One of the best ways to build a strong financial foundation is to have a firm handle on your budget. You want to get into the mindset of making small sacrifices today so that you can buy more later. If you do that, you will have a better chance at being able to afford things like houses, cars, and educations.
This can be tough to get across to someone who believes that money is better spent in the present as it is an item of necessity instead of something to be enjoyed as you get older. Necessity can often mean big life changes like a wedding, kids, and a home, which can take up a lot of your earnings.
I do agree that the shock of spending is apparent on things that pass quickly, like vacations and food, but I think that a lot of people overlook the fact that spending on things likes mortgages and retirement influences the ability to spend in the future. Even though it isn’t always fun, these kinds of things need to be planned around. Spending has a big impact on your life, so you want to understand it as thoroughly as possible. In this article, we’ll look at some budgeting strategies that will help you understand it all so that you can begin building a strong financial roadmap that can help you in your own life.
Costs of Living
Food, housing, and transportation, these are the areas people tend to do most of their spending. When you think about how much you do these things, it puts into perspective just how alike we all are. We’re so alike, in fact, that the percentages spent on these things are very similarly for low-income and high-income earners alike. There are differences, of course, like house size, age of cars, and variety of cars.
Generally speaking, you want to spend around a third of your net income on housing, so if your after-tax pay is $30,000 per year, then $850 a month should be the maximum you pay for rent or mortgage. Everyone’s situation is different and other factors can alter this figure, but that is the general rule of thumb. The next third should cover food and transportation. The trouble here is that people love to eat, so they have no trouble spending perhaps more than they should. Likewise with transportation, many people who could drive efficient economy cars instead drive larger cars and sport-utility vehicles that use more gas and need to be filled more often, meaning they spend more than they really should. In many cases, those people don’t feel the need to alter how they get around. This is another discussion entirely, but my point is that what could be money saved for other things is instead used to cover eating and getting from one place to another.
An Example in Budgeting
It always helps to give advice some context, so let’s take a look at an example of a budget. Say you have someone in their 20s who is single and works as a computer programmer making a monthly, after-tax income of $2500. This is fairly close to the median statistics of the United States and is a situation that can be used to illustrate the typical budgeting mistakes that many people make.
So let’s say that in this example, our typical American spends $1000 a month in rent. This is more than the recommended maximum, but that is offset by the fact that the person in our example lives in a major city and doesn’t have a car. Throw in cable and utilities and the total cost per month is $1200. This means our American spends $14,400 on living expenses. That’s 48%. That number could be lowered by getting a roommate or moving further away, but our American likes living where he does and says transportation costs would skyrocket by moving away.
Food is another big expense, as he likes to eat organic and buys food from places like Whole Foods. That cost is offset by the fact that our American doesn’t actually eat out all that often. The total cost of food comes to $4800 per year, or another 16% of income. Transportation is next, and comes in at 8%, which is another $2400.
Beyond these things, the person in our example doesn’t save anything and is starting to develop credit card balances. This comes from expenses like an annual trip with friends, buying things online, and gambling. Next you have things that people typically don’t think about, like birthday gifts, haircuts, and gym memberships, which can easily put someone over their spending limit. It’s easy for someone who fits this profile to insist that they will begin saving once they hit their 30s, but it’s easy for anyone to start saving right away. My suggestion is to always treat saving money as though it was another monthly bill. If you get paid on the first, have money taken out on the third and put into an interest-bearing account. If you have a retirement plan at your job, use it first because there are likely tax benefits attached to it.
Start as early as possible and increase the amount you save as you earn money in your career. No matter what the amount, saving should be a priority just like any bill. Cut out things like premium cable channels and daily coffee and you’ll start to see the savings pile up each year. Think about it this way: If you saved the $3 a day you would spend on a coffee, that’s $1095 saved in a year. (Example rate of return) If that money were invested at 7%, it would grow to $1172 after a year. Factor in 3% inflation and the numbers climb, after 30 years, to a $7.28 daily cost, a $2,657.20 yearly cost, a $52,095.00 total cost, and $103,434.00 when invested at 7%.This can be applied to anything, but helps show other concepts of financial planning, like time value and how compounding interest helps. Right now, we only want to worry about opportunity cost and how we miss out when we spend the money instead of putting it in the bank. Knowing that, it would be beneficial to takes steps like:
- Deduct $100 every month and put it into an interest-bearing account
- Capping food purchases to a set amount per week, as doing so will help you save money that can be invested
- Using a debit card or cash instead of a credit card. People who use cash tend to be more frugal while credit card users tend to overspend. Not paying the full balance at the end of each month leads to higher balances over time.
- Contributing to your work-sponsored retirement plan and seeking out ways to bring in more income.
Budgets Are For Everyone
Budgets aren’t only for those who struggle with money. A lot of wealthy people could use them to fix their imperfect habits. Think about financial problems of multimillionaire athletes and entertainers that you’ve heard about. If I made the kind of money some of them do, I promise I’d be saving at least half.
Budgeting when you have a larger income is a complex issue, as is doing so when you don’t have a regular salary. Think about people with commission-based jobs like brokers. Some might earn tens of thousands of dollars in a month, take time off, and then come back months later and earn another $20,000. When you have erratic earnings like that, long-term planning can be a bit tougher. Even so, the steps are pretty much the same. You just need to know what your expenses are, look at what can be cut back on, and save something every month.
There are a lot of resources online for budgeting. One site is Consumerism Commentary, where the site’s owner posts monthly balance sheets that show the change in his net worth. Assets are broken down into cash accounts, investments accounts, and intangibles like accounts receivable and automobiles. Other topics related to personal finance, like shopping and online selling, are also covered.
Another site, Free Money Finance, features content that focuses on tips for saving money, keeping financial documents organized, preparing for retirement, and many other topics. I also suggest The Dollar Stretcher for those who want to get as much out of a dollar as possible. You’ll learn how to save money in ways you never thought of through this site.
If you have any questions about budgeting and saving, please don’t hesitate to contact me and let me know how I can help you today!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The examples presented are hypothetical and are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.