Contents
Personal Finance Basics
How to Create a Budget
How to Save Money Effectively
How to Open a Checking Account
How to Manage Credit Cards, Charge Cards, and Debit Cards
How to Invest Your Money
How to Get a Loan
Personal Finance Checklist
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How to Create a Budget
A budget is a plan that helps you set spending limits based on your income and savings goals.
Why Create a Budget?
Creating a realistic budget—and abiding by it—is the foundation of successful personal finance. More specifically, budgeting helps you analyze your spending and avoid spending more than you earn.
Analyze Your Spending
Budgeting enables you to analyze where your money goes every month: you’ll see how much you spend on food, utilities, entertainment, healthcare, insurance, and so on. You can then use that information to adjust your spending if necessary, such as by cutting back entertainment expenses to increase your monthly surplus for saving or investing.
Avoid Spending More than You Earn
People who don’t follow a budget tend to spend everything they earn—and even more. In fact, in 2006 the average savings rate in the United States fell to –1%, its lowest level since 1933. Most people start by overspending and end up in debt because they fail to compare the amount of their income to the amount of their spending. The ease with which anyone can get a credit card compounds the problem, since credit cards enable you to spend borrowed money—rather than money you actually have in the bank—to buy everyday items or cover monthly expenses.
Sticking to a budget helps you avoid the temptation to spend beyond your means, even if you do use credit cards. Budgeting properly also leaves you with a surplus of money each month that you can use to save, invest, or cover unexpected expenses, such as medical bills.
How to Start a Budget
In its simplest form, a budget is a list that allows you to track and compare your monthly expenses and income.
- Expenses: These include both fixed costs, such as rent and mortgage payments, and variable costs, such as restaurants and entertainment.
- Income: These include sources of monthly income beyond just your paycheck, including investment dividends, alimony, child support payments, and so on.
You can create a budget using software, such as Quicken® or Microsoft Money®, or by following these four steps:
1. Track Your Spending for a Month
Carry a pocket-sized notepad with you everywhere you go for one month. Every time you spend money—cash, check, or credit card—write down the precise amount of the
expense with a brief description, such as “gas, $25.” At the end of each week, compile all of your spending data onto a spreadsheet in which you categorize each expense. All of your expenses should be divided into two main categories—
essential expenses and discretionary expenses—each of which should have the following subcategories:
Essential Expenses
- Food (groceries)
- Medical care
- Housing (rent or mortgage)
- Childcare (daycare, babysitting, etc.)
- Auto-related expenses (gas, maintenance, etc.)
- Utilities (water, heat, electric, home or cell phone, etc.)
- Insurance (auto, homeowners, health, etc.)
- Taxes (income and property taxes, if applicable)
Discretionary Expenses
- Clothing
- Personal care (haircuts, manicures, etc.)
- Cable TV and internet service
- Entertainment (not including meals out)
- Restaurant bills (meals out)
- Travel
- Pet-related expenses
- Health club memberships
- Alcohol and tobacco (if applicable)
2. Add Up Your Monthly Expenses
Using your spreadsheet or money-management software, add up the money you spent in each broad category (essential and discretionary), each subcategory, and overall. Use these totals to set budgeting guidelines for each subcategory. For instance, you might budget $300 per month for food (groceries), $100 for gas, and so on.
3. Add Up Your Monthly Income
Your monthly income is your take-home pay, the amount of money you actually receive after all taxes and other income-related expenses are taken into account. For instance, if you contribute to a retirement plan through work, don’t forget to deduct from your total take-home pay the amount of your contributions that gets taken out of each paycheck.
4. Compare Expenses and Income
Subtract your total monthly expenses from your monthly take-home pay. The difference should be equal to at least 10% of your monthly pretax income. For instance, if your income before taxes is $5,000 per month, you should have $500 (10% of $5,000) left over after expenses each month.
How to Cut Your Spending
If your expenses leave you with less than 10% of your
income, there are a few steps you can take to cut back your spending.
- Cut back discretionary expenses: Scrutinize your list of discretionary expenses and scale back on the subcategories that are least essential to you. For instance, if you have a gym membership, consider working out at home instead.
- Buy in bulk: Almost anything that you must buy can be purchased at surprising savings if you do a bit of legwork. For instance, you can save enormously on home essentials by buying in bulk from warehouse stores and price clubs, such as BJ’s or Costco.
- Buy for the lowest possible price: When shopping online, use sites such as Froogle (www.froogle.com) and PriceGrabber (www.pricegrabber.com) to find the lowest available prices.
- Avoid impulse buying: Various studies have shown that impulse buying accounts for as much as 40% of all purchases. Whenever you set out to buy something that you really need, buy that item only.
How to Stick to Your Budget
Once you’ve set up a budget, your next step is to stick to it.
So continue to track your expenses—only this time make sure your spending remains within the limits you’ve set for each expense subcategory. Though you can continue to record your purchases in a notepad, a much easier and potentially more precise approach is to use credit cards and debit cards, as explained below.
How to Use Credit and Debit Cards to Track Spending
If the notepad approach seems tedious and “low-tech,” consider using a credit or debit card to make nearly all of your purchases during your first few months of living on a budget. By using a credit or debit card, you’ll create a precise digital record of your spending that you can review whenever you choose—credit and debit card companies often categorize each expense automatically, which makes it easy to import your expenses into your budget. If you’re using money management software such as Quicken or Microsoft Money, you can configure the software to download and categorize your credit and debit card charges automatically.
You’ll most likely still make a few purchases with cash, or pay some bills with checks, so be sure to include those expenses into your budget as well.
If You’ve Had Credit Problems Before
If you’ve had debt problems in the past as a result of misusing credit cards, avoid this strategy and stick to recording your expenses on paper. For more on credit and debit cards, see How to Manage Credit Cards, Charge Cards, and Debit Cards.
What to Do with Your 10% Budget Surplus
Once you begin saving at least 10% of your pre-tax income each month, you can begin to use that money to reach your savings goals, and later, to start investing.
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