With the advent of every new financial tool of "convenience," it seems more and more folks are taking an out-of-sight, out-of-mind approach to personal finance. Credit cards, debit cards, ATM cards, online shopping and online bill-paying are a few of the tools that are replacing the monthly or bi-weekly ritual and sitting down with a stack of bills and the checkbook and conducting one's financial affairs. By allowing our finances to slowly slip through our grasp, as a society we are living beyond our means and relying on credit cards and other instruments of debt to support our more and more extravagant lifestyles.
The most effective tool to reclaiming your personal finances is with a well-constructed budget. I know that the very term causes most folks to cringe, but as the saying goes, "an ounce of prevention is worth a pound of cure." Taking the time and energy now to set up a realistic budget will save a lot of heartache later on when the burden of too much debt and not enough savings becomes too much to bear.
The first step in creating a budget is to write down all of your monthly expenses. I've found the best approach is to either start a spending journal for a few months or to sit down with three-month's worth of credit card statements, bank statements and bills to come up with a list of expenses. The reason I suggest three-month's worth of spending is that in that time, you should capture most, if not all of you irregular expenditures. That is, expenses that don't necessarily occur monthly, such as oil changes, hair cuts and birthday/Christmas gifts, etc. It's important to note such expenses, because they can become real budget-busters every month if they're not taken into account.
After all expenses have been recorded, they need to be categorized. You can do this in any way that makes sense, just make sure you have enough categories to get a good idea of where your money goes, but not so many that the budget becomes cumbersome to examine. This will aid in pinpointing those areas that are eating the largest portion of your income and help you to find areas that can possibly be trimmed.
The next step is to record all sources of monthly income. Salaries/wages, and rent/alimony/child support payments are to be included as income. Bonuses, tax refunds and other one-time windfalls can be treated any number of ways. My preference is to not include these in my monthly income (even when they're expected) but, rather, use these to supplement savings and/or debt reduction plans.
Next, total up monthly income sources and monthly expenses. More often than not, people will find that their expenses exceed their income. This is the living-above-ones-means epidemic that accounts for increasing debt and reduced savings. The good news, however, is that with a well-constructed budget, we can prevent this from happening anymore and begin working on financials goals.
Speaking of goals, that is the next step in our budget process. We need to identify what financial goals we want to reach. The first two goals that should be in place are a debt-reduction strategy and the establishment of an emergency fund. A debt-reduction strategy should consist of a plan to reduce any outstanding consumer debt credit cards, auto loans and store credit cards are usually the main culprits here. The interest charges on these are generally astronomical and are the single-biggest deterrent to building wealth. Making minimum payments alone will cause this debt to linger seemingly forever. My suggestion is implementing a snowball strategy. That is, you should list your debts in a logical order (usually smallest amount to largest, though some people prefer to list from highest interest rate to smallest). Throw every available dollar (we'll discuss in a moment) at the first balance on your list while making the minimum payments on the others. Once the balance of the first debt is paid off, add that minimum payment into the next minimum payment on your list. Continue throwing every available dollar into that balance every month, continuing to add on to the next balance, creating the "snowball" effect.
The second goal should be to create an emergency fund. The biggest budget-busters are unexpected emergency expenses. Hospital/doctor bills, emergency car repairs and the like can put a serious dent in a budget and start you back on the road of accumulating debt. The ideal size of an emergency fund is between three and six months of expenses. However, if you're carrying a lot of debt, it has been suggested that you start with a "mini"-emergency fund of around $1,000 while you aggressively pay off your debts. The important thing is that you build a fund that you're comfortable with and that you'll stick to. The most important outcome of the budgeting process is to change our thinking about money. Once debts are paid off and an emergency fund is built, the habit of savings should continue. Funding retirement and saving for big-ticket items should be accomplished through savings and budgeting. No more credit purchases!
One of the ways we're going to have to change our thinking is distinguishing between needs and wants. If your budget shows more money going out than coming in, then it's time to examine which categories are taking the biggest chunk of your income. Eating out and entertainment are generally the two biggest culprits that contribute to living above your means. Look in the budget for ways to limit expenses. Sacrificing certain things may be necessary to pay off debts. Constructing a budget can be a real eye-opener, but it's all about changing the habits that got us into trouble in the first place!
The key to budgeting is to not give up! The first few months will be difficult. Changing attitudes takes time and is not easy. You will make mistakes! The key is to learn from them. Blowing the first few budgets will show you areas where you need to concentrate on and allow you to tweak your budget to more reasonably accomplish your goals. Getting where you want to be won't happen overnight, but by taking these steps to construct a solid budget, you'll begin to see improvement right away!