Ep.10 - How Do I Budget?
Have you ever had a lazy Sunday, where the whole day just flew by and you don’t remember doing anything? Just like time, without planning, money flees without you even noticing.
Everyone needs a budget. It doesn't matter if you make $40k or $400k a year. We all have needs and wants, and if we want to meet those needs AND wants, we have to budget. Budgeting is not about cutting corners in the quality of your life, it is about putting money towards what truly matters to you.
HOW TO BUDGET?
There isn't just one way of creating a budget. Today, I will walk you through how I control my finances through budgeting.
Important note before we dive in: Write it down, don't just picture it in your head. I write down my budget in Excel, instead of making mental notes. Why? Writing it down REALLY helps me think through the relative importance of each item I spend money on.
Use my template: This is a template I created for my personal monthly budget. Download it and keep it open as you read through this episode, because I will refer to it throughout. Quick note: in the template, I use a fictitious female who is #youngandfree for illustration purposes. She takes home $4,000 a month after pre-tax deductions and all taxes. Her pre-tax equivalent salary is somewhere between $65k and $70k.
There are five components in a budget: Income, Fixed Spending, Discretionary Spending, Debt Servicing and Savings.
In my budget, income refers to post-tax, post-deduction take-home pay. This is the amount that's actually deposited to your bank account. 401k savings don't show up anywhere in my Excel because this is a monthly operational budget, and your 401k savings can't be spent yet. Enter each additional income stream, such as your side hustle, in a separate line. If your income from your side hustle is not always steady like your day job, calculate the monthly average from the past 6 months.
Fixed spending refers to expenses that are recurring and relatively consistent month after month. In my example, #youngandfree spends most of her income on rent ($1200), parent support ($200), gasoline ($150), auto insurance ($80) and utilities ($50 on Internet, $30 on natural gas). She doesn't pay for trash and electricity because she rents. She is a cord cutter. She subscribes to Netflix and Hulu, but waiting until Games of Thrones comes back in July, before pulling the trigger on the HBO subscription.
One important item in this category we should all list out is "miscellaneous." It covers one-off items you don't always anticipate, such as car registration, replacing your wall clock, tipping the valet, buying a screen protector after you drop your phone and etc. I would start with $200.
Discretionary spending is the type of spending where YOU have the flexibility to choose how much to spend. In #youngandfree's budget, I have three types of spending: groceries, eating out, and play money. Groceries are not part of fixed spending, in my opinion, because it really depends on how much a person eats out. #youngandfree knows she eats out quite a bit every month, so she budgets $300 for eating out, and only $200 on groceries. She also budgets $100 for play money, which she can spend on anything she wants. The existence of $100 play money highlights the point of budgeting, which is all about prioritization, not about pain and suffering.
Debt is a dream crusher. If you already have debt, you should put it in your budget. It is often a fixed amount. For #youngandfree, every month she pays $200 towards her undergraduate loan and $400 towards her Honda Civic (on a 42-month loan). One more thing, except for a mortgage (because it is not avoidable for most of us), try not to take on new debt.
Savings is the money that's left over. Shoot for 20% of your take-home income. If you take home at least $3,500 every month, you should have enough to cover the basics, so shoot to save 20%. If this is not the case, start by saving $50 - $100 dollars a month, because it's an important habit to develop no matter how much you make.
How to Save More:
1) A quick fix is to lower your total discretionary budget. You could eat out less, or shop at a budget-friendly grocery store. This can only take you so far, because your discretionary budget is only a small percentage of what you spend every month. This is why I hate the article "Millionaire to millennials: stop buying avocados in order to buy a dream house". Maybe this title is true for the 1%, but the vast majority of us spend the bulk of our money on fixed items, not on avocados and Starbucks.
2) The long term solution is to cut from the biggest fixed items, by making structural changes. The single biggest thing on everyone's budget is housing. It is expensive in LA! A one-bedroom can run between $1,200 and $2,500. Thus, the best way to save more is to a) live with roommates b) live in a budget-friendly area c) an extreme option: live at home. Right now, I am assuming #youngandfree lives in a one bedroom in LA for $1,200. It is a VERY good deal for living alone. But she still has room to cut it down to $800. For example, she can share a place with 2 roommates in Palms. That's $400 of savings a month. It would be very difficult to shave $400 consistently from your discretionary spending, even with a lot of self-control.
It is good to have savings in general. It is more motivating to save towards something specific. #youngandfree saves $300 towards a vacation and $200 towards a cushion for her parents. Outside of that, she still has her general savings.
HOW DO I KNOW IF I AM SAVING 20%?
Everything I talked about won't matter, until you go through your own budget with your own income and expenses. It will take no more than an hour. Use the template and try it out by modifying the dollar amounts, or adding new items that are specific to your situation. After you are done, the title and the pie chart in Excel automatically update to give you a snapshot of your financial health (see below).
Header: This is the one-stop shop to capture your pay, your spending and your savings. Try to make your savings reach at least 20%.
Pie Chart: This gives you a more detailed analysis on all the categories. Again, make the green pie at least 20%.
Some have reached out to me, very curious about what I read to keep myself informed on personal finance. In the next episode, I will talk about one website and one podcast that I use. See you next Friday!
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