In these hard economic times, it is necessary to develop a budget. Many have little practice in cataloguing their income, and even fewer have experience tracking their expenditures. Nevertheless, to be financially solvent, the development of a manageable financial strategy is absolutely necessary. In order to maintain this strategy , you must know how much money you make, where your money goes, and what expenses are optional. The formulation of a budget typically occurs in three steps.
1) Income – Gather your deposit slips for the past three months, and determine exactly how much you put into your account each month. Determine the mean value of your monthly income by dividing the total deposited by three. For a more accurate budget, use a longer period of time (but do not go farther back than your most recent pay cut).
2) Expenditures – This portion is rather time intensive. Gather your bank statements for the last three months. Categorize your expenditures into Food, Entertainment, Rent, Insurance, Loans, etc. Use the categorized values to create a subtotal from each category. Add these subtotals together to determine how much you spend in a given month.
3) Analysis – If your expenditures are higher than your income, your lifestyle is not sustainable, or your goals are not achievable.
The third step should be performed again after inserting error, savings, and investments. These three factors should be included in each budget after your initial analysis. These factors are what provide for flexibility in both lifestyle and life planning.
Error is a tool that is used to make your budget reliable. You should assume you lose between two and five percent of your income, and that sometime in the next six months, you will have some “rainy day” expenditure. The size of this expenditure should be about twenty percent of one month’s pay. Your budget should still be “net positive”, meaning there should still be some money left over each month.
Savings are used to make your budget more achievable. Not to be confused with investments, savings are mid-term accruals of liquid assets. Basically, if you can spend it the same day, but it is not part of your daily expenditure budget, it is classified as savings. Your savings balance can roll over at the end of each month. This money is for car repairs, furnishings, or a down payment on a car. This money is your impulse spending buffer. Your savings row should be large enough to protect you from eroding your investments, but small enough to allow for a healthy investment plan. I would recommend savings being about three to five percent of your monthly income.
The remainder of your income should be your investments. This does not necessarily mean that you should invest your remaining cash. What this means is, that you should not consider the remaining assets as accessible. Instead, you should not access these funds until they reach a predetermined balance, convert them to a less liquid asset, like a house, or a mutual fund, and allow them to make money themselves. The investment portion of your budget is for the accomplishment of long term goals, like retirement. However, it can also be used, if absolutely necessary, to cover the extra cost of a mid-term goal, like buying a car.
Remember when constructing your budget, that your goal is sustainability. Saving a thousand dollars in a month is great, but not if you spend two thousand the next month. Nor is it meaningful if these savings were accrued by non-payment of essential bills. Preferably, your budget will allow for the steady accumulation of meaningful wealth. Any spending adjustments you include in your budget should be capable of being made every month, without significantly affecting your quality of life. Hopefully, after a few months, the accumulation of wealth will be inspiration enough to keep your budget up to date, and maintain your enthusiasm for analysis. Until then, only your discipline can keep you on track.