How to Stick to A Budget: Money Management for Beginners!
Starting To Plan Your Budget
It can seem very intimidating to be in charge of your finances for the first time. Whether you've just graduated and are about to get your first real job, or you've been living paycheck-to-paycheck for some time but are ready to start saving for your future, this guide will take you step by step through the budgeting process.
- What are your goals?
First things first- you need to think about why you are budgeting. Do you have a lot of debt you want to get paid off? Are you saving for a big purchase? Have you set a long-term goal of retiring young? Putting money into savings and denying yourself instant gratification can be frustrating, so you want a clear picture of why you're doing it in the first place. It will be easier to pass up that expensive morning latte if you can console yourself with the thought of a debt-free existence, or picture yourself lounging on a beach with a drink in hand after you've retired.
- What is your current financial state?
Take into account everything going on in your life right now. Do you have a steady job? How much debt do you have? Where are you living, and what are the costs? Do you have any savings? Collect all the information you can regarding your income and expenses each month, and think about how much you expect them to fluctuate.
- How much knowledge do you have about finance?
You don't need to be a guru to set a budget and save for your goals. However, a solid knowledge base about money will help you in ways you can't imagine down the road. Maybe right now you just want to get some debt paid off, but what about when you start investing? Do you understand all of the options available? Do you know how to analyze your loans to see which will cost you the most over time, and when it's a good idea to refinance? Do you understand the concept of compounding interest, and how essential it is to start saving early and letting money grow?
Don't be intimidated how much advice is out there! If there's a topic you want to brush up on, simply google "Beginner's guide to..." and read articles written for people just like you. You don't need to be a professional analyst to get a good understanding of investing options. One book I personally recommend is "Boglehead's Guide to Investing". It's written for beginners, and tells you exactly what you need to know about stocks and bonds, and no more. It explains in simple terms how to pick an index fund (a basketful of stocks lumped together so you don't have to pick each individual stock yourself) and how to spread your money between investments. This is the book I read when starting out, but there are plenty of other personal finance books and websites out there.
Writing Your Budget
You've set your goal, collected your financial information, and brushed up on the basics. How do you actually get started?
- Figuring out your disposable income
The first step is to list all of your income. If you're on a salary, this will be easy. If you get paid hourly or based on tips, look back at the past few months and figure out how much you made on average. If you have any income outside of your main job, list that too. Maybe you receive alimony, a relative helps you with cash, or you do side jobs in your spare time. Don't include any money that isn't a sure thing, but get an average idea for what you make each month.
- Calculate your necessary expenses
Write down every single expense you have that must be paid each month. It's easy to remember the basics of rent, electricity, and phone bills. But don't forget your car insurance or car payment, student loans, gym dues, cable bill, transportation costs (either bus fare or average gas costs), and average minimum credit card payments. These are your mandatory expenses- outside of cancelling your memberships when contracts expire, you can't cut these costs.
- What is your discretionary income?
Take the total of your mandatory expenses that you just calculated, and subtract it from your total monthly income. This is your discretionary income. You'll have to figure out how to divide this money up between saving, paying off debt, and spending it on yourself. Of course you'll have to spend some on necessities like food and clothing, so you can't save it all. Now that you know exactly what your discretionary income is to work with, it's time to think back to the goals you set for yourself. For the purpose of the following examples, let's say your discretionary income is $800/month.
If you have a short-term goal of getting a small debt paid off or making a large purchase, it might be most appealing to you to spend a few months living bare-bones, and get it over with as soon as possible. In this case, figure out the lowest amount of money you can live off of, and put everything else towards your goal. If you can survive on $100/week, you'll only need $433/month. ($100 x 52 weeks per year / 12 months per year). That leaves you with $367 to put towards your goal every month, and $100 for groceries and living expenses per week.
If you have a longer-term goal of retirement savings, you'll want to allow yourself more wiggle room. Sure, you could get by on $100/week, but after a month or two of eating pasta and rice and never buying new clothes or splurging on a night out, you'll get sick of it and quit trying. Maybe you can allow yourself $130/week, so you can splurge on one nice meal or purchase per week. That means you're spending $563/month, and putting $237 towards savings. It will take longer to see results, but you're much more likely to stick with it, and this money will be growing in value for the rest of your working career.
- General goals everyone should have
A basic goal that everyone should have is to keep 3-6 months of living expenses in an easy-to-access savings acount. Take that number you calculated for your mandatory monthly expenses and multiply it by 3. Live as frugally as possible until you have that much money saved up. That will give you a little breathing room in case of any emergencies, like a big car repair or a break in your employment.
Once you have 3 months of expenses, it's time to aggressively pay off your debt. If you have large school or credit card debts, this may take some time. Figure out a plan that works for your exact situation. Any high-interest credit card debt needs to be eliminated fast. Take as much discretionary income as possible each month, and pay it towards your debt with the highest interest rate. If your debt has lower rates, such as student loans, car loans, or low-interest credit cards, you can be more relaxed about paying it back. Of course all debt it bad because it's costing you money every day, so this is a personal choice. If you can't stand the thought of owing money, keep living as frugally as possible and paying as much as you can each month. If the interest rate is low, and you'd rather pay a little interest each month and be able to splurge on yourself once in a while, go ahead and do that. Find your own tolerance for debt vs. frugality.
Once your debt is gone, it's time to start thinking about long-term goals. Saving for a house, your child's education, and your retirement are the next steps in your life. At this point you'll want to find an online retirement calculator and determine exactly how much you'll need at retirement, and how much to save to reach your goal. You can find similar college savings calculators as well. Use a calculator to determine exactly how much you need to save, and go ahead and spend the rest. You may want to put a little more away into savings each month to save up for buying property, unexpected expenses, or simply just to know it's there. But once you've got 6 months of living expenses saved, all your debt paid off, and a savings plan for retirement and children's schooling, what you do with the rest of your discretionary income is up to you.
How To Stick To Your Budget Plan
This is going to be the trickiest step. If you have amazing will power, maybe it won't be a problem for you at all. But for most of us, pulling that credit card out to buy yourself a $10 lunch because you forgot to pack one today just seems too easy. You need to have a plan in place to force you to stick to a budget, until you get used to living below your means.
- Set up your bank accounts
You probably already have a bank account, with a linked debit card. Maybe your pay gets direct-deposited into it. It's about to get more complicated than that. You want everything to be automatic, so that you don't even get to think about it and be tempted to spend extra money.
First, make sure you're using a bank with no fees. Shop around and find a bank that offers completely free checking and online bill pay. Hopefully you can find a local credit union, as they usually offer the best rates and might even pay interest on a checking account. Once you've selected a bank, open two checking accounts. One will be your "Bill Pay" account, where your paycheck is deposited and your bills are paid from. The second will be your "Spending Money" account, which will hold the money you've budgeted you can spend each week. You will have no debit card or ATM card linked to your Bill Pay account, so that there is no way to make an impulse purchase from it. Your only debit card will link to your Spending Money account. Finally, open a savings account to keep your 3-6 months of living expenses in.
The next step will probably take you about an hour, but it will save you immense time and stress in the future. Talk to your employer, and get them to deposit your paycheck into the Bill Pay account automatically- most employers offer direct deposit. (If not, you'll just have to manually deposit it.) Now go through that list of mandatory monthly expenses you wrote earlier. Go to the website for each company, and sign up for their Auto-Pay option using your Bill Pay account. If they do not offer Auto Pay, go to your bank's website and set up automatic bill paying- virtually every bank offers this option. You should never have to think about a single expense- money will automatically deposit into this account each pay period, and your bills will automatically be paid from it each month.
Now for your discretionary income. Look at your plan, and implement it automatically. Let's say you want to spend $130/week. Set up a weekly auto-transfer from your Bill Pay account to your Spending Money account. That $130 will be transferred to your debit card every week, and will be the only money you ever think about or have instant access to. In our earlier example, this left us with $237/month to save. Maybe you want to put $100 of that into savings to build up your emergency fund, and $137 towards paying off a high-interest loan. Set up a monthly automatic transfer of $100 from Bill Pay to Savings, and an automatic monthly payment of $137 towards your credit card.
Voila! It took you some time to set up, but now all of your money is moving around without a thought! You will never miss a bill payment, your savings is automatically growing, and you're staying within your budget every week! Maybe some weeks you go under and only spend $90, and that extra $10 is available to you the next week for a small splurge!
- Get rid of your credit cards
You want your wallet to only contain the debit card linked to your Spending Money account, so you can never splurge. That may not always be practical, however. Maybe you're out and your car breaks down, and you need a tow. Maybe you lock yourself out of your home and have to pay a locksmith. Whatever comes up, sometimes it's necessary to have access to extra cash. You have two options.
You can carry a credit card for those situations. If you choose to, be sure you have the willpower not to use it. Tuck it away in the back of your wallet, with all those random business cards and membership cards. Call your credit card company, and ask them to lower the limit to $500 and deny any overcharges. Choose your lowest-interest card for this purpose, and cut up all those other ones.
You can also choose to carry a checkbook. If your bank allows, you can link it to your emergency Savings fund. If not, you'll have to remember that when you write a check from your Spending Money account, you'll have to immediately transfer money over from your Savings to make sure that check doesn't bounce. I find carrying a checkbook prevents small impulse buys. If you're out of the money you budgetted, but a friend calls and invites you out to a movie, you're much more likely to reach for a credit card to buy that movie ticket than a check book.