Saturday, May 8, 2010

Five Steps to Effective Budgeting

The foundation of developing good financial habits as a college graduate or recent graduate is creating solid budgeting skills. Budgeting is not an art, it is a skill that is taught by practicing over and over again. You do not need a degree in finance to create and maintain a budget. Follow these simple steps to create a solid budget.

Step 1: Gather Information.
Gather together all of your bank statements, receipts, and credit card statements for a given month. Create a number of categories for living expenses such as food, gas, rent/mortgage, utilities, clothing, loan payments, etc. Based on the information you gathered, make an educated estimate for the amount that you spend in each category. Also, figure out your take home income (total monthly income minus taxes).

Step 2: Write it Down!
The biggest mistake that so many households make is that they skip the easiest step in the budgeting process — writing down the budget! You must write or type out your budget. There is something powerful about seeing it on paper rather than keeping it in your head. This is a good template for those of you with Microsoft Excel. It allows you to type in the projected and actual budget amounts.

Step 3: Spend Your Money on Paper
This is a very important step. There are two methods of budgeting: looking back and looking ahead budgeting. Looking back budgeting involves spending all of your money and keeping track of where it all went at the end of the month. Looking ahead budgeting means spending the money on paper in the beginning of the month, and then spending within the designated amount in each category. The latter is the only method of budgeting that is effective. If you write down $500 for food for the month of February, then you have $500 dollars to spend at the grocery store that month. You spend only that amount for the month.

Step 4: Create a System That Works For You.
Organization is the key to a successful budget. Make sure you have a system that you stick to for setting aside certain amount of money for certain categories. One popular method for organizing a monthly budget is the envelope system. Take an envelope for the food category and pay yourself $500 (or whatever your amount is) by placing it into an envelope marked “Food Money”. Do the same for Gas, Entertainment, Miscellaneous Money, and Clothing. The rest of the money in your checking account will cover bills that need to be paid with a check or debit card. If you do not like keeping envelopes full of money around the house, then check out this online envelope budgeting system at the Mvelopes website.

Step 5: Be Proactive.
This step is what keeps a budget working every month. Obviously, your first budget will not be the most accurate when it comes to setting aside money for certain categories. At the end of the month, analyze your budget. If you spent $50 dollars less for Gas, but you spent $50 more for food, adjust accordingly for the next month. It’s never this easy, but you get the point. Also, be sure to analyze any categories where you spent much more than you budgeted. If you are spending $500 on entertainment when you budgeted $200, then ask yourself some questions. “Why did I spend this much on entertainment this month?” “Do I need to change my habits for going out?”
Follow these steps for budgeting and you will start to see the rewards when you have extra money at the end of the month! It will feel like you gave yourself a pay raise! The idea is to budget in an efficient way to end up with extra money at the end of the month. This extra money should be used for paying off debt aggressively, saving long-term, and establishing an emergency fund.


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