Whether you are trying to pay off debt, save for your children's education, or just want to save more for retirement, first you have to track your expenses. This article is a step by step approach on how to identify your expenses and create a budget that works for you.
Step 1: Identify Your Expenses
Visualize your spending. Nothing calls things to your attention like having the numbers right in front of you. This is where budget apps like Mint are beneficial. There are several types of these applications, but the personal finance applications we recommend are Mint and Personal Capital. There is actually an excellent comparison on Investor Junkie site for those that are interested. In summary, while both applications can track expenses, Personal Capital excels for investment analysis, while Mint seems superior for budgeting. Both have excellent apps for your smartphone that you can also use to see your information while you are on the go. If you are just concerned about budgeting, then go with Mint. Bonus, if you already have a TurboTax account, you already have a login for Mint, as both products are owned by Intuit.
Regardless of the application you choose, the basic practice is to enter all your credit cards, accounts, etc into the application and allow it to calculate your expenses for the month. By having access to all your finances it is able to break your expenses down by category and calculate your monthly income. In the end you will be able to generate a screen like the one below.
Step 2: Examine Where Your Money is Going
It's not rocket science, in order to save money, you have to spend less than you earn. In this case, in order to have more money left at the end of the month, you need to define what you are willing to part with in your monthly spending habits. Not sure what to cut? This is where a budgeting method like the “50/20/30” rule comes handy.
Examine your last several months of expenses and then break them down into categories.
50% Of Your Income Should Go to Your Needs
- Mortgage or Rent
- Auto Expenses Like Insurance and Gas
- Medical Expenses
- Car Loan Payments or any minimum credit card payments required to ensure your credit rating does not get impacted
- Basically all expenses that are essential for you and your family for your day to day activities like work and school.
Ideally the items in this category will sum up to 50% of your income. If not, then you should examine your grocery bills, identify ways to cut on utilities, etc.
20% Of Your Income Should go to Savings or Debt
Set aside 20% for Savings or Debt, and then move on to calculating your wants.
30% Of Your Income Should Go to Your Wants
After you have covered the above, the last 30% goes to things that you want, but could live without. This includes things like cable, vacation, and basically items that contribute to a happier life. Once you examine the items in this category from your budget, then same rules apply. If the items in this category is more than 30% of your income, you should look for ways to trim out things you can live without.
Step 3: Define your Goal
Now it's time to use the 20% you set aside to meet your goal. If you have debt, then this is the first thing you should tackle. Allocate this 20% to paying over on the minimum payments for your loans. You can go the Dave Ramsey approach and tackle your smallest debt first, but I prefer to just tackle the debt with the largest interest rate first. So with that in mind, you would pay your minimum payments on your loans from the first 50%, then use this 20% to pay over on the loan you target. Once you complete that loan, you move on to the next loan and knock that out. Remember the key thing here is that the minimum payments for all your loans, comes out of your 50% essential category. This 20% is to pay over on your loans.
If you are not in debt, then you can allocate this money to investment or perhaps your child's college funds. This is a personal choice, but ideally you want to find a happy balance between ensuring your own retirement and making sure your kids have funds to get started on their higher education.