Over the course of our education we are taught many things that will help us in whatever our chosen career – grammar, history, biology, and mathematics to name just a few. In many school systems there are courses available that teach us life skills. Home economics comes to mind as does balancing a checkbook. We are taught a lot of useful things, but the basics of creating a household budget are not likely one of them.
For a household budget to be an effective planning tool it needs to be realistic. When going through the process you should take your time and really think about what your priorities are as well as the changes you can make to better your situation. The end goal should be to understand where you are, where you want to be, and what you need to do to get headed in that direction.
How Do I Get Started?
You do not know where you are going if you do not know where you have been. Thus, the first step in creating a household budget is to start tracking all of your income and expenses. Ideally, you want to be able to understand what your ongoing expenses are going to be.
And when we say everything, we mean everything. When you are looking at your expenses, you need to consider every penny you spend, from your electric bill right down to the daily cup of coffee. That $60 you take out of the ATM machine counts. The goal is to understand what your regular, ongoing life expenses are (utility bills, mortgage payments), as well as your non-regular expenses (car repairs, medical costs, holidays and birthdays).
On the income side you need to have an understanding of what income you have coming in from all sources. For many people the majority would be earned income, including your weekly pay and bonus pay. But for some, the income received from investments – stocks, bonds, real estate, etc – can be significant.
You should also see this as an opportunity to review your debt situation. What are your monthly mortgage obligations? How much consumer debt (credit cards, car loans) do we have? Are there any personal loans outstanding?
All of this information should be compiled in a spreadsheet or financial software to get a visual account of your situation.
Creating Your Household Budget
Now you know what monies you have coming in on a monthly and yearly basis and how those funds have been spent. Once you have compiled the raw data you can begin to analyze your spending habits to see how they measure up to your income. And what you find may surprise you. The cost of eating lunch out during work may not seem so bad each day when you are doing it. But when looking at the monthly expense of eating out 15-20 times it can be overwhelming.
A household budget defines your family’s spending priorities. When you make the conscious decision to develop a budget you are taking control of your finances and your future. We recommend that you think of your budget as a spending plan with four separate components:
- Core, Monthly Expenses – These are your normal, monthly bills. These expenses can vary from month-to-month but are fairly consistent. Mortgage or rent, utilities, car payments, groceries, and insurance would be considered your Usual Expenses.
- Unexpected or Unusual Expenses – Expenses such as car repairs, out-of-pocket medical costs, emergency travel, replacing broken appliances, holiday and birthday gifts, and wedding gifts.
- Savings – Includes money that you are saving for retirement (401k, IRA, ROTH IRA), college savings, and special life events such as a child’s future wedding.
- Discretionary Expenses – This is money that you spend on items that are beyond the core and unusual expenses.
While developing your Household Budget can be an eye opening process, success only comes after the budget is developed and successfully implemented. The plan is only worth the paper it is printed on if you do nothing with it. Effective implementation of a household budget can be defined as staying within the spending targets you set for your family.
Because you have an accounting of your debt situation from step one, you should take the opportunity of designing your household budget to look at your debt structure. Credit card debt is different from longer- term debt obligations and should be treated as such. By planning out a budget you can make clear decisions on what debt you want to carry and how to pay each month on this debt. Ideally, your budget plan will involve paying off your consumer debts (credit cards) as soon as possible. By paying off these loans you should have more money available for some of the discretionary things that are important to you and your family.
You should look at your core, monthly expenses and see if there are ways to lower some of these costs. Call your insurance agent to make sure you are properly insured and are paying a fair price; look at your utility bills and decide if there are changes you can make to lower your power usage. The more you can trim your core expenses, the more you will have for savings and discretionary spending.
It is suggested that you block a certain amount of money each month to go toward your unexpected and unusual expenses. By looking back at what you have spent in the past as well as what you have coming up in the future. Better to have some extra money on hand from time to time than to not have the money to purchase a birthday present for a close relative.
Savings will take a number of forms. It is a best practice to have money designated for an emergency, retirement accounts set up for your later years, college savings if you have children, and accounts designated for special events or projects, such as purchasing a house or a child’s wedding.
If you currently do not have an emergency savings account, you will want to consider designating some savings each month to build a cash cushion. Ideally, this savings should be equal to six months worth of living expenses. The interest rate you receive on this money is not as important as is the availability of the funds if needed.
Ideally you want to be saving around 10% of your earned income for your retirement. This will help you to save adequately for your retirement while, at the same time, living below your current income level. If you have a plan available through your employer you should take advantage, especially if there is a company match. A ROTH IRA is another excellent retirement savings vehicle for many people.
Saving for special life events can be done in a number of different ways. Some people prefer to have separate accounts for each future event, while others simply have one pool of savings that are used on these big, intermittent events. How you do this is up to you.
Finally you have your discretionary expenses. This is essentially all the money you have left over after paying your bills and paying yourself (savings).
Ongoing Budget Adjustments
A budget is not stagnant and will need to be adjusted from time to time. During the initial months you will want to review where you are at monthly and make any small adjustments that are necessary. For example, you may find that you forgot about a non-recurring expense such as a child’s summer swim lessons. Or you might have had a big non-recurring expense like car repairs before you have built a cash cushion to pay for them out of pocket. In cases like this you should look to see where you can cut back spending in the short-term.
After the initial modifications and the adjustment of having a spending plan your spending should be fairly consistent month after month. Over time, however, you will have modifications that are a result of either life changes – new job, additions to the family, a child’s wedding – or because you have reached a goal, such as paying off credit card debt.
How deeply you need to look at your spending plan will depend on the impact of that event. Only small adjustments are made when, for example, your child gets married and you do not need to fund a wedding fund any more. On the other hand, the birth of a child will result in a fundamental change in how you spend your income.
Putting It All Together
Taking the time to develop a household budget is one of the best tools to make sure your family is financially successful. It will take some time up front, but will allow you to understand where you are spending your money, help set your family’s priorities, and define the spending modifications necessary to get on the right track. Over time there will be adjustments that need to be made as life dictates.
For more information, Magellan Financial, Inc. can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.