Building a budget is not a science, but an art.
In Automatic Wealth, Michael Masterson emphasizes the importance of “facing facts” – being realistic about what you need to do to put yourself on the path to a favorable financial future.
A key step in getting a grip on reality is to create – and follow – a personal budget. By doing so, you’ll develop a blueprint to not only gauge how well you’re doing on the financial front, but also change your habits from being a “spender” to a “saver.” And as Michael points out, “To become wealthy, first you need to build a small nest egg by spending less than you earn.”
“To become wealthy, first you need to build a small nest egg by spending less than you earn.”
Saving money has become a challenge these days. In an era where consumer spending is high and there are plenty of new goods and services to buy that weren’t available even 20 years ago, knowing how to budget properly is essential to your financial success.
According to a recent American Express consumer survey on everyday spending, today’s list of typical, day-to-day expenses is still dominated by traditional items such as groceries, fast-food lunches, tolls, and gasoline. But they’ve been joined by such 21st-century wallet-sappers as cellular phone service and Internet costs. Consequently, managing a household budget has become more complicated.
What’s the solution? People tend to spend whatever money is left over after their fixed expenditures are taken care of – so you’ve got to get all of your fixed costs into your budget. And you’ve got to make one of them “savings.”
All budgets are divided into income and expenses, but most good ones now include savings as a third component.
Items in the “income” category can include after-tax salary, pensions, investments, and tax refunds. Items in the “expenditure” category can include rent/mortgage, food, gas, utility bills, child care, entertainment, gifts, and vacations. The “savings” category stipulates how much you put away each month after satisfying your spending requirements. As much as 10% of your take-home pay should be put into this category and earmarked for unforeseeable emergencies. Add another fixed percentage as a contribution to your nest egg.
When you have filled in the numbers in all three categories of your budget, simply subtract your total expenditures (including savings) from your total income. If the total is above zero, you are cash-flow positive. If the total is below zero, you are cash-flow negative. If the total is zero, you are cash-flow neutral.
If you are cash-flow negative or cash-flow neutral take a good hard look at what you’re spending and eliminate all non-essential items. If you are cash-flow positive, congratulations. You are doing the first thing that you need to do to build wealth: You are spending less than you earn. In that case, consider putting more money into savings every month to build your nest egg even faster. Here are some tips on how to create a more effective budget …
The most common problem people have with budgets is sticking to them. So don’t make your budget too restrictive. The less organized you are by nature, the more flexible your budget should be.
Where possible, use precise figures, not just estimates, so you know at any point exactly how much you need or have. Consider using an Excel spreadsheet to track your progress.
Don’t underestimate what you spend. Figure in all the “extras,” including newspapers and magazines you subscribe to, restaurant meals, “pay-per-view” movies at home, etc.
Create and manage your budget on a monthly basis. Or build one that’s based on how often you get paid.
When you first start your budget, review it every month (or pay period) – for accuracy and to see how well you’re doing. After that, review it quarterly.
And here are some tips on maximizing the amount of money you have to work with …
When the economy enters a low-interest-rate period, take advantage of it to consider refinancing your home. A number of websites have instant calculators that will estimate the amount you could save, including www.Quicken.com and www.realtor.com.
Review auto and home insurance rates and comparison shop for better values. Some companies offer discounts that you may not be aware of (e.g., for senior citizens, multiple policies, or autos with anti-theft devices). Consider raising your deductibles, too, in exchange for lower premiums.
Consider starting an automatic savings plan that will route some money directly to a separate account before you’re tempted to spend it.
Get rid of clutter and pad your wallet by holding a garage sale. Or get a tax deduction by donating unwanted items to charities. (Be sure to keep an itemized receipt of your donations.)