You probably like to make money, but chances are that you only have a vague idea of where it goes. Budgets can help with that, especially when your financial situation is complicated by a growing family or a home purchase. But in many households, "budget" is a dirty word.
Many people don't budget, says MSN Money personal finance columnist Donna Freedman, because it connotes deprivation, sacrifice and pain. "In fact, a budget is just a tool to make your money go where it will do the most good," Freedman says.
At its most basic, a budget is a plan for how you want to spend your money. It can also steer you toward specific financial goals, like buying a new car or putting aside money for retirement. Freedman's personal budgeting motto reflects that idea: "I save where I can so I can spend where I want."
Most importantly, though, a budget acts as an early warning system that alerts you when your spending and income are out of whack. It lets you identify and correct the problem before you wind up in over your head in debt [source: Kiplinger.com].
Budgets also can help couples and families talk about money. As you draw up and apply your budget, you'll get a clearer idea of what each family member is spending. The budgeting process clears away misunderstandings about where your cash is going. If you have kids, a budget teaches them about money and helps you allocate for things like child care, music lessons and other expenses [source: BankofAmerica.com-How to].
There are a few things you should always do when creating your household budget:
- Put it in writing. Just talking about spending is not enough. You need to put figures down in black and white, either on a ledger or in a budgeting software program.
- Build in flexibility. A budget that's too rigid is harder to stick to and can leave you discouraged. Always make sure you have some leeway for the unexpected.
- Keep a positive attitude. Budgeting does not mean scrimping and does not need to be painful.
- Expect setbacks. Some events, such as an illness or job loss, will put your budget out of balance for a while. Don't abandon your budget. Make the adjustments you need.
The most important step in drawing up a household budget is just getting started. So sharpen your pencils. On the next page, you'll go through the process step by step.
Tracking Household Expenses
The budgeting process is not complicated. Once you're determined to draw up a budget for your household, a few steps are all it takes:
1: Know your financial goals. You'll have long-term goals like creating a nest egg for retirement, intermediate goals such as amassing a down payment on a home, and short-term objectives like paying your monthly bills.
2: Get a clear idea of your income. Look at the after-tax money that you bring home in every pay check. Add back whatever's deducted for your 401(k) retirement plan, medical insurance or union dues -- you'll include those amounts in your budget. If your income varies considerably, take an average of what you've earned over the past six months or year. From that, calculate your average monthly income.
3: Track your past spending. You'll want to look at your credit card bills and debit card statements, your checking account records, and any payments you make through electronic banking. You'll also include amounts for retirement accounts, insurance or dues that are deducted from your pay. To account for cash spending, you and other family members should keep a spending log. Note every penny you spend, whether it's on a cup of coffee, a new pair of shoes or a jumbo popcorn at the movies [source: Peterson].
4: Categorize your spending. Group your expenses into buckets such as housing (including rent, mortgage, home maintenance, utilities), transportation (including gas, car payments, auto insurance), entertainment, food, clothes and savings. Make sure you include home owner's insurance or local taxes, which you pay only once or twice a year. Don't forget what you spend on credit card interest and bank fees, as well.
5: Make a spending plan. Based on your past spending and your financial goals, decide how much money to allocate to each category for the month. This is an extremely personal decision. You should be realistic and clear about your spending plans.
Author and Harvard Law professor Elizabeth Warren suggested a simple budgeting approach in her book "All Your Worth," which she wrote with her daughter Amelia Warren Tyagi. The appeal of her approach is that it's both simple and flexible. It sets a goal of spending no more than half your pay on necessities and of devoting one dollar in five to savings or debt reduction. She calls it the 50/30/20 plan, and breaks down spending into three distinct categories [source: Warren]:
- Must-Haves. Fifty percent of spending goes toward basic expenses like housing, utilities, transportation and basic phone service -- things you can't do without. Keeping your Must-Haves down to 50 percent, Warren writes, makes it easier to adapt if one member of your household loses a job or you're hit with unexpected expense.
- Wants. Another 30 percent should be budgeted for things you would like to have but that you can easily delay buying, such as clothing, dining out or a new smartphone.
- Savings. The final 20 percent of your spending goes into savings or debt repayment.
There are plenty of other systems for setting spending goals, too. For example, CNBC columnist Carmen Wong Ulrich advises spending 30 percent of income on housing, 18 percent on transportation, 10 percent on debt reduction, 14 percent for food, 7 percent for utilities, 10 percent for savings and 11 percent for everything else, from clothing to charity donations [source: Ulrich].
For a lot of people, creating a budget isn't the problem -- it's sticking to it that's tough. We'll discuss ways you can stay within your budget and even reduce household expenses in the next section.
Tips for Reducing Household Expenses
Now that you've drawn up a budget, you need to bring your spending into line with your plan. One way is to get a ledger book that's divided into columns. For each month, you'll create three columns for budgeted expenses, actual expenses and the difference between the two. A spreadsheet software program like Microsoft Excel can even do the math for you and make this record-keeping much easier.
As you look back over your income and spending each month, you'll see where you hit or missed your budget goals. If your spending is not staying close to the limits you set, you'll need to take action. One solution is to increase your income. You can take another job, start an at-home business or ask for a raise at work.
More often, though, you'll need to cut expenses. Your budget will help you to focus on areas where you can and should cut. Remember that the more you spend on a category, the more potential savings are available. For example, if you cut your $650 food bill by 10 percent through careful shopping, you'll save $65 for the month. If you spend $20 on coffee, a similar cut will net you only $2.
As you might expect, many of your cuts will come in the category of Wants. For example, you can put off buying clothes or shop at a thrift store instead. You can have pizza at home instead of a dinner at a fancy restaurant. But since some of your biggest expenses are in the "must-have" category, those areas might offer bigger savings. Does your home need to be as large as the one you now own? Do you need a BMW to get around? A more modest home or car can take a lot of strain off your budget.
Review your spending every month. If you're having trouble sticking to your budget, you might try a virtual envelope system to reduce expenses. Imagine that the budgeted amount for each category is an envelope with that amount of money in it. Once it's gone, no more spending. You'll be forced to live frugally, even if you still have funds in your other "envelopes" [source: BankofAmerica.com - Living].
What if you're running a serious deficit every month? The government might get away with it, but you can't for long. Resist the impulse to immediately cut the amount you've budgeted for savings. Instead, comb through your spending and look for relatively painless cuts. A budget is all about setting priorities for your spending.
It may sound contradictory, but the best thing about a household budget, says MSN Money's Freedman, is that it gives you freedom. "When you know you've got enough money for all of your needs and at least some of your wants," she says, "you can sleep at night."
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- BankofAmerica.com. "How to approach savings as a couple." http://learn.bankofamerica.com/articles/savings/how-to-approach-savings-as-a-couple.html
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- Freedman, Donna, MSN Money personal finance columnist and author of Surviving and Thriving blog. Personal correspondence, Nov. 9, 2011.
- Herdrich, Kelly. "Household Budget Management: Top Online Tools," womansday.com, June 16, 2009. http://www.womansday.com/Articles/Life/Money/Household-Budget-Management-Top-Online-Tools.html
- Intuit.com. "Set goals and manage your finances." http://quicken.intuit.com/personal-finance-software/deluxe-money-management.jsp
- Kiplinger.com. "How to Plug the Holes." http://www.kiplinger.com/basics/archives/2003/02/holes.html
- Peterson, Palyn. "Tips For Living On A Budget." DebtSteps.com. http://www.debtsteps.com/living-on-a-budget.htm
- Ulrich, Carmen Wong. "How to Budget Your Money," cnbc.com, July 30, 2008. http://www.cnbc.com/id/25933653/How_to_Budget_Your_Money
- Warren, Elizabeth and Tyagi, Amelia. "All Your Worth." Free Press. 2005.