Why Do You Need an Emergency Fund?
- Job loss or unemployment
- Medical or dental bills
- Home repairs
Whether you’re saving for retirement or college or just trying to make ends meet, one of the first financial recommendations you’ll get is to make a budget. That’s great advice, but you also need to know how to budget. Fortunately, the process is not hard to understand. Even better, once you establish a budget, it’s fairly easy to keep it going.
Balancing Income and Expenses
First, it’s important to realize that a budget has two parts: income and expenses; that’s really what a budget is designed to do – show the difference between the money you earn and the money you spend. More specifically, a budget contains actual or projected expenses and compares the sum of the expenses to your income. If you spend less than your income, you save money. If you spend more than your income, you’re losing money, which could potentially lead to debt. Finding balance between your income and expense takes a little getting used to, but once you get in the habit, budgeting your money has many rewards. You just need to know where to begin.
Start your budget by picking a time period; for most a monthly budget is common. You’ll need to know your income for the month so you can compare it to your expenses. It’s important that you use your take-home pay (after tax) rather than your gross salary. If you have regular overtime pay or bonuses, include the take-home amounts too. Be sure not to overstate your income. Either overestimating your income or underestimating your expenses can cause problems.
Start Tracking Expenses
Now that you know how much income you’re bringing in, you need to know how to budget your money. Set up a spreadsheet with categories of expenses. This can done be using lined paper and a calculator, a computer with Excel® or budgeting software like Quicken®.
Making modifications to your daily habits could show up in your budget in the months to come.
People often use expense categories of utilities, groceries, car, health care, eating out, entertainment, mortgage or rent, clothing and charity. Include one or more lines for savings too; this could be emergency, vacation, retirement and college savings. Adjust these categories based on your personal needs and lifestyle.
When you first set up the budget, fill your spreadsheet with the amounts you think you spend in each category. Then comes the fun part: start tracking your actual expenses. Write down or type in what you’ve spent in the different categories. Jot down cash spending – when you make purchases during the day – save all your debit and credit card receipts and use your checkbook or online checking records to note other expenses. Transfer all your expenditures to your spreadsheet daily. Add together the amounts within each expense category and compare these to your projections; then compare your total income to your total expenses for that time period.
Take a Step Back and Assess
You may find very interesting surprises during the first couple months of gathering this information. Look at the areas where you’re spending more than you expected and try to understand why? Is your daily double skinny latte costing twice as much as you realized? Could carpooling cut your car expenses dramatically – how big of an impact would that have on your overall budget? Use the new learnings to balance your finances and make necessary adjustments.
Making modifications to your daily habits could show up in your budget in the months to come; you may even find you have a little extra to put into a savings account for future needs.
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