Back to blogging ... The only difference now is that I am in my 30's and I am happily married now. So, I will be blogging about things that people in their 30s blog about ... like Personal Finance. In the next few blogs, I will write about a few things I learned over the past few years in my quest to achieve my financial goals. The first episode in this series starts with the most important one: Budgeting !
Budgeting is normally the first thing anyone does once they become serious about how they spend their money. But, it is not an entirely straightforward affair, mainly because there exist different allocation methods and tools that one can choose from. For a good overview, please refer:
http://en.wikipedia.org/wiki/Personal_budget
There are several reasons why budgeting is important. I believe that the following are the most important among them:
A budget is one of the best methods to make sure that you LIVE WITHIN YOUR MEANS !! (I am sorry that I had to over-emphasize the last part of my previous sentence, because these days credit is so much easily available that living within one's means has actually become a challenging thing to do - see this popular SNL video targeted towards every debtor).
Budgeting is a proven method to achieve both short and long term financial goals.
Now that we know why budgeting is important, let's take a look at the different aspects of budgeting and the methods that I found to be useful in creating my own budget:
Allocation Method: This refers to the amounts of resources that are allocated to each expense every month. There are several different types of allocation methods available to choose from. The one that impressed me is a lot is Richard Jenkins 60% solution. This is also the default budgeting method in the latest versions of Microsoft Money. The crux of this method is to split the monthly expenses into 5 categories (the percent value in brackets next to each category name represents the default recommended allocation):
Committed Expenses (60%): These include expenses such as housing (rent or mortgage payments), living expenses (groceries, gas), bills (cell, TV, internet, electricity, water, heating ...), insurance, and taxes - things that we need to spend every month anyway. Now, this percentage (60) may be a bit higher if you are living in areas with ridiculously high housing costs (Boston, anywhere in California, ...). The living expenses may be higher if you are supporting your family with a single income. In our case, we have a single income stream and we live in Southern California, and we always somehow seem to hit the 50% percent mark for this category. So far so good ... Please note that Charitable donations are also included as a part of committed expenses. On most months, your budgeted and actual expenses on this category must match closely with each other.
Savings and Debt (10%): These include payments for reducing any (non-mortgage) debt, and also contributions to (non-retirement) savings accounts and investments. Of course, the highest priority to pay-off all the high-interest debt first (for most people, this is probably payments towards their car). In the case of savings, this could include money saved toward an emergency " rainy-day" fund (more on this later) , or in the case of investments, this could be an investment towards some specific goal - such as buying a house, paying for college etc., My goal is to consistently hit 25% every-time, but on some months with irregular expenses (such as car insurance payments), this may not be possible. On most months, your budgeted and actual expenses on this category must match closely with each other. Exceptions include those months in which you may have to dip into your emergency fund to cover any unplanned expenses.
Retirement (10%): This is all the income that you are contributing toward your retirement accounts (such as 401K etc.,). I am sticking with 10%, as recommended.
Irregular Expenses (10%): These are expenses that don't occur every month. Good examples are automobile maintenance, health-care related expenses, gifts and other unplanned expenses. Of course, you will notice that the actual expenses per month will be either higher or lower than the budgeted value. This is OK, as long as you plan such that you don't exceed the budgeted amount on the average for the whole year. I am currently budgeting around 5-7.5% per month and this seems to work well for me.
Fun (10%): This is basically money that can be used as you please (a.k.a " fun money"). I use this normally on the following activities: dining out, movies, DVD rentals, vacations, electronics gadget purchases, etc., Again, parts of this 10% allocations (such as dining out and movies) can be strictly budgeted, but for the rest (such as vacations), you have to make sure that you are not exceeding the budget limit on an average for the whole year. I budget about 5-10% every month, with the upper-limit (10%) used for months on which I have a vacation planned.
There are, of course, several other allocation methods, but I like the 60% percent method, mainly because of two reasons:
It is incredibly simple. Please note that you DON'T have to budget items inside each of the five categories. For some categories, I do use a micro-budget, but this is strictly not necessary.
My personal finance tool Microsoft Money has this budgeting method build into it.
Alright, this article is getting too long. I will continue the rest later ...
