Budgeting will make or break you. Get it on paper and implement it.
Budgeting is not only an important aspect of wealth-building, but a vital tool for it. Without a working budget you simply can’t win with money. Clients and friends ask me all the time how they can formulate a cash flow plan that not only works with their long-term goals, but is also attainable in their day-to-day lives. Here are a few key takeaways to help you construct and implement the best cash flow plan possible.
- Pay yourself first. The first payment you make every month should be to yourself because you should always be saving and investing in your future. If your savings is always relegated to whatever is left at the end of the month then you’ll never save what you really want to and you’ll perpetually prioritize other, less-important things. Paying yourself first ensures that the appropriate amount of money is being put towards the goals that you value the most. Whether it’s $20 or $2,000 a month that you can save, every bit helps. Paying yourself first gives you the satisfaction of watching your net worth grow and also saving up and paying cash for the things that you like.
- Write it down. The key here is to write down the amounts of your monthly income and expenses. You should always have more coming in than going out. This is a basic concept, but you’d be surprised how many people are living with negative cash flows, absorbed by credit card balances which grow and compound over time to a breaking point. When you write down your budget you tell each dollar where to go. You are creating a roadmap to success for your financial future. Without this plan in place your finances will float away like a piece of driftwood.
- Be specific. Write down where every dollar goes. For example, this can include your mortgage/rent, car payment, student loan payment, utilities, groceries, eating out, clothes, video and music subscriptions, home maintenance costs, savings, and other discretionary items. Every budget will be different, so plan yours to fit your specific situation.
- Create attainable goals. If you’re top goals are too lofty at the beginning, then you can fall short and your whole plan can unravel. You want to create goals that are tight enough to be challenging, but loose enough to be attainable. Once you stick to your budget for a week or a month, you’ll be all the more motivated to do it again the next month.
- Plan for fixed monthly costs and save for annual one-time costs such as membership fees and car maintenance. It can be easy to forget to budget for annual and semi-annual expenses and that can railroad your efforts. Such expenses can include routine car and home maintenance, appliance replacement, home renovations, birthday and holiday gifts, vacations, and other expenses. For example, if your goal is to pay for your next car in cash and you know it will cost $22,000 in three years, then you’ll want to save the appropriate amount each month to reach that goal. $22,000/36= $611.11. You can set that $611 aside in a savings account each month so that you can pay cash for your car in three years.
- Check your budget with a few rule-of-thumb ratios. Mortgage officers and financial advisors like myself like to practice a few rules-of-thumb to ensure proper financial stewardship. The housing ratio, for instance, says that your mortgage, taxes, and insurance shouldn’t be more than 28% of your gross income. If it is then you could be house poor, or you may find it difficult to stay on budget each month. The debt-to-income ratio is all your monthly debt payments/your monthly net income. This figure should be less than 36%. If your housing costs or your debt-to-income ratio is too high than cut back where you can and seek ways to increase your income such as a part-time job or elimination of another monthly expense.
- Use an app, spreadsheet, or whatever works for you. Thanks to technological advances there are now dozens of wonderful apps you can use to create and track your budget. The best one I’ve found is mint.com. With Mint you can sync all your banks and credit cards and automatically sort transactions into budget categories. This way you know exactly where you stand in terms of your monthly budget. If you’re uncomfortable with apps you can also use an excel spreadsheet, pen and paper, or whatever you’re used to—the key is just to do it.
- Modify as needed. Your budget will change as your priorities do. Emergencies and unexpected expenses will come up. Instead of letting this throw you off course, whenever your budget fluctuates, roll with the punches and adapt. The success of your budget doesn’t lie in stalwart defense of an old spreadsheet you came up with. It lies in the ability to adapt to your situation quickly and wisely. Always be seeking ways to eliminate debt, minimize expenses, and maximize your income. This is how you can continue to build a future and chase your dreams.