How Do I Create A Budget?

I spent some time with a friend this week who wanted to figure out a way to save more.  As I read this basic article from LiveMint about the keys to budgeting, I kept nodding my head as it aligned well with the conversation I had.

Here are the five keys to successful budgeting:

  • Set goals and targets.  For my friend, the concrete goal we set was to establish an emergency fund of 6-9 months of expenses.  While she had minimal debt, she hadn’t built up a cash reserve and felt that this would bring peace of mind from life’s vagaries.
  • Follow the money.  While my friend had a clear sense of fixed expenses (car payment, allowances, groceries, utilities), she was less clear on her discretionary expenses.  She went back and tracked her spending over the last month and created a spreadsheet to account for her spending.
  • Categorize to manage.  A good way to categorize is the way discussed above: fixed or mandatory costs vs. discretionary expenses.  If fixed costs are too high a percentage of take-home pay, it will be difficult to save a significant amount and more emphasis might be placed on debt reduction.
  • Save and then spend.  My friend committed to divert 10% of her paycheck to a savings account going forward.  I am a big believer in this method of making saving automatic.  Companies that offer direct deposit generally allow such split deposits to be set up.
  • Fund for emergencies.  Given the curveballs that life often throws at us, having an emergency fund can be utilized in such situations and avoids situations where a consumer goes deeper into debt to cover unexpected expenses.  This emergency fund is the #1 priority for my friend who is already maxing out their generous 401(k) plan.

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