posted Nov 10, 2015, 6:13 PM by Sam Neale
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updated Mar 21, 2016, 11:53 AM
]
A
budget, or spending plan, is the the single most powerful, practical
tool for wise money management and is the foundation for the 10 Steps to Financial Freedom.
Creating and using a budget involves three key activities:
- Estimating current income and expenses
- Giving your money a purpose
- Tracking and comparing actual versus planned income and expenses.
Let’s take a look at each one.
1. Estimating Current Income and Expenses
On a piece of paper, or in a spreadsheet, start by
entering your household’s monthly take-home income—the amount after
deductions, such as taxes, health insurance premiums, or retirement plan
contributions. Next enter your planned spending in categories like:
- Housing, Utilities, Food, Transportation, Clothing, Medical/Health, Personal, Recreation, Debt Payment, Charity/Giving, Savings
A.D. Financial Planning Budget Guide2. Giving your money a purpose
Start with your income at the top of the page and then start assigning
every dollar a purpose. Dollars that don't have an assignment will
disappear!
Charity. A.D. Financial Planning encourages you to aim for giving at least 10 percent of your monthly gross income.
Housing.
This category consists of items such as rent/mortgage, repairs, property
taxes, homeowner’s insurance and even furniture. Mortgage payments
should be no more than 25-30% of your take-home pay when financed on a
fixed rate 15-yr conventional mortgage.
Utilities. You’ll want to keep services like your phone,
electricity, water, internet, gas, and trash pick-up running smoothly
each month, 5-10% per month should do it.
Food
. Everybody has to eat, but this is one area where you can cut
your budget by bring your lunch to work, cooking at home more and not
picking up a drink from the gas station or drive thru every time you go
to town. 5-15% depending on your family size is a good starting point.
Transportation. You'll need to account for auto insurance, repairs, license,
registration, taxes, gas and oil changes. If you are making car payments – do not include that here,
include that in the DEBTS category. Not including car payments this category should cost you around 10-15% of your take-home pay.
Clothing.
Even though you might think this is more of a personal item, it really
is a necessity; especially if you have growing children. It should not
be a large part of of your budget, depending on your family size and
work dress code (construction worker vs. lawyer) this category should be
in the 2-7% range.
Medical. This category includes things like health insurance, disability
insurance, life insurance, doctor bills and medicines/prescriptions. For most families is less than 5-15% of your take-home pay.
Personal.
This category contains a lot of variety. Examples include hair care,
school supplies, alimony, child care, subscriptions, pet supplies,
toiletries, gifts and other miscellaneous items. This category can get
out of control if you let it - so beware! Keep this category to 5-10% of
your pay and it'll work.
Recreation.
Don’t let life go by without having some fun. Live a little, but make a
plan first. Set aside some money for entertainment, vacation or even
that impulsive purchase every now and then. At first this category will
be small as you focus on getting out of debt, then as you begin to see
the light at the end of the tunnel this category will grow. 5-10% of
take-home pay is a good range for money set aside for recreation.
Debts.
You don’t want items in this category, so get it paid off quickly. Add
up things like car payments, credit cards and student loans. Include
everything you owe money on EXCEPT the house you live in. You want this
category to be zero! For most Americans it is around 5-15% right now. If
you have credit card balances that you do not pay in full each month or
other types of non-mortgage debt, commit today to go no further into
debt and then start attacking your debts! See step 3 of the 10 Steps to Financial Freedom for advice on how to wipe out your debts.
Savings. Once you have your debts paid off and an emergency fund established
increase your emergency and retirement savings. A.D. Financial Planning recommends the
following emergency fund:
- Single person: save and set aside 3 months of expenses
- Two income family with stable jobs: save and set aside 3-6 months of expenses
- Single income family or two income with unstable
jobs: save and set aside 6-9 months of expenses
- Self-employed family: save and set aside 9-12 months of expenses
The younger you start, the longer your money has
to grow. There is a benefit to starting saving early; A.D. Financial recommends
saving the following percentage of your annual pre-tax (gross) income into your
retirement account(s), based on when you start saving:
- Starting in your 20’s: save 5-10%
- Starting in your 30’s: save 10-15%
- Starting in your 40’s: save 20-25%
3. Tracking and comparing actual versus planned income and expenses.
As you spend money, keep your receipts or jot
down how much you spend. We often create budgets based on a what we
think we do, or should do, not on what actually happens. So keep track
of your spending and adjust your budget where necessary. Of course, allocating more to one category means you’ll have to allocate less to another so make cuts to your spending where appropriate too. It may take several months to get a budget that works for you. Stick with it! A budget, or spending plan, is the the single most
powerful, practical tool for wise money management and is the foundation
for the 10 Steps to Financial Freedom.
Choose the System You Prefer
There are several different budget systems that are available. You could
use a paper & pencil system, a copy of the A.D. Financial Planning
budget is available on this page. If you’ve never used a budget before,
this is a great way to get started.
You could also use an Excel spreadsheet, which can make it easier and
quicker to total up your spending in the various categories.
You could use the Envelope System where you fill envelopes each month
with cash in the amounts that you have budgeted for each category. For
example, if you have $400 budgeted for groceries, you would fill an
envelope with $400 in cash at the start of the month. You would then
take that envelope with you when you go to the store, pay the bill out
of that cash, and put the change back in that envelope. It’s a very
hands-on way of seeing how you’re doing in each category throughout the
month. You wouldn’t use an envelope for your mortgage money, but it can
be a great system for groceries, entertainment, clothing, and other
discretionary categories.
Lastly, you could use software like
Quicken or an online tool like Mint.com. It might be difficult starting
with such tools, but after you’ve used a paper & pencil system for
6-12 months, you might consider switching to one of these tools.
Remember,
budgets are not about living on less or having less fun. They’re about
more – having more knowledge about where your money is going, having
more of purpose for your money, so you have more for what really
matters. Stick with it. As you get accustomed to using a budget, you’ll
find yourself living with more margin, accomplishing more of your goals,
and enjoying a lot more peace of mind.
To discuss budgeting, spending plans or just where to begin on your path to financial freedom, contact A.D. Financial Planning we are here to help. |
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