For many people, creating a budget is a mystery. In fact, according to the 2012 Consumer Financial Literacy Survey from the National Foundation for Credit Counseling (NFCC) and the Network Branded Prepaid Card Association (NBPCA), more than 50% of Americans don’t have a budget and 20% have no idea what they spend on housing, food, utilities – you know the essentials.
Unfortunately, many people live paycheck to paycheck with little regard for their future or living within their means. That should come as no surprise, since financial literacy is not something that is taught in our schools and isn’t something shared by too many parents. So, it is a self-perpetuating cycle of financial illiteracy.
Setting a budget and living within your means does take discipline but the end result is financial peace of mind in knowing how much income you have coming in the door and how much in expenses you have going out the door. This inevitably allows you to understand what you can apply to discretionary spending, savings and investments.
So, what’s involved in setting up a budget? There are many philosophies when setting a household budget in regards to how much you should allocate to housing, groceries, utilities, insurance, etc., but the actual fundamentals of a budget really don’t change. Budgets account for your sources of income and categorizes your expenses.
To begin to create your budget, you have to start gathering your financial information. Let’s start with your sources of income and start to categories them for your budget:
- Salary: Most individuals have a salary or hourly wage from a job or jobs from which they earn income. If you’re self-employed, there is usually a salary or some other monthly income from which you draw from the business.
- Bonus/Commission: If you receive a bonus or commission, categorize that income as best you can.
- Interest Income: Interest you receive from savings and other interest bearing accounts.
- Dividend Income: Dividend payments you receive from investments.
- Expense Reimbursements: Reimbursements for expenses you’ve accrued during the course of your employment or business.
- Miscellaneous or Other Income: Would account for gifts, tax refunds, etc.
With the exception of salary, most of the income above is variable. When creating the budget, project out the amount. When you know the exact amount, you can finalize that within your budget.
Next step is to categorize your expenses. Most of us have a staple of expenses we need to pay each month, quarterly, semiannually or annually. You can aggregate expenses into broad categories like utilities that might include electricity, gas, water, trash, etc. Or you can break out all of your expenses into specific categories. The choice is yours. It depends on how detailed you would like to get.
From a broad standpoint though, some of the more common expense categories would be:
- Credit Card Payments
Those are the big ones but you may have others you would like to include in your budget. For instance, a general one like Household expenses that may include haircuts, projects around the house, etc. Most financial experts believe the living essentials above should be no more than 50% of your income. That, of course, varies by your location. In high housing cost areas, that percentage can skyrocket to 80% of income.
However, that is what a budget is for, so that you can learn to be disciplined in your spending. If you are able to keep your essentials to 50% of your income, you should then set aside roughly 20% to 25% of your income toward savings, retirement and investment.
Finally, what is left over is for discretionary spending such as dining out, entertainment, vacation, etc. This is your fun money. You can categorize this however you like based on your lifestyle. Include a monthly cost for vacation if you like to travel. Another for dining out if you like to do that for entertainment. You know your lifestyle best, so set your budget expenses for discretionary spending in a manger that best suits you and your goals.
There are plenty of tools to help you create and maintain budgets. If you want to do it manually, you can get a ledger at an office supply store and enter everything manually each month. You can also create a budget within spreadsheet software such as Excel. There are even budget templates you can use within Excel. Or you can invest in financial software like Quicken.
However, you decide to record your budget, the important thing is to create it and maintain it on a monthly basis. In this manner, you’ll be able to live within your means and achieve your financial goals.