If this information seems rather simple and "old hat" to you that may mean that you have graduated Budgets 101 -- Maybe you know someone that is struggling with their finances and it is not that they do not have enough but do not know how to practice discipline and have the guidelines to plan and prepare -- Maybe you could help them with this info and hopefully the next one will be of more benefit to you and stretch your learning -
I Want to Set Up a Budget BY Laura Shin
1. Learn the 50/20/30 rule.
The first thing you need to know when you set your budget is that your goal is to live on your net paycheck, the money that hits your bank account after all your deductions. That means your budget excludes any pre-tax retirement contributions such as those to an employer-sponsored 401(k) or 403(b).
You’ll divide that amount into three buckets according to what we call the 50/20/30 rule:
50% goes toward Essential Expenses, which are housing, utilities, daily transportation and groceries.
20% goes toward Financial Priorities, which are after-tax retirement contributions, emergency fund, debt repayment and other big savings goals, such as travel, wedding, a down payment, etc.
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Lastly, 30% goes toward your Lifestyle Choices, which are eating out, shopping, the gym, travel that isn’t saved up for, etc.
Refer back to this list as you set your budget so you can be sure you are categorizing your expenses correctly, and so you come as close to these percentages as possible.
In order to do this, you need two pieces of information:
i. How much one paycheck is
ii. How many paychecks you receive a year
Let’s say your paycheck is $1,000.
If you receive one paycheck a month, that’s easy: you receive $1,000 a month.
If you receive two paychecks a month, that’s easy, too: you receive $2,000 a month.
If you receive a paycheck every other week, rejoice! Budget as if you receive two paychecks ($2,000) a month, but then you get a bonus check every six months, which you can put toward one of your financial priorities—savings, debt or retirement!
Lastly, if you receive a paycheck every week, then let’s just pretend you get four checks ($4,000 – lucky you!) every month. For the four months of the year that you get a fifth paycheck, put that toward one of your financial priorities: debt, savings or retirement.
So, let’s say Jane receives a $1,000 paycheck twice a month, so her monthly income is $2,000.
In order to line up with the 50/20/30 rule, she’ll have to keep her essential expenses from exceeding 50% of that, which is $1,000.
Similarly, 20% of it, $400, goes toward retirement contributions, debt payments and savings.
The remaining 30%, $600, pays for her lifestyle choices.
Tally up your essential expenses and divide that sum by your net paycheck. If you’re looking at a percent that is 50% or lower, you’re good. If not, we have more tips for you in a few steps.
Tally your debt payments and savings and retirement contributions (not including what you are contributing to an employer-sponsored 401(k) or 403(b) before you receive your paycheck). Divide that number by your income.
If it works out to 20% or more, then great. If it’s less than 20%, we’ll give you some ideas in a second on freeing up more money to put toward your financial priorities.
Based on the first two calculations, you should know how much you are spending on your lifestyle choices. If it’s more than 30% and you aren’t meeting your financial priorities, you should probably ratchet down your discretionary costs, which we’ll help you do in a second.
As outlined above, you will enter how much you pay every month for:
(While groceries are an essential expense, we’ll reserve that for Step 4 of the Budgeting Tool.)
To continue the example from above, hopefully Jane’s essentials don’t exceed $1,000. If they do, she might see where she can cut her costs (cable? energy bill?) or try to bring in side income to meet those costs.
In Jane’s case, she has $400 a month to contribute toward debt and savings. She decides to split it evenly between her debt payments and her emergency fund.
However you choose to divide your financial priorities money, put your debt payments in Step 2, under Necessary Expenses, then put your contributions to your emergency fund and other savings goals into Step 3.
Again, lifestyle choices include shopping, entertainment, going out and other expendable expenses such as your gym membership and travel. Also add in groceries from your essential expenses here. Our example, Jane, has $600 for these expenses. If you find yourself wondering how much you need per category, you can look at the transactions in your Financial Inbox and use how much you normally spend per category in a month as a guide.
Now that you’ve set up the numbers so they work out perfectly, try living on your budget for a month or two. If you find that you’re consistently spending above your means and falling into debt or dipping into savings, you may want to temporarily try a cash budget in which all your lifestyle spending is done in cash.
You can do a cash budget two ways. One is to give yourself a weekly allowance. For instance, cash-budget Jane would divide her monthly $600 by four to see how much she can spend per week—$150. At the beginning of her week, she puts $150 in her wallet, and she lives on that until the next week.
Another way to do it is to follow the folders in the Budgeting Tool. If Jane gives herself monthly allowances of $200 for restaurants and bars, $150 for clothing, $50 for health, $50 for personal care, $50 for home, $50 for gifts and $50 for charity, she can put those amounts into envelopes marked with those labels.
Then, when she goes clothes shopping, she only uses the cash in her clothing envelope, and when she goes to the drugstore, she only uses the $100 in her health envelope, and so on.
She stops spending in any one category for the month when the money in that envelope runs out. (However, if she has leftover clothing money at the end of the month and needs that cash for health expenses, she can transfer from category to category.) The following month, she replenishes the envelopes.
If you do revert to a cash budget while you get your spending under control, we still recommend that you use the Financial Inbox to log your expenses. You can enter all your cash transactions there, and in fact, doing so provides an opportunity for reflection on whether that purchase was a good use of your money or not!
If you’re really finding it hard to spend your money in worthwhile ways, check out our Purchase Appraiser, which will help you figure out when it’s worth it to spend and when you should save.
We only recommend a cash budget for people who are in the habit of spending beyond their means. For everyone else, debit and credit cards are better than cash for two reasons: they usually offer rewards, and, at least when it comes to credit cards, using them builds your credit history, which will someday help you buy a car or a home.
Thus, a cash budget is a temporary, not permanent, solution.
There are only two ways to free up more room in your budget: decrease your expenses or boost your income.
1. To cut your costs
First look at all your regular expenses, from your rent to your utilities to your cell phone bill. Call your providers to see if you can negotiate for less expensive packages. Or cut the service if you’re not using it, whether it’s a gym membership, a cable TV subscription or a texting plan far beyond what you need.
Then analyze the recent lifestyle purchases you made. If you see that in the last month you ate out 10 times, perhaps you can cut that to eight times. If you regularly buy clothing, assess how much wear you really get out of every new piece and whether the items you buy are really different from others already in your closet.
2. To earn more
Check out our tips on negotiating your salary here, and take our free Build Your Career Bootcamp to learn how to shine in your career, nab promotions and raises right and left … and plump up your bank account. Also, consider generating side income, perhaps from a hobby you love—whether that’s baking cakes, making jewelry, taking photographs or opening your own eBay store.
Finally, the only way to make a budget truly work for you is to actually follow it. While you can set up a budget that, in theory, will keep you spending below your means, only by diligently adhering to it will you keep your costs down, pay off your debt, grow your savings and build real wealth.
To that end, the Financial Inbox is an excellent tool for ensuring that you stick to your budget. Because each folder has a limit, you can easily see when you are spending beyond your means. Get in the habit of logging in every day to see how you stack up against your monthly spending goals. (If you haven’t yet connected your accounts yet, do so here.)
Lastly, remember that you can do it. A budget is the foundation of all your finances. If you stick to your budget, you can achieve any money goal you set for yourself.