Understanding personal finance and having the discipline to manage a budget and save for the future are key factors toward achieving personal life goals. Building knowledge about personal finance – or financial literacy – enables people of all ages to manage their financial lives with confidence.
Learning how to manage your money is the key to protecting your finances. Budgeting or planning is the most important part of your financial management formula. Research shows that for every minute spent in planning, ten minutes are gained in execution. Meaning if you budget your money strategically, you are ten times likelier to achieve your budgeting goals.
Once you understand the overall picture of your finances - specifically, how money flows in and out of your life - you can better see how to reach your financial goals.
What is the purpose of a budget?
A budget helps you set and reach financial goals:
Start by collecting bank, credit card, and income statements for the past six to 12 months. Determine, on average, how much you spend monthly and break down spending into categories like food, gas, entertainment, monthly household bills, insurance, debt payments, medical expenses, and savings. It also pays to calculate and record exactly how much of your debt payments are going toward interest.
Fortunately, there are multitude of financial cellphone applications that will categorize your expenses for you. Applications such as Mint.com Personal Finance, will categorize your purchases for you and present summarizes on where you can improve your spending habits.
Next, input all your income. Once you identify where your money is going, you can formulate ways to improve your situation. You may also wish to create a timeline for reaching goals, such as paying off debt or saving for a vacation.
If you're in the dark about how much you spend and where you spend it, changing your habits will be difficult. Even if you're financially comfortable, a budget can help you identify unnecessary expenditures and deduce ways to redirect funds towards your priorities. For example, if you don't realize you spend $70 per month on coffee, it will be much harder to break that habit.
A budget helps you meet your monthly obligations:
If you're trying to get out of debt, it's essential to budget your limited funds to make debt payoff a priority. To cut back on expenses you need to first see where your money is going so you can then limit yourself to a specific amount per spending category. A useful method is the envelope budgeting system. In this system you divide your money into areas of spending: food, gas, clothing, entertainment, etc. by creating an envelope for each category. Fill each envelope with the money that you've allotted to that particular category. Pay for your purchases out of the appropriate envelopes – using the food envelope for food purchases and the clothing envelope for clothing purchases – but only until the money is gone. At that point, all spending in the drained category must cease until the next month.
Once you have a clear view of your overall financial picture, you can shift your focus to aggressively eliminating debts and building wealth. Once you've solved your personal debt issues, you will already be in the habit of putting a certain amount monthly toward debt. So rather than change that habit, simply redirected those funds toward your savings.
A budget helps you build wealth and increase your money for savings / emergencies:
As your savings and investments build, you will be able to generate a passive income from interest payments and capital gains while still using your actively generated income to budget for monthly expenses. In other words, you will be able to increase your total income simply by being smarter about how you use my regular paycheck.
Lastly a budget can help you save for retirement:
Though technically an aspect of building wealth, retirement planning is so vital to your future that it warrants special attention. A recent participant poll of Pocket Smart: Know your Taxes workshops in Los Angeles, Houston and Sacramento revealed that 88% of Latino Americans have no retirement savings, and many of those that do have a retirement fund don't contribute enough.
Saving $100 per month can increase your retirement nest egg by as much as tens of thousands of dollars, depending on how long you have until retirement and how well your investments perform. This is primarily because retirement funds receive tax-advantaged treatment, and gains have decades to compound. This is reason enough to aggressively pay off debt, as interest payments can easily exceed $100 per month and prohibit you from enjoying a comfortable retirement.
Also, plan to have a surplus for when you retire. Believe it or not, money will mean a lot more to you when you have less of an ability to earn it.
When developing a budget, consider some of the following questions:
- What are my fixed expenses?
- What are my variable expenses?
Fixed expenses are expenses that do not change such as: Rent, car payment, insurance, cable, internet and phone
Variable expenses that change month to month such as: Food, electricity, water, gas, public transportation and misc. expenses
Examine your wants versus needs:
Wants are things you desire, but can live without: New clothing, shoes, electronics, jewelry, cable, internet, the latest iPhone, etc.
Needs are items that you must have for basic survival: A roof over your head, food to eat, gas and electricity
Budget according so that your needs are met before splurging on wants.
Here are some valuable tips to developing a successful budget:
- Keep a list your fixed monthly expenses
- Compare your income with your expenses. If you frequently struggle to make ends meet and have no money to apply to your saving, you may need to reevaluate whether you’re living according to your means
- Track and plan for expenses: rent, car payment, insurance, etc. (use online banking to aide in the process)
- Set priorities, goals and limits
- Set a savings plan and make it a priority
- Always keep an emergency fund.
- Plan ahead for major purchases, thus avoiding impulse decisions.