If you’ve ever tallied up your weekly or monthly income and compared it to the average amount that you spend over the same period, you’ve been guilty of drawing up a rudimentary personal budget. Like those of a well-run business that keeps its expenditures in line with its income to avoid becoming insolvent in the long run, your finances will improve dramatically once you’re in the habit of making and sticking to a budget.
To create your personal budget, which you may also know as a “spending plan,” you must first accurately determine your total income. Your income includes the salary from your primary job, secondary earnings from a part-time job or freelance work, and any interest, dividends or other investment windfalls that you don’t reinvest. If you own a business, you’ll need to include its after-tax profits in your income calculations as well. Since most of these amounts will fluctuate over the course of a given year, you’ll need to recalculate your income each month to ensure that your tally is accurate.
Next, you’ll need to calculate your total personal expenses over the budget period. Since expenses tend to vary from month to month and major obligations have a way of appearing when you least expect them to, this is a more complicated and less accurate process than tallying up your income. It can be done, however.
First, start with what you can control. No matter how precarious your financial situation may be, you should be setting aside at least 5 percent of each paycheck to protect yourself against unforeseen expenses. You can count this as the first recurring expense in your ledger. Other expenses that you can predict with reasonable accuracy include mortgage and utility payments, property taxes and any recurring club or membership dues.
Unfortunately, your debt payments are also a fixed cost that must be prioritized over virtually everything else. After all, your debts will continue to grow if they’re not managed, sucking more money out of your pocket each month until you resolve to do something about them. For the purposes of your personal budget, determine how much you must spend to stay current on your outstanding loans and lines of credit each month and add that amount to your expenses column.
Next come necessities like food, clothing and car maintenance, which should include gasoline. Unless you’re a serious creature of habit, you probably don’t spend the same exact amount on each trip to the grocery store, and you certainly can’t standardize your outlays for clothing.
What you can do is determine about how much money you spend on groceries and clothing per month by keeping a running total of your expenditures in each area over the course of a year. Drawing up and sticking to a budget involves a healthy dose of self-discipline, so try not to splurge during this process. Once you have a handle on your average weekly or monthly outlays, choose a realistic target amount for each category and resolve not to exceed it.
You may fancy yourself a fairly frugal person, but chances are good that there’s plenty of fat left to trim from your budget. Financial professionals use the term “spending plan” to describe personal budgets because they’re more than just informational charts: They’re tools that aim to strengthen financial discipline and keep more money in the pockets of their users.
Aside from working closer to home or trading in your car for a bicycle, neither of which are likely to be viable options, there may not be much you can do about your monthly gasoline costs. On the other hand, those pesky grocery and clothing bills are ripe for reduction.
You can make a convincing case that name-brand jackets, sweaters and dress clothes are worth their often-hefty premium. They tend to be more durable and fit better than their off-brand or store-brand counterparts, so they may actually save you money in the long run. If your upmarket fleece jacket lasts twice as long as a no-name ripoff but only costs 60 percent more, it’s clearly a good deal.
The same logic may not apply for clothing staples like socks, underwear and undershirts, and it certainly doesn’t apply for everyday grocery items like canned beans and boxed pastas. No matter how well they’re made or how good they taste, most of these items are either lost, worn out or eaten before they have a chance to make a lasting impression. Rather than spend 50 to 100 percent more for a recognizable label that says nothing about the quality of the product to which it’s affixed, save your money for the next part of your personal budget.
The more you’re able to reduce the cost of your household necessities, the more hard-earned pay you’ll have left over for discretionary purchases, which are the holy grail of budget discipline. This should be one of your biggest incentives for keeping a personal budget in the first place.
Discretionary purchases are known by several other professional terms, including “fun things to buy” and “things you always wanted but weren’t able to afford before.” Some, like trips to the movies or meals at the local burrito joint, are relatively small and may not even have crossed your mind before you kept a spending plan. Others, like fancy restaurant meals or trips to major-league sporting events, are larger and more memorable and may not have been prudent to make while your finances were in disarray.
You may not be able to make many discretionary purchases at first, but that’s okay. To begin with, focus on paying down your debts and getting the cost of your household necessities under control. Every dollar that you don’t spend on interest and name-brand pinto beans in the coming years is another dollar that you’ll have to spend on the things that really matter to you, like a new bike for your kid or a newer minivan for the family.
Once you’ve slimmed down your budget, laying out each month’s spending plan can be downright exciting. Many professional budget-keepers set aside a portion of the money they have left over after accounting for their fixed costs and household expenses each month for major discretionary purchases.
These big buys might include a destination vacation, a pleasure vehicle like a boat or motorcycle, or a big home improvement like a game room or livable basement. Your discretionary savings should be kept in a separate account from your emergency savings to prevent confusion and reduce your natural temptation to raid the latter to pad the former. Likewise, when times are tight, you should stop building your discretionary savings and concentrate on maintaining your emergency savings.
While it’s normal to want to spend every penny of your income and put off planning for your financial future, such a shortsighted strategy will backfire on you sooner or later. Your spending plan isn’t just for show: It exists to keep you on a steady financial course and, eventually, to reward your good habits. As with most things in life, you won’t reap the rewards of your personal budget right away. Sooner or later, though, you’ll be glad that you took the time to make one.