disability, pension, child support, and alimony. Any money that you regularly receive can be considered income for your monthly budget.
It can be difficult to remember all of your monthly expenses. Start by listing out the bills you pay each month. These will likely include:
After you’ve listed your monthly bills, add in variable expenses including:
The strength of a budget will be determined by how accurate it is. Look at 3 months worth of credit card and/or debit card charges to make sure you are capturing all of the categories where you typically spend money.
Once you’ve identified all of your expenses, add them up. How do your expenses compare to your income? Do you have a surplus or a deficit?
If you have a surplus, consider how you’ll invest or save the surplus money.
If it’s a deficit, study the expenses and decide what to cut. If one of the biggest outflows is lunch at work, consider brown-bagging it four days a week. If it’s a cable TV bill, go for a cheaper plan or cut the cord. A big cellphone bill? Find a cheaper plan or a less expensive provider.
Managing expenses might not be enough. If you can’t get where you need to be, turn to the income. Can you work overtime or find a second job a few nights a week? It might be necessary.
Your income should always exceed your expenses. Budgeted expenditures should never exceed 90 percent of your income. Remember, this is a goal and you might not make it every month, but that’s why you keep a savings account as a backup. Only tap that emergency fund when absolutely necessary, and deposit extra money to it during any month when you take in more than you budgeted.
Using a budget calculator can help you quickly add up your income and expenses. InCharge’s online budget calculator will help you capture all of your expenses and assess what income is required to maintain your expenses.
You can keep budgets on paper, but there are also lots of apps and software that can help you plan your cash flow more efficiently. Quicken, Mint, You Need a Budget and GoodBudget are some the best known and longest running programs. Banks, mutual funds and investment-advice companies offer their own budgeting apps. Look around and find one that works for you.
Remember that a key part of the process is tracking actual cash flows. Keep a ledger or enter income and expenses in a computer program. Then compare the results to the budget. If you’re expenses are too high, rein them in.
Whether a paper budget or something on a computer or smartphone, remember that the budget is a planning tool. You have to take the actions needed to make it work.
Here are some of the top budgeting software options:
Mint, from accounting software powerhouse Intuit, allows you to connect your bank accounts and credit cards and track your expenses. It categorizes them as well and can compare them against budgets you set up. Mint will also send email alerts when you pay bank fees or exceed budget categories. Mint’s expense tracking and budgeting software is free, though you will be targeted with advertising based on your consumer profile.
You Need A Budget is a paid budgeting app that also connects with your bank accounts and credit cards, tracks your spending and allows you to set up budgets and savings goals. The cost is $5 a month or $50 per year. There is a smart phone app that can help you check your spending against your budget in real time.
A spreadsheet is a good tool to use while budgeting because you can change your assumptions and see how they affect your surplus and/or deficit. A well-designed budget spreadsheet will have formulas pre-programmed to add up your expenses and subtract them from your income. You can see how reducing costs 5-10 percent across small areas of your budget add up to larger savings.
When maintaining a budget spreadsheet, consider having two: one spreadsheet reflecting your actual income and expenses and a duplicate that reflects your goals: expenses you are working on reducing (monthly debt payments, for example) and income opportunities you are working to grow. Your goal budget can help you visualize the power of savings over time. Remember, any expense you are able to reduce permanently represents recurrent savings: savings times twelve months in the year.
Download InCharge’s Budget Spreadsheet
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