Wednesday, May 4, 2011

How To Budget

I've now talked about why you should budget, so now let's talk specifically about how to budget before going on to budgeting tools.  I found a really good article at this other blog called Get Rich Slowly, which you can take a look at, and I like their breakdown of necessities and discretionary items which I will mention again.  And although it is insightful to further break down these categories, generalizing them into three overarching sections can help simplify your budget and make it more easy to read.  It references the Balanced Money Formula which breaks down your after-tax income into three categories: 50% needs, 30% wants, and 20% savings.  I've copied the helpful picture below.
They define needs the same way I do necessities: your rent, food, health care, transportation, insurance, clothing.  Wants are cable TV, cell phones, books and magazines, vacations, and food and clothing beyond the basics.  Again, they also recommend that this is a guideline instead of a bible.  For example, I would probably move the phone bill to necessities in my budget.  

Also, the 50-30-20 budget breakdown can be adjusted to your desires.  For me, savings would probably take up more than 20% simply because I don't have many wants besides my needs.  Right now, about half my income is spent on necessities, albeit I do go out and eat at a nice restaurant once in a while, and the other half I usually just save.  I try to take advantage of free internet and free food events (which I will probably have a post about later as well) so my formula is pretty different.

The main takeaway is to shift the weights to match your goals.  Your basic rent and insurance premiums probably do not change month to month, so after a while you should be able to see what percentage it is of your income.  Find out if your needs takes up 30% or 50% or 70% of your income and learn what excess income you have to allocate to wants and savings.  If you plan on making a large purchase in the near future (a house or a car), you may want to have savings take up the majority of what's left of your after-tax income after your needs.  If you don't plan on purchasing anything big for a while, perhaps you can spend more on your wants and save a little less (but hopefully after reading about how much your savings can grow, you will be a little more enticed to save).

So, figure out your goals in terms of your plans for large purchases over the next few years.  As a college student, it may be a while before you start really thinking about buying a house and a car but it shouldn't be too far off.  Remember that budgeting is simply a guide to let you know how strong you are setting up your financial position for the future.  If you want to celebrate during Christmas and spend most of your income after your needs on high-end restaurants and a shopping spree, go for it as long as you are okay with it.  But you should always try to save at least a little of your paycheck for emergencies to have some margin of safety. With later posts, whatever money you do save should be able to grow significantly to help you out when you do need it and you should be able to feel secure with your finances.

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