As a byproduct of getting people divorced or helping them fight custody battles, we see a lot of financial statements for a lot of people. Today, we’re going to take some of the experience we have in reviewing those finances and put it to work in a multi-part series focused on financial security.
Think of your financial future like building a house. First, you have to draw up the plans, then you have to lay the foundation, then you have to build the walls that will support the structure, and so on and so forth. On the road to financial security, your budget will be the foundation and plan upon which your independence is built. A sound budget will tell you exactly where your money is coming from, where it’s going, and how you can adjust your plans for the future. Building your budget can be a bit tedious and time-consuming upfront, but once it’s done, you only need to spend a bit of time reviewing the numbers and updating it based on your habits and goals.
To create your budget, start by finding your take-home pay is – not your pay before taxes – over a given period of time. For this exercise, we will assume a one-month period. If you’re starting a new job and don’t know what that will be, these calculators will help you plan ahead: salary, hourly. Otherwise, check your most recent pay stubs that cover the last 30 days. If your monthly income is variable, take the average of your lowest 3 months and use that as your baseline. Anything above that will give you breathing room to carry you through tighter months.
Once you’ve got your take-home pay figured out, look at your mandatory/fixed expenses. This is non-negotiable spending essential to your independence or survival, such as mortgage/rent, essential utilities, grocery, transportation, and health care. Things that are not mandatory will include dining out, cable subscriptions, gym memberships, etc.
Next, we need to figure out whether or not you’re spending too much on mandatory expenses. There are some general targets to try and stay under, but remember, these are guides, not really hard and fast rules:
Housing: less than 30-35% of take-home pay
Transportation: less than 15% of take-home pay
Grocery: less than $250 to $300 per person, per month.
If any of your mandatory expenses are above these targets, you may have to consider some serious lifestyle changes like moving to a cheaper home, getting a roommate, buying store brand foods or going to cheaper grocery stores (or learning to cook – check out or entire feature on Cooking!), carpooling, etc. Now remember, budgeting requires a wholistic view of where your money is going and not just focusing on any one thing, and changes to one part of your budget can easily affect another. Moving to a cheaper area might increase your transportation costs if you’re farther from work, likewise, moving closer to work might increase your housing costs, but what if it allowed you to cut out almost all of your transportation costs? If moving closer saves you more money elsewhere, even if it pushes housing to higher overall % of spending it is potentially a smart financial decision.
Once mandatory expenses are accounted for, the remaining funds are where you lay the foundation for the future. Generally speaking, there are three jobs that we can assign to our money: Servicing debt, building our retirement, and building for financial goals. If you aren’t in a position of relative security, then we recommend the following priority list: Service your debts and establishing an emergency fund. We’ll discuss these goals more in depth in Part II of this series. How much you put into towards any of these jobs is up to you, but the more you apply, the faster you will generally obtain financial security.
Now, this is important: You need to have fun and still leave room for going out and enjoying your life. Budgeting is not all about restriction, it’s about liberating yourself to enjoy the fruit of your work and not worry about the future. Unless you really need to focus on something like getting debt under control, make sure that you set funds aside every month for discretionary spending – shopping, hobbies, dining out, anything you want to enjoy in life. While some people have a hard time saving, there is an equal and opposite problem where people sometimes feel guilty for spending too much. A good budget plan will resolve those issues.
Finally, the last part of your budget will be finding a system that works for you. There are a lot of methods out there that range from the tried and true envelope system to using apps like You Need a Budget (YNAB) and Mint to excel spread sheets. This brings you to the hardest part of financial security – being disciplined and following through on your budget.
Some closing thoughts:
As you begin to track your expenses, start taking notes about where your money is going and why it’s going there. As you move along, you should start identifying the places where you can make meaningful and appropriate cuts in spending, or repurposing of where your money goes. Remember, you get to decide what is meaningful. When making changes to your budget, you should be SMART:
- Specific: Example: “I will cut my beer and wine spending by 25% this month.”
- Measurable: Your changes should be readily quantifiable. Measuring changes in with money is easy. If your goal was to spend 25% less on beer and wine, you can check your expenses against the new goal.
- Assignable: Changes in budget need to be carried out by someone. Most often, this will be you. However, changes can be assigned to anyone. For example, if you have a partner, an assignable goal can be “Max out retirement contributions this year.”
- Realistic: Don’t set yourself up for failure and discouragement by setting unrealistic goals. If you’re in a place of financial instability, it’s probably not realistic to state that you’re going to buy a home by the end of the year. Likewise, it’s not necessarily realistic to say that you will cut your bad habits out of your budget by 100% effective tomorrow. Habit changes are done gradually.
- Time-bound: Set a real deadline to achieve your goals. “Eventually” doesn’t help you set benchmarks or improve anything. You are more likely to achieve something if you set a deadline.
Next month, we’ll talk about building an emergency fund and strategies for paying down debt. If you have any questions about how to build a budget, email us at email@example.com.