Personal budget
From Wikipedia, the free encyclopedia
A Personal budget is a plan for managing income and expenses in personal finance. A comprehensive personal budget provides a clear understanding of an individual's expenses, encouraging informed financial decisions. The main objective for any budget is for income to meet or exceed expenses. Predicting and accommodating future expenses and sacrificing discretionary spending in favor of obligatory spending or a savings goal can achieve this objective.
There are several methods and tools available for creating and tracking a budget.
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[edit] Tools
The following tools are helpful to have for constructing a personal budget. Regardless of the tool used, a budget's accuracy is only as good as the accuracy of the individual updating budget data; an old budget that does not reflect actual income or expenses is of little use to a current budget.
[edit] Pencil and paper
A simple budget can be written on a piece of a paper with a pencil, and optionally, a calculator. Such budgets can be organized in three-ring binders or a file cabinet.
[edit] Spreadsheet software
Spreadsheet software, like Microsoft Excel or OpenOffice.org Calc, helps arrange budgets and performs calculations easily with rudimentary formulas. Spreadsheets can also be used to keep track of expenses.[citation needed]
[edit] Money management software
Some software is written specifically for money management. Commercial products such as Quicken and Microsoft Money are designed to keep track of individual account information, such as checking, savings or money-market accounts. These programs can categorize past expenses and display monthly reports that are useful for budgeting future months.
[edit] Spending management software
Spending management software is a variation of money management software. This type of software focuses on giving the end-user information regarding what's left to spend in the current month. Like money management software, some spending management software packages can connect to online bank accounts in order to retrieve a to-the-minute status report of the current monthly budget.
[edit] Concepts
Personal budgeting, while not particularly difficult, tends to carry a negative connotation among many consumers. Sticking to a few basic concepts helps avoid several common pitfalls of budgeting.
[edit] Simplicity
The more complicated the budgeting process is, the less likely a person is to keep up with it. The purpose of a personal budget is to identify where income and expenditure is present in the common household; it is not to identify each individual purchase ahead of time. How simplicity is defined with regards to the use of budgeting categories varies from family to family, but many small purchases can generally be lumped into one category (Car, Household items, etc.).
[edit] Flexibility
The budgeting process is designed to be flexible; the consumer should have an expectation that a budget will change from month to month, and will require monthly review. Cost overruns in one category of a budget should in the next month be accounted for or prevented. For example, if a family spends $40 more than they planned on food in spite of their best efforts, next month's budget should reflect an approximate $40 increase and corresponding decrease in other parts of the budget.
"Busting the budget" is a common pitfall in personal budgeting; frequently busting the budget can allow consumers to fall into pre-budgeting spending habits. Anticipating budget-busting events (and underspending in other categories), and modifying the budget accordingly, allows consumers a level of flexibility with their incomes and expenses.
[edit] Budgeting for irregular income
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Special precautions need to be taken for families operating on an irregular income. Households with an irregular income should keep two common major pitfalls in mind when planning their finances: spending more than their average income, and running out of money even when income is on average.
Clearly, a household's need to estimate their average (yearly) income is paramount; spending, which will be relatively constant, needs to be maintained below that amount. A budget being an approximate estimation, room for error should always be allowed so keeping expenses 5% or 10% below the estimated income is a prudent approach. When done correctly, households should end any given year with about 5% of their income left over. Of course, the better the estimates, the better the results will be.
To avoid running out of money because expenses occur before the money actually arrives (known as a cash flow problem in business jargon) a "safety cushion" of excess cash (to cover those months when actual income is below estimations) should be established. There is no easy way to develop a safety cushion, so families frequently have to spend less than they earn until they have accumulated a cushion. This can be a challenging task particularly when starting during a low spot in the earning cycle, although this is how most budgets begin. In general, households that start out with expenses that are 5% or 10% below their average income should slowly develop a cushion of savings that can be accessed when earnings are below average. Whether this rate of building a cushion is fast enough for a given financial situation depends on how variable income is, and whether the budgeting process starts at a high or low point during the earnings cycle.
One approach is to live on last month's income. This way when budgeting for the month a person will know exactly how much they have available. However, in order to do this, families have to do everything within their power to not spend any paychecks for one entire month to do this. Perhaps some savings you could be used to start.
[edit] Allocation guidelines
There are several guidelines to use when allocating money for a budget as well. Past spending is one of the most important priorities; a critical step in most personal budgeting strategies involves keepings track of expenses via receipts over the past month so that spending for the month can be reconciled with budgeted spending for the next month. Any of the following allocation guidelines may be used, but none are absolutely ncessary.
Each allocation guideline may differ from other guidelines; which to follow depends on the individual and his/her situation.
[edit] Using an existing template
Many budgets start with a percentage template. A template allows an individual to see suggested percentages in various categories, and allows the individual to compare the suggested category values to what was actually spent in the past month, and what should be budgeted for the next month. One such template is available on Crown Financial Ministries' Budget Guide Calculator.
An example template generated by the Crown Budget Guide Calculator is shown below. The guide assumes a $45,000 yearly gross income, $4,500 reserved for a tithe, and $7,000 to taxes.
| Category | Suggested Percentage | Annual Amount | Monthly Amount |
|---|---|---|---|
| Net Spendable: | 100% | $33,500.00 | $2,791.67 |
| Housing: | 36 % | 12,060.00 | 1,005.00 |
| Food: | 12 % | 4,020.00 | 335.00 |
| Auto: | 12 % | 4,020.00 | 335.00 |
| Insurance: | 5 % | 1,675.00 | 139.58 |
| Debt: | 5 % | 1,675.00 | 139.58 |
| Ent/ Rec: | 6 % | 2,010.00 | 167.50 |
| Clothing: | 5 % | 1,675.00 | 139.58 |
| Savings: | 5 % | 1,675.00 | 139.58 |
| Med/Dental: | 4 % | 1,340.00 | 111.67 |
| Misc: | 5 % | 1,675.00 | 139.58 |
| School/Childcare:* | 6 % | 2,010.00 | 167.50 |
| Investments: | 5 % | 1,675.00 | 139.58 |
* School/Childcare is not part of the remainder of the budget, and must be deducted from the remaining categories if this category is to be used.
[edit] The 60% Solution
The 60% Solution is a budgeting system created by MSN contributor Richard Jenkins. The name "The 60% Solution" originates from Jenkins' suggestion on spending 60% of a household's gross income on fixed expenses. Fixed expenses includes taxes and regular bills, like car and house payments.[1]
The other 40% breaks down as follows, with 10% allocated to each category:
- Retirement: Money set aside into an IRA or 401(k).
- Long-term savings: Money set aside for car purchases, major home fix-ups, or to pay down substantial debt loads.
- Irregular expenses: Vacations, major repair bills, new appliances, etc.
- Fun money: Money set aside for entertainment purposes.
If an individual has a high amount of non-mortgage debt, Jenkins advises that the 20% apportioned to retirement and long-term savings be directed towards paying off debt; once the debt is paid off, the 20% (Retirement + Debt) is to be immediately redirected back into the original categories. According to Jenkins, tracking each individual expense is unnecessary, as the balance of his primary checking account is roughly equivalent to the amount of money that can be spent in this plan.
[edit] Housing as 25% of spendable income
Another allocation principle is that housing expenses (mortgage or rent) should be limited to 25% of spendable income. This rule of thumb especially applies to families moving to new housing; if a house payment for a $300,000 house, plus taxes, will result in a $2,000 monthly mortgage bill, will it take up too large a portion of the budget?
In housing markets with exceptionally high prices, such as California or Boston, Massachusetts in the early 2000s, this rule of thumb may be difficult to follow. A high percentage of expenses spent on housing forces cuts to be made in other categories.
[edit] Following a budget
Once a budget is constructed and the proper dollar amounts are allocated to their proper categories, the focus for personal budgeting turns to following the budget. As with allocation, there are various methods available for following a budget.
[edit] Envelopes
Envelope Accounting is a method of budgeting where on a regular basis (i.e. monthly, biweekly, etc) a certain amount of money is set aside for a specific purpose, or category, in an envelope marked for that purpose. Then anytime you make a purchase you look in the envelope for the type of purchase being considered to see if there are sufficient funds to make the purchase. If the money is there, all is well. Otherwise, you do not make the purchase, at least not until the next allocation is made. The flip side is true as well, if you do not spend everything in the envelope this month then the next allocation adds to what is already there resulting in more money for the next month.
With envelope budgeting, the amount of money left to spend in a given category can be calculated at any time by counting the money in the envelope. Optionally, each envelope can be marked with the amount due each month (if a bill is known ahead of time) and the due date for the bill.
Credit cards are paid for directly from other envelope categories. For example, after a gasoline purchase at a gas station, money from the fuel envelope can be transferred into the credit card envelope. The remaining amount of money in the gasoline budget is the amount of money in the gasoline envelope. If a credit card carries a balance, another envelope may be used to keep track of finance charges.
Spending management software tools operate similar to the envelope budgeting system by maintaining "virtual envelopes". With many of these tools, users can log in to a website and download the most recent spending activity automatically from online credit card or banking websites. The figures in the spending management software are then updated to reflect actual monthly expenses, compared to budgeted expenses.
[edit] See also
[edit] References
- ^ Jenkins, Richard. A simpler way to save: the 60% solution. Retrieved on 2006-07-26.
