“The budget is not just a collection of numbers, but an expression of our values and aspirations.” – Jacob Lew
It’s not what the market does.
It’s not who gets elected.
It’s not what the Fed says at the next meeting.
In our opinion, the biggest risk to a financial plan is a person or household that doesn’t know what they spend.
Pure Portfolios is an advocate for optimizing the things in your control, and in an ever-changing environment, your expenses are at the top of the list.
Let us turn our focus inward and optimize the things we can control. Understanding what comes in (income) and what goes out (expenses) is foundational to a successful financial plan.
Budgeting often carries a negative connotation. It’s viewed as restrictive, difficult, and unexciting. Here’s the truth: budgeting is one of the most empowering things you can do for your financial health. It’s not about restricting what you spend; it’s about making your money work for you.
Here’s how to craft a realistic budget that you can stick to.
1. Identify the Game You’re Playing
What does financial success look like to you? Maybe it’s maxing out your 401(k), retiring early or buying a vacation home. Whatever your goals, identify them and quantify them. Having clear financial goals will guide your budgeting process.
2. Determine Your Income
This includes your salary, bonuses, rental income, pension or any other income sources. Make sure you’re working with net income figures, i.e., the amount you take home after taxes.
PRO TIP: If you have variable income, use the minimum you can expect on a monthly or quarterly basis. It’s better to underestimate and have extra funds, than overestimate and be short.
3. Identify Your Expenses
These fall into two categories: fixed and variable. Fixed expenses are those that remain constant month after month like rent, mortgage payments, car payments, etc. Variable expenses fluctuate and include groceries, dining out, entertainment, gifting, etc.
PRO TIP: Think of your budget as categories you are giving yourself permission to spend in. You don’t have to feel guilty spending if you’ve already planned for that expense.
4. Allocate Your Income
Divide your income among needs, wants, and savings or debt repayment. A popular rule of thumb is the 50/30/20 rule, which suggests that 50% of your income should go to needs, 30% to wants, and 20% to savings or debt repayment.
While the 50/30/20 rule provides a helpful guideline, it’s important to customize it based on your specific circumstances and financial goals. For instance, if you have significant debt, you may need to allocate more than 20% of your income towards debt repayment. If your goal is to save aggressively for a down payment on a house, you may choose to adjust the percentages accordingly.
PRO TIP: To make it easier to stick to your allocations, consider automating your savings and debt repayment. Set up automatic transfers from your paycheck or checking, savings, or investment accounts. This way, you prioritize these financial goals and remove the temptation to spend the money elsewhere.
5. Track Your Spending
Tracking your spending is a fundamental aspect of budgeting that allows you to gain a clear understanding of where your money is going. This is where planning turns to action. By monitoring your expenses, you can make informed decisions about your financial priorities and identify areas where you can cut back or save more.
Once you have tracked your spending for a reasonable period, take the time to analyze and review your data. Look for patterns, trends, and areas where you can make improvements.
Ask yourself the following questions:
- Are you meeting your needs and wants without sacrificing your goals?
- Are there any categories where you are consistently overspending or underspending?
- Are there any surprises or unexpected expenses that you need to account for in your budget?
5. Review and Adjust
Your budget is not set in stone. It should be dynamic, changing as your income, expenses, and goals change. Regularly reviewing and adjusting your budget ensures it continues to serve your financial needs.
PRO TIP: While budgeting is important, don’t overthink it. Many people get lost in the details. Get the big stuff right, and the rest will fall into place. A $5 latte isn’t going to derail you from your goals.
Crafting a realistic budget is a crucial step towards financial stability and achieving your goals. By accurately assessing your income, prioritizing your expenses, and tracking your spending, you can make informed decisions that align with your financial aspirations.