Budgets

Budgets

A budget is the tool in your money tool kit that actually helps you manage all the other tools. When you have a budget, you can handle your checking and savings accounts better; pay all your bills on time more easily; be more responsible with your credit, debit and ATM cards; and build a better credit score.

THE DEFINITION

A budget is an itemized forecast of income and expenses expected for some period in the future. –Investorwords.com

QUOTABLE

A budget tells us what we can’t afford, but it doesn’t keep us from buying it.
-William Feather

Another definition

The website investorwords.com describes a personal budget this way:
With a budget, an individual is able to carefully look at how much money they are taking in during a given period, and figure out the best way to divide it among a variety of categories.

When making a personal budget, an individual will typically designate the appropriate amount of money to fixed expenses such as rent, car payments or utility bills, and then make an educated guess for how much money they will spend in other categories, such a groceries, clothing or entertainment.

By keeping track of where your money goes, you are less likely to overspend, and more likely to meet your financial goals.

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Benefits of a budget

A budget helps you develop a healthy relationship with money and is the best way to see Your Whole Money Picture.

When you write out a budget, in fact, all of the principles you’ve learned for developing a healthy relationship with money just fall into place:

  • You can see Your Whole Money Picture.
  • You can Protect Monday Me.
  • You can Avoid the Spending Rip Current.
  • You’re much less likely to buy Tomorrow’s Junk.
  • You’ll be able to Dodge the Ad Barrage.
  • You’ll be much more likely to Stay in Your Money Stance.

Developing money memory

Another benefit of doing budgets is that they help you build the personal-finance equivalent of what some athletes call “muscle memory.” Pro ball players spend so many hours practicing the same moves over and over that their entire body remembers exactly what it needs to do to make those moves on game day. It just becomes reflex. That’s muscle memory.

Muscle memory puts your body on autopilot for success.

The same is true with budgets. The more you write down the details of how you want to spend your money, the more easily you’ll respond correctly when confronted with all those money decisions you’ll face every day. You can think of this as developing “money memory.” Doing budgets is how you practice.

QUOTABLE

Budget: a mathematical confirmation of your suspicions. -A.A. Latimer

FAST FACT

A July 2011 Bankrate study found that 58% of those surveyed track their monthly spending, while 40% do not.

Budgets can make the difference

A budget can help you uncover a lot of the important information about yourself that you learned in the first section—like how much money you spend out of boredom (a sign of the Spending Rip Current) and how many purchases you make that you soon consider mistakes (Tomorrow’s Junk).

When you can see those trends clearly, you can then put that wasted money toward something far more valuable to yourself, like saving and investing.

Because you’re young and have the power of compound interest working for you, by setting aside just a small amount of money now and in your 20s and 30s, you can build real wealth over time. This is why the few minutes it takes to prepare and monitor your budget will be well worth the effort.

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Knowing your whole money picture

Before you can actually prepare a budget, you’ve got to get a good idea of how much money you actually have coming in and where you’re spending it—in other words, your Whole Money Picture.

So it’s time to start tracking your money. For one week, write down everything you spend—everything—along with how much money (if any) you receive as income. You can use this sample form.

Tracking your money

The best way to do this is to carry a pen and small notebook with you, everywhere you go, for the whole week.

You’ll probably be shocked at how much and on how many different things you’re spending money—most people are when they do this. Spending way more than you realized on music? Did you buy something that has already turned out to be Tomorrow’s Junk? That’s okay; you’re learning.
Now you’ve got at least a little bit of an aerial view, and you have a starting place to get into the habit of spending more wisely.

But this works only if you truly record every dollar you spend. Otherwise, you don’t get your whole money picture. If you buy an iTunes song, record that $.99. Stop at the store to get a soda? Record the $1.49. Don’t let any purchase go unrecorded.

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Doing your budget

When you’ve completed the one-week snapshot above, you’ll have a good idea of where your money goes. Now you’re ready to prepare a real budget. Your budget will have three basic categories of information:

Income

That paycheck you worked so hard for!

Fixed Expenses

Like rent or Internet, which stay pretty much the same from month to month and which are necessary to your way of life

Variable Expenses

Like entertainment, gas for your car and meals out, which change from month to month.

Fun spending is a variable expense

When you prepare a monthly budget, you’ll write down all sources of income. That’s how much money you have for the month. Then you write all your fixed expenses. What’s left is the money you have for variable expenses (like entertainment) and to put toward your financial goals like saving or investing.

This budget will look similar to the sample form you saw earlier. But instead of just tracking how much you’re spending, with a budget you’re actually setting goals and limitations on how much to spend in any given area.

Setting targets for variable expenses

Notice that in the sample budget form, your variable expenses are listed as targets. That’s because when you’re operating on a budget, your variable expenses are where you can control how much you spend. Both your income and your fixed payments, like rent, will stay pretty much the same each month. But with your variable expenses, like meals out, you really have the opportunity to gain control of your financial life—and to get ahead.

On your monthly budget form, you should write down the maximum you want to spend on each category of variable expense. You might write down $100 for entertainment for the month, for example.

That’s your target. Every time you spend money on an entertainment expense (like a DVD), you can record that and mark it against your $100 entertainment target for the month.

POP QUIZ

Your budget is most closely associated with which financial principle?

QUIZ ANSWER
Your budget is most closely associated with the financial principle Know Your Whole Money Picture.

Needs vs. wants

A great strategy when preparing a budget is to sit down and write out all the things you spend your money on (or want to spend your money on). If you’ve done the one-week tracking of all your expenses, then you can use that as the basis of the list.

Now, take an honest look at these items and ask yourself if each is a need (which you can mark with an “N”) or a want (mark with a “W”). You might be surprised at how much you spend on things you assume you need, but that are really just wants. You might also be surprised, when you see all your purchases on paper, just how many of them you didn’t even really want that much.

This is also the power of budgeting. It can save you from all sorts of purchases you probably wouldn’t be happy with anyway.

The envelope method

Once you have a budget in place and have decided how much you want to spend on variable expenses, one clever way to budget is to write out each type of expense on different envelopes, and then place in them the amount of cash you’ve allotted for that category for the month.

It’s a great way to keep yourself from cheating by spending more on a type of expense than you wanted to. If you check your envelope marked “Clothes” and there’s no more cash in it, then you’re not buying anymore clothes until next month.

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Budgets as a way of life

Many people don’t like preparing and living by budgets because they fear it means they won’t be able to enjoy their money.

The truth is just the opposite.

Getting into the habit of preparing budgets for yourself will indirectly lead to lots of fun throughout your life. That’s because budgeting sets you up to have more money, and have more fun with your money, than you ever could if you simply spent carelessly without ever budgeting.

PRINCIPLE IN PRACTICE

A budget is one of the best ways to protect Monday Me.

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