If you’re any kind of a football fan you know that the game is played in four quarters. But did you know that you could also divide your budget into four quarters? This is because of what’s known as the “25% Rule to Budgeting.” If you follow it, you’ll find that balancing your personal budget will be less tedious and less time-consuming. While budgeting has become much more challenging these days, the “four quarters” approach can simplify things for you considerably.
It’s a zero sum game
Like it or not, household budgeting is a zero-sum game. In other words, you only have so many dollars available before you have to either drain your savings account or pile on debt. To make matters even worse, most financial management is done through hindsight – or after your mortgage payments have been locked in, your spending patterns have become ingrained and you’ve already racked up debts. This can make you feel as if your budget was more like a diet that a menu.
A better way
Fortunately, there is a better way to handle your family budgeting. First, divide your before-tax income into four quarters or four equal parts. Then group the expenses your income must cover into four categories: housing (rent or mortgage), taxes, debts (excluding your mortgage payment) and living expenses.
The first quarter
You are going to be taxed. There’s just no way around it. This will include federal and local taxes, your Social Security and Medicare, etc. Consider this to be a bill that would equal one quarter or 25% of your pretax income if you were a moderate earner. Make sure you also take into consideration your retirement contributions and any other payroll deductions.
The second quarter
Your second 25% will be for housing. Whether you rent or own, you need to limit your monthly housing payments to no more than 25% of your pretax monthly income. To put this another way, you should figure that one week of your salary should equal your mortgage payment or rent.
The third quarter
It’s also important to limit your monthly loan payments to no more than 25% of your monthly salary. If you will need additional credit, you need to keep your total debt obligations as close to 30% as possible. In fact, there is an inverse ratio at work here. As the percentage of your debt obligations go up, the less likely it becomes that you will be able to get new credit.
The fourth quarter
You’ve now used up three quarters of your salary in taxes, rent or your mortgage payment and your debts. This means your last quarter or 25% will need to take care of everything else, including groceries, gas, entertainment, clothing and putting money away into an emergency savings account. If this were the best of all worlds, your emergency fund should be equal to six months’ worth of rent, debt and living costs. If you can’t do this, at least shoot for three months’ of living expenses.
If it doesn’t add up
If you find that you can’t live on 25% of your monthly income, you will need to take another pass at your plan and try to adjust whatever allocations are within your control – which should be everything but taxes. For example, you might need to move to a less expensive house or apartment or get a roommate. Or maybe you will have to wait on some upcoming purchase – especially if you would need to finance it.
Finally, if your debt obligations are already close to the 30% danger limit, you will have no choice but to find ways to cut the other two categories in order to accommodate that reality.
You may need a cash journal
What this boils down to is that trying to juggle a long list of expenses is tough to do unless you have a good sense for how they all fit together, the limits you will need to set for each category and the strategic trade-offs you may have to make. If despite all of your good efforts, you’re still not making it to the end of the month, you may have to keep a cash journal for 30 or 60 days. This is where you write down every single expense you make and in whatever form it took – whether it’s by check, cash, credit card or debit card — and for what ever reason you made the expenditure such as food, gas, laundry, groceries or whatever. What this will do is help you find the “budget busters” in your spending so that you can get back on track.
What to do about those budget busters
Once you have identified your budget busters, there are some things you can do to eliminate them. For example, if you find that your biggest problem was impulsive spending, try instead to be impulsive about paying off your credit card bills rather than just waiting until their due dates. If you can make early or multiple payments, this will mean paying less interest and a quicker pay-down.
Did you have a tendency to forsake your budget completely after you made one or two blunders? You could actually turn this avoidance tendency into a positive behavior. For example, you could automate your contributions to your retirement account, emergency fund and other savings account directly from your paycheck. That way you will not be able to abandon your financial goals, despite whatever the temptations might be.
Spend but get paid for it
If you feel that you can be responsible in how you use credit, you could turn your budget busters into cash in the form of cash back credit card rewards – especially if an unequal amount of your budget goes to groceries, fuel or travel. Also, many credit cards offer additional value in the form of travelers insurance, car rental insurance and so forth.
Make a contribution
Another way to handle those budget busters is that every time you give in to a temptation, make a three-dollar contribution to your savings account. This may not seem like much but over time it will add up.
Ensure that your home continues to be an investment
Whether you rent or own, you should take a home inventory so that you will have an accurate value of your possessions. When you have determined that figure then make any necessary adjustments to your homeowner or rental insurance coverage. In addition to your 2014 budget, you should also have` a property maintenance calendar. These will not only allow you to cover your maintenance expenses, it will reduce the possibility that you’ll be hit with unexpected repairs. In addition, if you set a maintenance schedule for your major home appliances and systems – think heating, refrigerators and cooling units – you will reduce your monthly utility bills and help maintain your home’s value.
Document your improvements
If your budget can include some larger improvement projects, be sure to take before and after photos and organize all of the documents you have related to those purchases. This will help you with your taxes and when it comes time to sell the house.
Do you have a problem with resolutions?
If you are like most of us, you may find that you have a problem sticking with your financial resolutions. We read recently that only about 55% of us actually keep our New Year’s resolutions for six months. If you’re normally part of the 45% that don’t, here’s an infographic that could help you stick to your resolutions this year. Who knows, a new outlook might be just the thing to help you accomplish all those goals and resolutions.