Mastering Personal Finances
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We all know that if you eat too much, you could end up having a heart attack. It is the same for your spending habits. You can end up having a financial attack if you are consistently spending more than what you earn. Foreclosure, bankruptcy, debt that is out of control and a lousy credit report for life are all consequences of a “financial attack.” Your finances need a diet and the diet for finances is a personal budget.
The two main purposes for a budget are:
1. Figure out exactly what your income is.
2. Figure out what you are spending your money on.
An honest assessment of your finances is required for a good personal budget. Creating a personal budget sometimes is the first moment that some actually take a good look at the way they spend their money. Some facts initially can be shocking. Perhaps you realize you spend almost $150 a month on coffee, but then you are satisfied when you realize that last month when you brewed your own, it saved you $135.
The main goal of a personal budget is to maximize savings and minimize expenses. When you cut down unnecessary spending and increase your monthly savings, you will have extra money to put towards long term financial goals that are important to you such as:
· Paying loans off
· Lowering credit card debt
· Saving money for your child’s college education
· Investing in a 401(k) or another retirement account
· Saving for a large purchase, such as a home, boat, car or vacation
How much money each month should you save? Save as much as you can afford. Even as little as an extra $20 a month is a good start. You will watch your savings grow as you earn more money and cut more expenses.
Perhaps, commitment is the most important tool for a successful personal budget. Budgets require the entire family to actively participate. If mom is buying generic brand groceries, but her teenage daughter is using the credit card to buy a $200 purse, then the budget will fail. Everyone needs to be working towards the same goal and must be on the same page at all times.
First Step: Carefully log all of your expenses and earnings
Many people find it very helpful to use financial software rather than just a pencil and paper. Regardless, the first step to create a budget is to calculate your earnings for the month. Only include fixed earnings such as job paychecks, royalties, alimony and legal settlements. Do not include uncertain income like bonuses or raises. Tracking your earnings is the easiest part of budget creating, however it is very hard to figure out your spending. Personal software such as Microsoft Money or Quicken are very helpful because they can download all of your recent transactions from your online banking records to create a detailed analysis of your spending.
Once you have a completed list of all deposits, transfers and outgoing checks, you can start the task of categorizing all of your expenses and income. With a couple clicks, you can deposit a paycheck, transfer $500 to your car payment and deposit your $2,500 paycheck. Experts of personal finance recommend that on top of specific categories like groceries or rent, you should organize all expenses under two broad labels:
· Discretionary spending: Includes every expense that changes regularly. Some discretionary spending is necessary such as groceries and clothing. Other discretionary spending isn’t absolutely necessary, like travel, hobbies, gifts, entertainment and eating out.
· Fixed expenses: Expenses that never change each month such as daycare, insurance, mortgage, loans, utilities, and tuition.
In addition to taking advantage of personal finance software, it might be beneficial for you to carry a little notebook with you in order to track all of your expenses. This is very helpful if you regularly take money out of the ATM or if you use cash to buy lunch, pay a toll or buy a newspaper; write EVERYTHING DOWN!
Second Step: Analyze the data of your income and expenses to draft a better budget
The first step when drafting a budget is to compare your expenses and monthly income. If you earn more than what you spend, then you can be assured that you are on the right track. However, if you spend more than your earnings, you should get ready for some serious adjustments.
The goal is to come up with a 10 percent savings of your earnings each month, which for most people involves spending cuts. If you use finance software, it will let you know if you are spending too much on certain things. But if you are only using a notebook and pencil, look at recurring purchases and figure out which ones are not necessary.
Some culprits you may find:
· Tobacco products
· Meals from Restaurant
You may find this to be a good time to quit smoking and learning how to cook!
Third Step: Create spending goals and stick to them
Once you realize certain ways to cut expenses, start to deduct those amounts from the total of your current spending.
Next, take a look at discretionary spending. Maybe you are spending too much on organic produce or new clothes. Create estimates of how much you could save if you only bought clothes when they are on sale or if you shopped at the local farmer’s market. Use the estimates to create a new budget.
If you look at all of your current expenses list individually, it is usually pretty obvious what you can cut back. Take your lower spending estimates and jot them down in each category and use the estimates as your monthly goals for spending. CONGRATULATIONS! You have a personal budget!