Okay, so budget is an ugly word. That’s why many financial experts prefer instead to talk about spending plans. I’ve gone a different direction and shaped mine like a pie. Yours can be cherry. It can be apple. Whatever you’re envisioning the premise is exactly the same: It’s a road map for how you’re going to meet your monthly bills and commitments and save for future goals.
Before you can fill in the numbers, you need to know two things.
- How much are you bringing in each month?
This amount includes your take-home pay and any other sources of income—maybe you run a small business on the side, or you sell on eBay, or you own rental properties. Add it all up. If it varies from month to month, find an average for the last year, assuming your income didn’t decline recently.
- How much goes out each month?
This amount tends to be the sticking point for most people. They just don’t know how much they spend each month, and if they do, they don’t know what they spend it on. Getting the answer to this question is paramount to your financial success, because if you don’t know where your money is going, you’re going to have a hard time staying out of debt, and you’re going to have an even harder time saving.
Track Your Spending
Look back over the last month or two of your bank and credit card statements, if you’re a plastic user, or track your spending for the next month if you tend to use cash. (Note: If that corresponds with a period when your spending was out of the ordinary – the holidays, or a summer vacation – be sure to keep that in mind and make adjustments as needed). Every time you take your wallet out, whether it’s for $2 or $50, write it down. If what you find scares you—$100 gone to lunches out, $30 to ATM fees—then you know what you need to trim.
The Budget Breakdown
People often ask me how much is appropriate to spend in various categories. I like to follow this breakdown:
- 35% goes to housing. That includes your mortgage or rent, maintenance, taxes, utilities, and insurance. In other words, the cost of the place you’re living and the cost to actually live there.
- 15% to debt repayment. This is student loans, credit cards, personal loans and any other debt you’re carrying above and beyond your mortgage or auto loan.
- 15% to transportation. Here’s where those auto loan payments come in, along with gas, insurance, repairs, parking and tolls, and train or bus tickets.
- 10% in savings. All the money you’re putting away for your emergency cushion, retirement, college, and other goals factors in here.
- 25% to other living expenses. This is, in part, what you make it. Consider a portion of this your play money, for entertainment, clothing, gifts, eating out, and vacations. Some not-so-fun things, like groceries and healthcare expenses, also fall in here.
Saving Is Sacrosanct
Note that there are some expenses that are locked in, meaning you can’t change them. Generally your car loan, mortgage or rent, and credit card payments fall under this umbrella. Other expenses, most of which you’ll pay out of your 25% living allotment, are more flexible. This is where you should scale back if your pie chart is out of whack. Finally, you have my permission to borrow from any category but savings. So if, say, you don’t have debt – good for you – or your transportation costs are lower than average, you can put that money toward one of the other buckets.