Creating and following a budget can be a daunting task for anyone, especially for the first-time budgeters. To begin with, many people have a psychological aversion to record-keeping (so if you do, you’re not alone), and developing a budget can be both time-consuming and mentally taxing. There are many items that need to be included that you may have never considered. You also need to keep your budget flexible and be ready to adjust for both emergencies and opportunities.
While you can start a budget at any time, the best time to start the process is before you leave the comfy and stable confines of your parents’ home. This can help you get a better idea of how much you can afford for your first and largest budget item — housing. Here’s how to get started.
Determining Needs vs. Wants
Basically, there are two broad categories of expenses: Non-discretionary expenses are those that you must pay. They include things like housing, food, auto insurance and clothing. Discretionary expenses are those that can be eliminated like entertainment, vacation and cable TV. Some people also classify these two categories as Needs and Wants.
The first step is to develop a list of non-discretionary expenses, since these are required regardless of taste or preference. A good starting point to get an idea of your expenses is to look back over the past year and categorize all of your expenditures by looking at checking accounts and credit card statements. (You can track those expenses using this cash flow worksheet.) It is important to include all expenses for at least a year, since some expenses occur only once or twice a year. One of the largest items you will need to include in your budget is Federal and State income taxes. This is typically an easy number to determine because it is usually deducted from your paycheck before you have a chance to spend it.
Considering New, Unexpected Expenses
Beyond the obvious items like food and housing, there might be things that you have never considered before. For example, if you are renting for the first time, you may find that your landlord will require a renter’s insurance policy. These can typically be obtained as an addition to your auto insurance policy for a reasonably low monthly premium. Additionally, the monthly apartment lease rate quoted may not include additional required fees, say like for trash collection. Some insurance premiums, like auto and medical insurance, may increase if you are leaving your parents’ plans and to become the primary insured. Finally, student loan debt is often a major expense for recent college graduates. Most loan payments must begin within nine months of graduation, although some repayments commence immediately.
Budgeting for Savings
While not technically a non-discretionary expense, savings and investing should really be considered non-negotiable. Start with saving at least 5% of your paycheck into your 401(k) or an IRA. Since the contribution is pre-tax, less than the 5% will actually be deducted from your paycheck. As your income grows, increase your contribution rate until it reaches 10%. It is also important to establish an emergency cash reserve. A reasonable amount to start is three months’ worth of non-discretionary expenses. You will want to use any extra cash to build this up to six months as soon as possible. It is a very good idea to try to build up this reserve before you leave your parents’ home since there will be an enormous amount of competition for these dollars once you head out on your own.
Planning for Wants
Now that you have listed your non-discretionary expenses, it’s time to consider your discretionary expenses. This is where you will have to make some difficult decisions. You will have to weigh each of your wants with its associated cost. There are many ways to save money on discretionary expenses. You may be able to lower your costs by bundling Internet, phone and TV together with one provider. If, however, you live in an apartment, you may not be given a choice of providers or plans. You might find that you will have to settle for slower Internet speeds than you’re used to in order to afford other wants. Additionally, things like premium television channels are likely too costly for a first timer. While food is considered a need, dining out is certainly not. You might have to plan ahead and hone your culinary skills rather than going to a restaurant for a quick meal. You can probably eliminate your monthly fitness center fees by selecting an apartment that has a fitness facility on site, particularly if use of these onsite centers is included in your monthly rent.
Finalizing Your Budget
Once you have listed both your non-discretionary and discretionary expenses, you will need to determine whether you are over or under your net income and make adjustments as necessary. Make sure you keep a written budget handy for comparison to your actual expenses. It is important to compare actual versus budget on a monthly basis to see where adjustments need to be made so that you can stay on track. Remember, budgeting is a fluid process. Change is inevitable and you need to be prepared for it. Many of my clients have found it helpful to use a software program to help track expenses. A quick Internet search for budgeting software can provide several options, some of which are available at little or no cost.
While the budgeting process can be time-consuming as well as somewhat overwhelming, it is a critical step to a solid and secure financial future. It is very much like exercising, once you get into the habit, it becomes a way of life.
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