The first step of wealth building is to have a workable budget that will get you to your financial goals. Without a budget, you’re flying blind with no idea where your money is going and how to make your money work for you. For most of my life I have had a budget. When I’ve adhered to my budget is when I’ve been able to make the most headway with my finances. When my girlfriend and I got engaged and decided to work on our finances as a couple, I developed this budget and over time I’ve refined it to this current formula.
1. The first step is to have an emergency fund of at least $500, but preferably at least one month’s worth of income. If you’re married, pick the amount that is less of the two incomes provided that the amount is at least $2,500. If you’re struggling to make ends meet, having at least $500 saved will get you some breathing room. If you can save at least one month’s income, you can get yourself out of a lot of sticky situations without adding more debt to your credit card. It’s hard to get out of debt when you’re constantly pulling out the credit card as a bail out fund. You’re not Congress, you will have to pay back that money and it’s going to cost you a lot more than what you spent, usually somewhere between 18-27% of interest.
2. Your emergency fund must be split between your savings account and your checking account. You must have at a minimum $100 in your checking account as a starting balance. This will help if you overspend and you need extra cash. The remainder should be in your savings account, readily available to be transferred to your checking account when needed to cover an emergency.
3. A budget is a living document. It cannot stay rigid. Every month of the year is different, so you have to project into the month and see what you have to put money aside for. Plan ahead for birthdays, anniversaries, summer vacation, trip to visit family members and Christmas. The budget you set for March will definitely not work in December unless you’re that person who doesn’t believe in the magic of Christmas.
4. Your budget has to be free-flowing, meaning that you have to be flexible and move money around if something cost more than you expected. For example, if you budgeted for $50 to pay the electric bill and all of a sudden the bill comes in and it is $75.00, that means you then have to go back to your budget and cut something out to make up the $25 difference. Maybe you cut your clothes budget by $25 so that you can make up the $25 difference. You don’t dip into your emergency money simply because there is an unexpected increase on a bill. The first thing you do is adjust the categories that are discretionary or adjustable in your budget (i.e. restaurant, entertainment, clothes). Groceries should be the very last thing you adjust, so cut back on everything else, including going out to eat at restaurants, so don’t have to dip into your grocery fund.
5. You need to save money within your budget to pay for things that you know are going to be an expense. This is called a sinking fund and it helps you cover all or some of the cost for certain expenses. At least budget a small amount per month for car repair expenses. Your car will need new tires, or oil change or some other expense that you should at least put some amount aside for in your budget to cover the expense. You could also put aside a small amount to cover trips, summer vacation, birthday gifts and Christmas presents. A good way to think about this category within your budget is if you don’t think you could move money around your budget to cover the expense, then it deserves a line item under your sinking fund category. This is a very unique and personal part of your budget, and one that will make or break your budget if you don’t pay attention to it.
6. After your emergency fund, you budget should focus on six main categories: (a) tithing and giving (if your religion requires you to tithe 10% of your income); (b) saving (even if you’re focusing on getting out of debt, you should at least contribute enough to get the match); (c) housing expenses; (d) debt payment; (e) sinking fund; and (f) discretionary expenses. If you’re trying to get out of debt, cutting back on the discretionary expenses will be the first section to drastically cut back on. Notice I didn’t say delete. It is simply unrealistic to completely cut out all discretionary expenses. However, failing to cut back on them will be the difference between getting out of debt and staying in debt far too long or giving up during the process.
7. Your budget will have items that are stagnant and others that fluctuate in nature. Stagnant means that they are going to be the same amount every month so are easier to plan for in your budget. Items such as rent/mortgage, car payment and insurance are in the stagnant category. However items that fluctuate in nature are not easy to plan and can make or break your budget. The best way to handle these items is to leave extra room in your budget to soften unexpected increases. They are not in the category of a sinking fund because fluctuating items tend to occur on a monthly basis. Fluctuating items tend to be your phone, electricity and monthly items of that nature. The fall back for fluctuating items is to decrease your discretionary items to cover any unexpected increases in your fluctuating expenses.
If you need help deciphering your budget, feel free to drop us an email.