Building a Budget
Once you've calculated your personal net worth, your next step will be looking at cash flow. When you're ready to start building your nest egg, you're going to need some cash to do it. However, there are things standing in the way of this cash stream, from your monthly bills to that nagging weekly urge to treat yourself to a dinner out. New technologies and new products crop up with amazing frequency, making it harder and harder to curb excess spending. The solution is to outline your total expenses, knock off the unnecessary ones, create a budget, and stick to it.
It's remarkably easy to lose track of where your money is going. Many people indulge in small luxuries like buying coffee in the morning and ordering pizza for dinner more often than they realize. All these little extras add up to some big daily spending. Keep track of these expenditures for a week and see for yourself!
Resist the temptation to use your credit card for all your purchases as a simple way of tracking them. That strategy is great for the credit card companies, but it's not so good for your net worth. Instead, invest a little time in keeping an expense notebook; a mere two-week listing will do. You'll be glad that you don't have a whopping credit card bill at the end of the month, and you won't be making a year's worth of interest payments on a cup of coffee.
Budget Components
Before you get started building your budget, you should take a brief look at what makes up a budget. You may already know that budgets have both income and expense sections, but you may not recognize all the things that qualify for those categories. And since your budget will be used to help you create a nest egg, you should also add a section for savings.
Most budgets start with income. For these purposes, income includes all the cash you have flowing into your household. So, in addition to your regular take-home pay, you'll include items like interest and dividends you receive, any pension payments, and tax refunds. The second section, for expenses, will probably be a lot longer. This category includes things like mortgage or rent payments, utility and phone bills, groceries, cable, child care costs, and entertainment. Don't forget to add in periodic expenditures, like auto insurance premiums or vet bills. The savings section includes all the cash you put away at the end of the day. For planning purposes, a good savings number to shoot for is 4 to 10 percent of your expenses, at least until you have enough to cover about three months of regular expenses.
To make your budget the best it can be — and not so annoying to work on that you just throw up your hands and walk away — here are a few simple guidelines to follow:
Be realistic when forming goals. If your target budget is too hard to live with, you won't follow it.
Use real numbers, not estimates. Estimates may help you fill in the blanks, but they won't help further your goals. You can find true figures by backtracking through your checkbook.
Use your computer to help track your budget. Create a spreadsheet in Microsoft Excel or pick up some prepackaged budget software, like Quicken or Microsoft Money.
Make your budget easier to read by categorizing some of your expenses. For example, electricity, gas, water, and heating oil could all go under the heading “Utilities.”
Include absolutely everything you spend money on. Don't leave out even occasional expenses, like theater tickets, haircuts, and charitable donations.
Initially, track your budget at least once a month. Even better, update the numbers every time you get a paycheck.
Take an in-depth look at your budget each quarter to make sure it's accurate and to see how well you're managing your cash.
Completing Your Budget
Once you've listed all of your income and expenditures, add the components of each section to come up with totals. Then subtract your total expenses and savings from your total income. The result is your net cash flow. If that number is greater than zero, you have positive cash flow. If it's less than zero, you have negative cash flow. If your bottom line comes out to exactly zero, your cash flow is considered neutral. When your result is positive cash flow, you have options. You can spend the money, hide it away as extra savings, or consider investing the surplus, perhaps in stocks or mutual funds. With a negative cash flow result, you'll first have to concentrate on either increasing your income or cutting back your expenses wherever possible. You might have to sacrifice some favorites, but it'll be worth it if you can save some cash every month.
Throughout this entire process, you may find that sticking to your budget is very difficult to do. You're not alone. Many people struggle to stay inside the boundaries of their personal budgets. You're also not alone if you already have debt to deal with. Try not to let debt discourage you — it's never too late to improve your situation. Luckily, there are ways to get debt under control and start fresh.
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The first step to dealing with debt is to use your credit cards only when absolutely necessary. The second is to reduce the balance you're carrying. If you have equity in your home, you may want to consider a home equity loan while interest rates remain low. In addition to reducing your interest burden, you may be able to deduct some of the expense on your tax return (check with your accountant). Another approach is a debt consolidation loan. While the rates typically aren't as low as home equity loans, they are usually considerably lower than the interest credit card companies charge.
