Budgeting 101

Budgeting is the key to feeling financially secure. It may seem like common sense but here are four main steps to making a budget.

1. Know your Income: Your gross income is how much your boss told you you’d make. Your net income is the money left over after deductions (things like income tax, Social Security, health insurance premiums, and your 401(k)). This is the amount deposited in your bank every pay period.
2. Set Goals: Do you want to pay off a credit card? Save up for a trip to Australia? Save up for a home? Start with one big goal and write down the magic number that corresponds with it.
3. Fixed expenses: Calculate your fixed, necessary monthly expenses. These are your “need it” expenses that stay fixed month-to-month. That includes rent, utilities, and transportation.
4. Tracking: For a month, break down everything you spend that’s not a fixed expense. These are your “want it” expenses. That includes clothes and travel. Be specific so you know exactly where you’re spending, and where you can cut down. Don’t just say “$350 on food and dining.” Instead, save all of your receipts: coffee: $40; groceries: $80; dinners out: $110; lunches: $120.

After a month of saving your receipts, subtract your expenses (both “need it” and “want it” expenses) from your monthly salary. Is that number negative or positive? Are you spending more than you’re making, or do you have some cash money left over?

If it’s positive…start saving. Calculate how long it will take you to get to your savings goal in step 2 if you save $50 a month vs. $100 a month vs. $200 a month vs….you get the picture. Experts recommend saving between 10 and 20 percent of your take-home pay. That might seem daunting, especially when you have a mountain of debt. Start with 5 percent. Even 1 percent. Just start somewhere.

If it’s negative…take a red pen to your “want it” expenses. Try these tips:

• Food: Eating out can be expensive. If you’re spending too much on food, stop eating out so much. Also, don't buy food you don't eat. 
• Cuts: Take the top two biggest monthly expenses from your list (for example, lunches and dinners out) and try to cut those expenses by 10 percent. If you can do that, graduate to 20 percent the next month. Keep going until you’ve chopped your two biggest expenses in your most spend-happy category in half.

If you can’t decide where to cut down…remember that no one said budgeting was easy. 

Savings rules: 

• 50/30/20 rule: Try the 50/30/20 rule. Here’s how it works: Half your paycheck goes to things you need (the “need it” expenses, like rent). If you live in a major city this might be tricky to keep at just half. Another 30 percent goes to things you want (the “want it” expenses, like wine and plane tickets). And 20 percent goes to paying off debt or to savings and investing.
• Rainy day fund: You should try to have enough money to cover three to six months’ worth of essentials (your “need it” expenses, like rent) saved up. This gives you some cushion in case you lose your job or need to take on extra expenses. By the time you are 30, you should try to have the equivalent of your annual salary saved up. This may seem pretty unrealistic but start small like saving three months’ worth of essentials and see how that goes.
• Savings fail: If you are not meeting your savings goal, relax. First things first. As in, transfer your monthly goal amount to your savings account at the beginning of the month. To take it a step further, set it and forget it: Set up automatic, recurring savings transfers with your bank. Every month, your money should be making moves (from your checking to your savings). Having a separate savings account will make it easier not to touch that money for other things.

Savings accounts: Here are some of the different ones you can open with your bank.

• Standard: The tried-and-true. This is the type of savings account most Americans have. Some have zero or low minimums. Do this if…you’re starting out and don’t have a lot of money to put into the account. Interest rates are low on standard accounts.
• CD: Not that kind. This is a certificate of deposit. Banks often let you open a special kind of account with better rates than you would get in a regular savings account. But you have to keep your hands off that money for a certain amount of time (usually a few months up to a few years). Do this if…you won’t need to access that money for the period, and you want a “can’t touch this” way for your cash to earn interest.
• High-yield savings account: An account where you put more in and get more back. The interest rates are often higher, but you usually need to invest a certain amount to get one. Do this if…you have more money to invest and want the flexibility of withdrawing it at any time.

Saving for retirement is kinda like eating right. It’s annoying and feels unrealistic in the short term, but it has long-term benefits. That may sound like BS but it’s true. Here are some of the retirement savings terms and concepts you’ll come across and the benefits of each.

• 401(k): An employer-sponsored retirement savings plan. It lets you save and invest a piece of your paycheck before taxes are taken out. You won’t be taxed on it until you start withdrawing the money (hint: That’s why you shouldn’t withdraw until you retire). Some companies will match how much you contribute to your 401(k) up to a certain amount. This is free money. You should avoid turning down free money. If it still sounds scary to set a piece of your paycheck away, know that you’ll have options for how to invest it. One common option is to park it in a target-date fund that tweaks your investments over the years based on what year you plan to retire. So as you get older, your 401(k) spread will become less risky. Do this if…your company offers it. Especially if they offer to match your contributions. Every company’s plan is different, so read the fine print. 
• IRA: Individual retirement account. There’s a max amount you can contribute to an IRA each year—it’s $6,000 for 2020, but typically goes up a little every few years. Like with a 401(k), you decide how you want to invest it. If you do a traditional IRA, you hit snooze on paying taxes on the money until you take it out. If you do a Roth IRA, you’ll pay the taxes up front. Some experts say it’s better to do a Roth IRA, since you don’t have to pay taxes when you withdraw all that money that’s been gathering interest for years. It’s also advised to invest your money into your IRA or Roth IRA at the beginning of the year, so it has the chance to gain interest over the year. Do this if…your company doesn’t offer a 401(k), or if you’re maxing out your 401(k) and want to put aside even more money for retirement. Or if you just want to pay less taxes now while saving up for the future.

Budgeting is a b-word. But it will result in the savings you need in the long run—which means extra money in the bank and cash to invest.

Source: How to Skimm Your Life

After your budget is done, click here to read some money trivia.