We’re covering the Six Steps that you should be taking if you’re not quite sure where you money goes every month, or if you know you could be doing better with your budgeting. We covered Steps 1 and 2- how to identify where your money is going- in this article. This week, we’ll cover how to plug the leaks in your budget, how to practice more mindful spending, and how to put your money to work in more productive ways.
Step Three: Determine How Much Should Be Going Where
I usually have clients think of their expenses in four broad categories:
Fixed Expenses and Bills
These are things like student loans, rent or mortgage, car payment, utility bills, and other debt payments.
Since these are usually not that easy to change, just add them up. If they are more than about 50-60% of your take home pay, you might need to take more dramatic measures to decrease them.
Variable Expenses
These could be anything, but big ones are usually eating out, personal care, shopping, etc. We’ll come back to this one, because it usually requires a little more effort to control.
Short-Term Savings
This is for things that you may need to pay for over the next year. This could include travel throughout the year, an insurance bill if you pay semi-annually or annually, property taxes, HOA fees, and similar expenses.
Make sure you account for these in your budget by estimating how much you’ll need. Then, divide by the number of months until you need the money. This will provide you with a monthly amount you need to save in order to easily pay these infrequent or semi-annual costs.
Finally, open an online savings account for just these expenses. Automate the monthly transfer to savings and treat your contribution as a bill like any other that is due every month. Your future self will thank you when it’s time to pay a large bill all at once – and the full amount can simply be pulled from your short-term savings.
Long-Term Wealth-Building
This may be paying down your student loans faster, building up your emergency savings, saving for retirement, or saving for college for a child.
You want at least 10% of your take home pay going to your longer-term goals. The higher your savings rate, the better. Aim for 20% or more.
Set up accounts specifically for each goal (i.e. a savings account that is just for your emergency savings or a 529 plan for college savings) and automate this as well. If this is too much to bite off as you’re getting started, begin with 5% of your take home and work your way up.
Step 4: Set Up a Budget Hack for Variable Expenses
I mentioned that I would come back to variable expenses. To get your “magic spending number”, subtract your fixed expenses, short-term savings amounts, and long-term savings rate from your net pay (what you take home after taxes, insurance, and other payroll deductions).
This is your “Should Be” spending number for variable expenses.
What you really want to do is to decide on a number somewhere between what you are spending on variable expenses now and what your “Should Be” number is, and commit to trying it for at least 3 months.
If you had some expenses that were a surprise when you completed the Where is Your Money Going section, make an effort to start dialing those back while setting up automatic savings or working on debt repayment.
This will allow you to give yourself an allowance each month. It may take a little getting used to, but once you adjust, you will love how much easier this makes everything.
Step 5: Schedule Time to Keep Up with Your New System
It takes 3 to 4 weeks to start building a new habit, so set up a calendar reminder every other day to log into your new cash flow tracking system. Spend five to ten minutes looking at where you are for the month.
Make sure to think about any one-time costs you have coming up over the next month, like birthday gifts or wedding presents, and make sure you subtract that from how much you have left to spend.
Step 6: Enjoy Your New Financial Freedom
Give yourself a reward if you stick with it for a month, then at three months and six months. It will take a few months, but soon you’ll have a new, organized, and functional money management system in place.
Prepare to feel awesome about how much more in control of your finances you are now!