Having a financial plan is crucial if you want to achieve your long-term goals. A large component of a financial plan is knowing how much money you can save towards your goals. How are you supposed to know how much you can reasonably save? The simple answer is having a budget, but is it really that simple?
To me, budgeting means not spending more money than what you make. It can be a monotonous task for most individuals. Even as a financial professional, I find myself dreading updating my budget. Although it can be a hassle, updating it avoids the helpless feeling while checking your bank account and wondering where your money has gone.
Whether you are constructing your first budget or looking for improvements, these are some key components of budgeting I like to use.
Create an Emergency Fund
An emergency fund serves as a support in times of financial hardship and is a must have when getting your finances in order. Many financial gurus would agree accumulating 3-6 months of spending in a high yield savings account is a good cushion. This is used for unexpected expenses such as medical expenses, home repairs (not renovations), car repairs, or unemployment. No one saw this magnitude of unemployment coming from the coronavirus which has left people without income now for months. During these times of economic uncertainty, not having an emergency fund can knock you off your feet and throw your financial plan out of whack, which we want to avoid by budgeting, right?
These funds can be put away in an account that is easily accessible and not subject to market fluctuations, such as a savings account at your bank or an online bank that offers a higher interest rate on deposits.
Sort Discretionary vs Nondiscretionary Costs
Breaking apart your expenses into two categories on paper or a spreadsheet can be a good start to understanding what your expenses are. One category will be nondiscretionary spending – expenses to cover your needs in society such as housing, utilities, food, insurance, and debt. Grasping what you spend on these expenses will shape how much you save for your emergency fund, because these are the expenses to get by.
The other category will be your discretionary spending, which is what we wish our budget was solely comprised of. This will include hobbies, travel, dining out, and shopping. These expenses can be reduced during times of financial hardship since they are your wants in life.
Breaking discretionary and nondiscretionary spending into subcategories will help you narrow things down further. How do you know if you are spending too much in one area though? A few of the common rules of thumb are:
- 15% – Retirement Savings
- 25% – Housing costs
- 5-10% – Utilities
- 10-15% – Food
- 10-25% – Insurance
- 10% – Transportation
- 5-10% – Health
- 10% – Giving/Gifting
- 5-10% – Recreation
- 5-10% – Miscellaneous
These are ideal percentages and won’t be exact. Depending on your financial plan, your budget is going to be unique to you. It is important to establish a savings objective that is based on you hitting the goals you are planning for. Once established, you always want to pay yourself first and fill in the other expenses around that. Consistently paying yourself first and staying within your budget parameters is what will help you take the gradual steps forward.
Automate Money Movement
One of the easiest ways to stay within your budget parameters is to automate. Setting up reoccurring savings every time you receive a paycheck is an easy way to consistently stay on track. I set up a reoccurring money transfer twice a month into my savings account. This strategy makes budgeting easy if you can automate the reoccurring fixed costs in your life such as rent, utilities, savings, and insurance.
Prioritize A Wish List
Once you have fixed costs and savings covered, you can set parameters for your discretionary spending, or your wants. You can start by prioritizing what is currently important to you. This can help free up additional cash flow. For instance, I spend less on shopping/clothes so that I can prioritize dining out and groceries. Prioritizing costs that make sense to you can allow flexibility in the areas that make you happy.
Once you start having additional cash flow you can begin asking yourself, where does my next dollar go? You can put additional cash flow towards savings to help reach your goals sooner, or you can make your discretionary spending more flexible. Theoretically, every dollar should have a place to go within your budget. My preference is to split any excess cash between savings and dining out, again this is where you get to prioritize your own budget.
While a budget is not the most exciting activity to do, it does bring a sense of accomplishment into our lives and helps us take one step closer to achieving our financial goals. Whether you are building a budget or financial plan for the first time, or looking for areas of improvement, we at WealthPoint would be happy to help you take those additional steps to accomplishing your financial goals in life.