If you are anything like me or most Americans, it is highly likely that you have some hopes and dreams of striking it rich and not getting up to go to the office the next day. I think we all would love the opportunity to spend our time doing anything besides our normal day job. We all have passions, hobbies, and obligations that we would rather be doing.
In reality, many people are able to spend their days doing all those other activities that they would rather be doing. The difference is that they got there through hard work and discipline rather than having some large inheritance or winnings. It was with a goal and a plan that they were able to live the life that they really wanted. The life of Financial Independence. The plan that they used to get there is called their BUDGET.
Anyone who has ever read any personal finance book, blog, website, or article knows that there are a million different "experts" on the subject of personal finance and budgeting.With each of those experts comes their own version of the simple method of understanding and planning your income and spending. Most follow the same rough path to get to the same place with your money. That place is to spend less than you earn each week, month, and year.
You may think that I will try to provide some new ideas on how to budget and get you where you need to be, which is to have a surplus of cash. I am not going to do that. I want to try to simplify the principles of budgeting to make it a less daunting task. I will also share some of the difficulties that I run into that I am sure others can relate to.
Step 1: Understand The Income Flow
The first step in planning how you will spend your money for a set period of time is to fully understand how much and how often you will have money coming in. It is important to focus on the Net Income for the purposes of budgeting. Net income is the amount you actually bring home to spend. Gross income includes all the money taken out for taxes, insurance, 401k deductions, etc. If you work a regular number hours per week you should be able to expect to receive almost exactly the same pay every pay period. This allows us to understand how much money is available to live on.
Personal Application:
For me this is the easiest aspect. While there are two incomes in our household, we primarily live off my income and my wife's is saved and invested. If that was not the case and we used her money for monthly expenses, being able to understand our income could be very difficult. That is because my wife is in sales and her income can vary by several thousand dollars per month, depending on her success.
Step 2: Understanding Spending Habits
Once we know how much money we have available to live on, we need to study where we normally spend it. There are several online tools available that allow you to see where you have been spending your money. This can also be done by reviewing your bank statements.
The most important part of this is to identify the unavoidable expenses, that typically are pretty consistent. Items such as mortgage, car payment, gas, groceries, child care are all categories we should know what we spend each month. Other categories such as vacations, dining out, and entertainment are things that if not planned, can fluctuate drastically.
Personal Application:
In our house this is probably one of the more difficult tasks. We fully understand our regular monthly expenses such as mortgage and car payments, etc. The confusion for us comes with our real estate investing business. Occasionally we will need to put some of our personal money towards a project for our business, and this can skew our spending.
Step 3: Plan your spending for each category
Once you fully understand where your money is going, you need to allot that portion of your income to each category. One category that most people forget, but is probably the most important, would be savings. Most personal finance experts follow the rule that you need 3-6 months of expenses in savings and readily available. I think the higher end would be perfect to avoid any big emergencies.
There are many methods of generating your savings but the best ideas in my opinion are the idea to pay yourself first and make it automated. If you make yourself and your savings the top priority when it comes to allocating your cash, you will be in good shape. The ability to automate savings also makes it so much easier simply because of the fact that if you do not see it, then you will forget you even have it until the day comes that you need it. This really allows you to build your account quickly.
Once you have your 3-6 months of savings accumulated, I would suggest making an automated investment account to help realize the positive effect of investing in mutual funds. That is a topic for a later date.
Personal Application:
For our family we allocate our spending in a pretty simple fashion. All monthly payments come out of a joint account. All personal spending comes from our own separate accounts. We pay our utilities and insurance bills each monthly automatically using 1 credit card which gets paid in full automatically. We also have a credit card used for our groceries and other household expenses. These are all paid from the joint account.
Step 4: Stick to the Plan
At this point you should be living by your written budget. Over the first few months you will probably have to tweak and adjust your budget as you learn more about your spending. That is just fine tuning. Unless you have an increase in income or a change in your expenses, there should not be any large changes.
Part of sticking to the plan is being disciplined to not blow the budget. Do not splurge if you do not have the money. Learn to say NO. It is the best way to stick to your budget. A couple other methods I like to apply to spending would be to evaluate if the purchase is a want vs. a need. I also like to analyze a purchase by thinking of how many hours I spend working to make that purchase.
Personal Application:
Our plan seems to constantly be evolving and changing due to new ideas and opportunities that we decide to take advantage of. The budget should be looked at as a living document that is always tweaking.
Step 5: Enjoy Life
If you can follow these steps to create and follow a monthly budget, I think you will 100% enjoy life more. Knowing where your money goes and how much is available to you will absolutely simplify your life and decrease your stress. You should no longer have to worry about money.
In addition to enjoying life, you should be able to accumulate wealth pretty quickly which will allow you added benefits later in life.
Personal Application:
We definitely enjoy our life, but its always work before play. The plan is to work hard now so we can both retire around 40.
A few added topics that can be considered in a budgeting discussion are:
Cash vs. Credit Card spending: This is a highly debatable topic that everyone seems to see differently. I think the most important thing is that if you use credit, pay it all off every month. I believe that the answer to this topic is based on each individuals income and maturity level. If you can successfully manage your budget using cash for 6 months or longer, then I would say you should incorporate a rewards credit card that is used to auto pay regular utilities and gas bills. As long as its all paid off each month. Do not use credit as your emergency fund.
Reducing Expenses: I personally feel that once you have your budget in place and are working hard to stick to it, it is a good idea to look for areas we can reduce spending. This is a good chance to find things that we can analyze as a want vs. need. I personally have set a goal for 2016 to reduce our household monthly spending by 20%. To this point I have gotten rid of a storage unit and changed my cell phone service and have saved $150 per month. This is roughly 8% reduction, but I still have time this year to find more savings.
That will be all for now. I hope any readers will enjoy this quick article on budgeting and hopefully it will help you get where you want to go financially.
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