It’s not a secret that most of us hate to keep a budget. Personal finance is hardly part of our education and tracking our spending each month in various categories is tedious. However, learning to spend under budget is one of the essential keys to financial success. Whether starting a first job, merging money with a partner, or stepping into retirement, creating a budget creates a guide for other financial decisions that will have to be made. Over the years in working on various budgets, I have found that the easiest process for sticking to a budget is by following 3 steps and focusing on 1 number.
Step 1: Know your essentials
Your essential expenses are your basic costs of living. These are the things that you really can’t go without, so you have to make sure you know how much they cost, almost exactly. Your essentials include housing costs, food, health/medical care, insurance, transportation, utilities, childcare, and required debt payments.
The important part of this step is not only to know these costs, but to optimize them. We need to make sure that you are spending as efficiently as possible on essentials. Reviewing your utilities for cost savings, coordinating insurance policies, making smart decisions about housing and vehicle purchases all can reduce essential costs.
If at all possible, try to target 50% of your net income as the total for your essential costs.
Step 2: Automate money for your financial goals
Pay yourself first! Set up automatic transfers of money into savings for future goals. I recommend starting with a regular savings account. Choose a reasonable amount that you can transfer into savings each time that you get paid and then use an automated transfer so that you can set it and forget it. If you need a guideline, try 5% of your gross income. After this, take care of goals like investing for retirement. I recommend using a retirement plan at work first if possible. If you have a 401(k), make sure you are contributing enough money to get your match. Try to target 15% of your gross paycheck into your 401(k), a Roth IRA, or a combination of both.
The other piece of this step, if your goal is to payoff debt, is to automate any excess debt payments toward paying down debt as quickly as possible.
Step 2 requires some thought. Make sure to try to set aside at least 10% of your income toward your savings, investment and debt goals with a target of 20% total.
Step 3: Your 1 number
After itemizing your essential expenses and setting up automated savings you have taken care of your needs, you will have a dollar amount left over from your income. This amount is your lifestyle number. This is the 1 number that you need to keep track of.
Example:
Net Income = $8,800
Total Essential Expenses = $4,200
Automated Savings = $1,200
1 Number for Lifestyle Spending: $3,400 ($8,800 - $4,200 - $1,200)
This 1 number can be spent however you like each month. You just need to make sure that your total spending stays under this number.
Easy ways to track your number:
Use 1 credit card for your lifestyle spending. A credit card can be a great way to keep track of spending because you can keep track of the balance and keep it under your 1 number. In addition, if you use a card with good rewards, it can be a great way to build points consistently. It is important to be diligent and pay your full balance off each month.
Use a cash management account: This process involves having your income all deposited into one account (your cash management account) and then transferring the 1 number amount into a different account (your spending account). You can use two different checking accounts to accomplish this. This can be the best way for people who need some help with discipline and sticking to the number.
Stick with it
Once you get your budget set up, make sure to give it some time. Check your progress once a month and adjust as needed. I recommend focusing your 1 number on what you value. If you love dining out, then it is ok to spend your money on restaurants as long as you keep it under your 1 number. Same with fitness, shopping or travel. It is up to you. Just stay under budget!