Creating and sticking to a budget is one of the best things to do on the path to financial freedom. Learn about the easy steps involved in creating and effectively using a budget.
- A recent study reports that if a family in the US were hit with an unexpected bill of $500, only 40% of those responding had the money on hand to handle that bill. Too many living too close to the financial edge. Now, is the cause too little income, or too much outgo? Everyone would say that if they just made a little more money, all would be well. They would build a financial buffer which would allow them to handle these unexpected mishaps. Well, I hate to be the one to break it to you, but that's typically not how it works.
It turns out that most of us, when we get just a little more income, adjust our spending habits quickly up. In other words, we quickly spend that increase, and then find ourselves living on the financial edge again. Well, what to do, what to do, what to do? Well, step one is to accept the likely reality that until you get a handle on your expenses, incremental increases in your income are not going to solve your financial problems. Best to focus on getting your arms around your expenses first.
Today we're going to talk about personal budgeting. I know, I know, you've heard all this before, and you know what you should be doing. Well, perhaps today is the day that things finally click and you determine that things will be different from this day forward. If you've ever had a car get stuck in a snowbank, you know that rocking the car back and forth will eventually get you the momentum that will get the car out of trouble. But you never know which push is going to be the one that gets the car unstuck. Likewise, you may have heard all this talk about budgeting before, but maybe today is the day that makes the difference.
Maybe today will be the day that you start to get out of your financial snowbank, so let's go. Step one, get your arms around how much you bring home, not your gross wage or salary, but what do you bring home after taxes, after insurance and after other withholdings? Your net amount. This is what you spend. It turns out you cannot save a nickel if you don't spend less than you bring home. That's an eternal truth. Step two, spending. You have to write things down.
You will never get your arms around your spending habits by keeping track of things in your head. Use a computer, use an app, use a paper and a pencil, whatever, but you need to start writing down every penny that you spend. And right here is where most people say, I don't want to do that. Fine, don't, but then do get comfortable with that sinking feeling in the pit of your stomach that tells you you're living on the financial edge. You will likely not build a financial cushion until you understand where your money is coming from, and where it is going.
Once you have a list of your expenditures grouped into categories, like food, entertainment, housing, utilities, et cetera, then it's time to break those expenditures down into two classes, fixed expenses and variable expenses. Why these two classes? Because fixed costs are exactly that, they are fixed. It is tough to make adjustments to those expenditures in the short term. You have to make that house payment, that car payment, that student loan payment. Now subtract your fixed expenses from your take-home pay.
This called is called your discretionary income. This is the amount that you can more readily control, and this is where you are going to find your most immediate savings. Now subtract your variable expenses from your discretionary income. This is either good news or bad news. If the result is positive, you are spending less than you make, good news. If the result is negative, now you need to look where you can cut back, fewer movies, fewer nights of eating out, fewer cable channels, fewer of a lot of things.
You have to do what it takes to turn this negative number into a positive, and it might be unpleasant for a time. But if you want to be one of those Americans who can handle a $500 negative surprise, the first place to start is with a careful examination of your variable expenditures. Down the road, you can reevaluate your fixed costs, a smaller home, perhaps a more prudent vehicle. But step one, get your arms around your variable costs and you do that by systematically writing down all your expenditures, and keeping track.
Now it may take some time, but it'll be worth it. It is naive to think that unexpected bad financial things always happen to someone else. Everyone seems to get a turn. Get prepared now should your turn come.
Skill Level Beginner
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