Introduction: Your Budget Will Help You Get What You Want
Part I: Getting Started
Chapter 1: What Do You Need to Create a Budget? Chapter 2: Setting Your Goals
Chapter 3: What Do You Have?
Chapter 4: What Are You Spending?
Chapter 5: What Do You Owe?
Chapter 6: Okay—You’re Ready to Create a Budget
Part II: Sticking to Your Budget Chapter 7: Saving Around the Household Chapter 8: Saving on Transportation
Chapter 9: Watching What You Spend
Part III: Expanding and Adjusting Your Budget Chapter 10: Paying Down Debt
Chapter 11: Saving and Investing
Chapter 12: Merging Your Finances
Chapter 13: Baby on the Way
Chapter 14: Your Biggest Purchase
Chapter 15: Finding Money in Your House
Chapter 16: Saving for Vacations and Holidays Chapter 17: Saving for College
Chapter 18: Saving for Retirement
Chapter 19: How to Survive Unemployment
Chapter 20: Sticking to Your Budget—No Matter What
Conclusion: Living the Life You Want
Appendix A: Debt-Restructuring Resources
Appendix B: Budgeting Websites and Online Tools
Your Budget Will Help You Get What You Want
Establishing a budget is the act of deciding how much of your money you’re going to spend on one item, how much on another, and so on, before you’re actually in the position of spending the money. Sticking to a budget is the act of following through on those decisions. Creating a budget isn’t easy, but sticking to any budget is extremely difficult.
The trick is to focus on the word realistic. It doesn’t take much research or many difficult decisions to decide that you’re going to spend $200 per month on food. But if you’ve never spent less than $500 per month on food, you’ll blow your budget right out of the water the first week. Instead, before you begin deciding on the numbers in your budget, you’ll need to fully assess your current situation, take a hard look at where you can cut back your financial obligations (both large and small), restructure your debt (if necessary), and see whether you can add income. Only then are you ready to decide realistically where every penny will be spent.
A budget is a tool, and like all tools, the results you get from it will be determined by how you use it. If you make a realistic budget and stick to it, you can watch your life move forward. If you set unrealistic budgetary expectations and don’t even bother to follow through with them, don’t think your financial problems are over.
Setting Budgetary Goals
Used correctly, a budget doesn’t restrict you; it empowers you. You’re going to establish a budget because you have financial goals that are not being met. For example, you may want to:
- Be able to pay all your bills from your paycheck—and maybe have a little left over
- Buy your first house
- Save for retirement but can’t seem to find any extra money to get started
- Pay off all your credit cards and never get into debt again
- Give more money to your church or to other nonprofits
- Be your own boss
- Take a vacation
- Stop hearing from the hospital about your medical bills
- Buy a new—or at least newer—car
- Stay home with your baby
- Remodel part of your house
- Pay for laser eye surgery
- Finance at least part of your child’s college education
- Buy health insurance
- Rebuild your credit
- Find a way to care for your aging parents
- Finally build your dream house
- Take a leave of absence from your job to work in the Peace Corps
- Go back to school and begin a new career
- Buy the downtown coffee shop when the current owners retire
- Get a whole new wardrobe
Are any of these your goals? If so, budgeting will get you there, even if the odds seem impossible right now. Even if you’re stuck in a job you don’t like, desperately want to go back to school, have to take care of an aging parent, and have $19,000 in credit card debt, you can meet your financial goals—just as others have done before you. With a good budget, a little patience, and a whole lot of determination, you’ll eventually get there.
PART I – Getting Started
Chapter 1 – What Do You Need to Create a Budget?
You might be tempted to answer this question with something clever like “money.” But if you do that, you’re missing the point. Creating a budget isn’t about having money; it’s about figuring out what you’ve got, what you’re spending it on, and how you can realize your dreams.
In order to do this, you’ll need some basic tools.
Of course, people made budgets in the days before computers, and you can still make a perfectly good one, sitting at the kitchen table with a pencil, a pad of paper, and a calculator. But why not do things the easy way? If you have a good, working computer, put it to work for you. Create a folder marked “Budget” (or something similar) so you know where all your files are going to go. If you have thoughts about your budget and about ways you can save money or extra sources of income you forgot about, note them down and toss them into the “Budget” folder. That way, they’ll all be centralized, and you can get at them easily.
One note of caution here: you’re going to be putting down in written form a lot of confidential information—not your password to your online banking account or something obvious such as that, but certainly information about your finances that you might not want other people to see. Make sure your computer’s security systems are strong. If possible, create a password protection for your “Budget” folder so only you (or anyone else you authorize) can get into it. Remember, these are your dreams we’re talking about. You don’t want anything to get in their way.
The Right Software
There are all kinds of financial software programs out there, each one claiming that it’s the only one you need. I won’t recommend any one of them in particular, although if you decide to use one, get a clear idea before you buy it of what it’s offering. After all, you’re inaugurating an era of responsible spending, so you don’t want to purchase something that isn’t exactly what you want or need.
On the other hand, you can bypass all those bright, shiny programs and just do the work and construct the spreadsheets yourself. It’s not hard—as you’ll see in the following pages—and if you have a quality spreadsheet program such as Microsoft Excel, you’ll be in good shape.
Spending and Income Records
One goal you’re going to accomplish as you go through this book is keeping accurate and careful records of your expenses and income. However, it’s possible that you’ve not been doing that up to now.
Assemble all your bills in one place, possibly in a folder or other container so you won’t lose any of them. At your local office supply store, you can find expanding accordion folders, each slot marked with the name of the month. These are great for keeping bills, since you can file them as they come in based on when they’re due.
In a separate folder or box, keep your pay stub records. This applies whether you’re paid with physical checks or through direct deposit into your bank account. You need to see exactly what’s coming in and when you’re receiving it. Keep the stubs in the order in which you receive them. Also in this folder, keep stubs of any other checks you receive (tax returns, gifts, etc.) These records are essential both for budgeting and for tax purposes.
Most financial advisers recommend keeping your financial records for at least three years. This doesn’t need to be a huge burden; just make sure you keep them sorted and somewhere you can have easy access to them if you need them. When it comes time to get rid of them, I strongly recommend purchasing an inexpensive shredder from an office supply store and shredding them. This way you minimize the possibility of identity theft.
One of the ironic consequences of the growth of technology has been that it’s easier for people to obtain illegal access to your records. There are a lot of things you can do to protect yourself against this (see How to Survive Identity Theft by David H. Holtzman, Adams Media, 2010), but one of the most important ways is to shred your personal documents rather than just throwing them away. This particularly applies to old, expired credit cards. Never just throw them away. Shred them or, minimally, cut them into very small pieces. There’s no reason to give identity thieves a helping hand.
A Quiet Place to Work
You’re about to embark on one of the most important things you can do to realize your hopes and dreams. This is big. It’s important. And to do it right, you need some peace and quiet.
Constructing a workable budget is something that takes concentration and hard thought. It’s not easy to find those things in a room filled with shouting children, barking dogs, meowing cats, and a spouse who wants help with a clogged dishwasher drain or finding where the tie is that he threw across the back of a chair last Thursday.
Pick a time when you’re going to be alone. Find a place that’s comfortable and away from the tumult of your daily life. If you like, put on some nice background music or sounds; you’ll make better decisions when you’re relaxed.
As mentioned above, you’re going to need an effective storage system for your income and spending records. Make sure they won’t be disturbed or accidentally thrown out. Make clear to members of your family that what you’re doing is important; after all, their dreams are at stake too.
All right. Got everything? Relaxed? Right. Here we go.
Chapter 2 – Setting Your Goals
Budgeting is all about getting from where you are financially to where you want to be. And in order to do that, you’ve got to decide exactly where you’d like to end up. One of the reasons people often have trouble budgeting is that they haven’t really sat down and thought realistically about the kind of life they want and how they might pay for it.
You’re going to do things differently. You’re going to start by asking yourself some hard questions.
What Do You Want?
Meet Billie DeSantos, age thirty-eight, whose budget we’re going to peek at to see how this process works. Billie has worked at the same company for eight years, working up to management level last year. She bought a condominium six years ago, has a car payment on a three-year-old car, owes about $2,800 in credit card debt, has some money in savings, is a single parent with two kids (ages ten and fourteen), and participates in the company’s 401(k) retirement plan. Billie usually has enough money to pay the bills every two weeks, although the kids’ growing expenses are starting to pressure the family’s income.
Billie’s decided that she needs a realistic, achievable budget with some goals. To that end, she’s come up with the following list:
- Help the kids pay for college
- Pay off the credit card
- Put away some income in a savings account
Notice that these are all pretty general. That’s fine at this stage. You can afford to be general; you’re just trying to get an idea of what you’d like your life to look like. Billie wants a life in which her kids are in college (or have graduated), she’s largely debt-free, and she can retire with some money to supplement her Social Security payments.
Having set general goals for herself, Billie has to look at them again, this time with an eye to what’s realistic and reasonable. Obviously, we’d all like to retire immediately and live in a beach house in Tahiti, but that’s not going to happen. Being realistic about her goals doesn’t mean Billie has to give up on them; she just has to add a time frame and some numbers to them. This is what she comes up with:
- Help the kids pay for college. Pay for half the expenses at one of the three large state universities (currently $14,500 per year for tuition, fees, room, and board) or put that same amount toward a private or out-of-state college.
- Pay off the credit card in nine months. Get the balance to zero, and then if it’s used at all, pay it off in full every month.
- Retire from the company at age fifty (in twelve years). Billie’s current salary is $49,248 after taxes but before deductions for insurance and 401(k) contributions.
- Save six months of income over the next twelve years. This money would be for emergencies only, not to be touched for any other expenses.
Let’s go through these adjusted goals in a bit more detail.
Help the Kids Pay for College
It would be great to pay the kids’ entire education costs so they didn’t have to take on student debt. But Billie knows she can’t afford that. Instead, she creates two alternative plans: one involving in-state tuition (on which she’ll receive a discount); the other for a more expensive alternative but one that will mean the students taking on more debt. When we come to consider budgeting for college, we’ll see there are some other alternatives as well as the ones Billie’s come up with.
Pay Off the Credit Card in Nine Months
Currently Billie’s credit card debt isn’t too high. The important thing, though, is that she wants to get out from under the constant interest payments. Again, she’s realistic enough to know she can’t simply pay the $2,800 she owes in one lump sum; it’s going to take some small payments spread over most of a year. But the important thing is she’s got a plan.
Retire from the Company at Age Fifty
Retiring at age fifty is probably a bit unrealistic given her salary and age, although this is a goal she can adjust. Retiring at fifty means she has twelve and a half years before she can start receiving Social Security benefits, so this might be a bit tight. Still, it’s a good place to start from.
Save Six Months of Income over the Next Twelve Years
At Billie’s current rate of pay, this would amount to $24,624 after taxes and before deductions. This is a reasonable sum to set aside for emergencies such as medical problems, accidents, or other unexpected events.
It’s a good idea to have a stretch goal—that is something you aspire to but only can attain by working very hard. Billie has such an aspiration: When she retires, she wants to open a bed-and-breakfast in a small coastal town. B & Bs in similar towns currently cost about $650,000 for the building and operation, but that price will surely rise in the next twelve years. On the other hand, if Billie is successful, the B & B will also provide a source of income during her retirement.
Income and Expenses
Now let’s see just how realistic these goals are, given Billie’s current income and spending patterns.
Billie’s biweekly income after taxes (which provides her with a refund of about $450 per year), company-sponsored health and dental insurance (at a cost of $55 per pay period), company-sponsored life insurance for $250,000 of coverage ($30 per pay period), and 401(k) contributions ($75 per pay period, matched by the company) is $1,892, which totals $4,100 per month. Billie also has $1,700 in savings. Her monthly expenses are as follows:
Ways to Reduce Debt
Billie’s monthly obligations just about equal her monthly income, so to achieve her financial goals she’ll have to eliminate some expenses. Here’s what Billie decides to do:
- Keep the car and car payment. After paying off the car in one year, continue to drive it for five years after that, putting $342 into savings each month for the next car. No monthly savings.
- Cut down on utilities. Get rid of her landline (go cell-only), and install a programmable thermostat (at a cost of $46) to save on gas bill. Estimated monthly savings: $83.
- Spend a maximum of $125 per week on groceries. Limit eating out to pizza or Thai takeout once a week. Estimated monthly savings: $175.
- Eliminate the small stuff. Keep Starbucks visits to once per week, borrow magazines and DVDs from the library, and otherwise reduce monthly spending money to $150 ($100 for both kids’ allowances; $50 for Billie). Monthly savings: $50.
- Investigate car insurance options. Lower annual insurance costs by $400. Monthly savings: $33.
- Limit vacation spending. Reduce annual amount to $500 per year by being creative (see Chapter 16). Monthly savings: $191.
- Allow each member of the family $600 per year to spend on clothing and shoes (teaching the kids budgeting skills in the process). Any more than that, the kids will have to use their allowances or get part-time jobs. Monthly savings: $117.
- TOTAL Monthly Savings: $649.
To meet her financial goals Billie must increase monthly savings and investments:
- Refinance the mortgage on the condo at 5.8% for fifteen years, paying it off in twelve (so that it can be sold, debt-free, to help pay for the B & B, which will then be mortgaged for fifteen years). Monthly increase: $290.
- Use savings plus increase in monthly payment to pay off credit card in nine months. Monthly increase: $122.
- Begin saving for college in a 529 plan (see Chapter 17). Monthly new expense: $600.
- Save six months of income over the next twelve years. Monthly new expense: $171.
- TOTAL monthly increase: $1,183
Revisiting the Sample Goals and Priorities
Billie is $534 short each month, so it’s time to revisit the listed goals to see which can be changed or eliminated. Here’s the revised list of goals (changes in italics):
- Help the kids pay for college.
- Pay off the credit card in three months, and begin saving for the kids’ college fund only when it’s paid off.
- Retire from the company at age fifty-four (in sixteen years) and open a bed-and-breakfast in a small coastal town.
- Put away six months of income in a savings account over the next sixteen years.
These changes mean the following financial adjustments:
- Refinance the mortgage on the condo at 6 percent for thirty years, with the understanding that in eight years (when college savings will no longer be necessary), the money currently used to save for college will be redirected to the mortgage. Making those large extra payments toward the mortgage after the kids finish college will result in the mortgage being paid off in eighteen years, not thirty. Reduces monthly shortfall by $310.
- Put away $130 per month into savings (instead of $171) over the next eight years, and then increase savings with reduction in food, utilities, clothing, and other expenses because the kids will have left home. Reduces monthly shortfall by $50.
- Delay contributions to 529 plan by three months, using that money plus funds from savings to pay off credit card debt. After credit card is paid off, begin saving for college in a 529 plan, putting $418 (instead of $600) away, with the understanding that all future promotions, raises, and tax refunds for the next eight years will go directly to the college savings account. Reduces monthly shortfall by $304.
- TOTAL monthly increase from current spending: $0
Billie has created a working budget. It won’t be easy to cut back, but the family does still have some discretionary spending money, the kids’ educational savings are in good shape, and Billie will realize the dream of owning a B & B in just sixteen years.
Billie’s success depended on her ability to do two important things that are essential to the budgeting process: prioritize and compromise. She had to prioritize her goals and decide how much she wanted to achieve each of them. She had to balance long-term goals against short term ones and decide which were immediately realizable and which were going to take longer. And she had to figure out what she’d be willing to give up in order to realize those goals. This process of prioritizing and compromising is at the heart of good budgeting.
Now that you see the basics of how it’s done, let’s roll up our sleeves and begin the work of evaluating what you have, what you’re spending, what you owe, and how you’re going to create a plan to realize your dreams.