The first step in beginning to save more should be tracking your expenses and creating a budget. I touch on this in a previous post, however I think it's important to dive a bit deeper on the actual budgeting aspect.
Creating a budget can be daunting. Often times people don't budget because they don't know where to start. In this post, I'll break down the concepts of income, expenses (fixed and variable), and shed some light on how simple and beneficial it is to budget and track expenditures.
Different Types, All Serve Their Purpose
There are many different types and ways of budgeting. Some people advocate a 50/30/20 rule (50% of income spent on needs, 30% on wants, and 20% towards savings). Others like to use spreadsheets or apps to help them save. All of these are great options, the bottom line is that you should be using something to help track and budget your spending.
I’m not going to advocate a particular method here, but I do want to lay out the basic structure of our finances. It won’t be the same for all of us, however it will be very similar.
First is our income. Most of us have jobs and earn a consistent paycheck every month. This is our income. We have to pay taxes, including state, federal, social security, etc. Whatever is left of our income after taxes is called net income. Our net income is the amount of money that goes directly into our pockets after taxes are taken out.
Then we have our fixed costs. Fixed costs are things that you have to pay every month, and generally they do not change from month to month. These are things like rent, bills (phone, cable, electric, insurance, etc.). Fixed costs are very easy to budget for because they are pretty much the same every month.
After fixed costs, we have to account for variable costs. This is where budgeting can make the biggest impact on your savings. Variable costs are things such as groceries, gasoline, etc. We know that we need to eat every month, and we know we need to put gas in the car to get to work every day. However, generally speaking these amounts are variable and change from month to month.
This is where your budget will hold you accountable for spending in these variable categories. It’s easy to buy more food than you planned, or more expensive grocery items than you planned without having a concrete budget. It’s easy to overspend in other categories, and not have enough money left to put gas in the car when you’re running low. This is where a budget will save you.
Tracking your spending against a budget will force you to be conscious of how much money you are spending, and how much room you have left to spend on food, clothing, etc. Without this it is easy to spend money that you originally allocated for one thing, on something else.
An example of how a budget might look is below:
We start by listing our income, then fixed expenses. These will generally be the same every month. If you are a business owner, your income may fluctuate a bit more than employed individuals who are on a paycheck. Once income and fixed expense are accounted for, we get into our variable expenses.
It's extremely important to budget for what you think you will spend on the variable categories. Once you have a reasonable and realistic amount allocated to these, you need to do your best to stay within your budget! It's very easy to overspend and go over budget if you're not careful.
In this example above, variable expenses consist of items like groceries, transportation/gasoline, dining, travel, & entertainment, and miscellaneous. It's crucial to budget for miscellaneous expenses and emergencies as there will no doubt be unexpected expenses that come up. This is life - sometimes you'll get a flat tire, sometimes you'll break an arm and need to go to the hospital, etc. Budget for this so when something comes up you are prepared.
At the end of the month you should go through your bank and credit card statements, and calculate how much you ended up spending in each variable category. Then update your budget, and you can see how you did for the month.
If you spend less than you budgeted, good news - you saved money! If you went over budget, unfortunately you won't be saving any money this month.
Budget & Learn Your Spending Habits
This is one of the first steps, and one of the most important actions you need to take in order to maximize your savings. Learn your spending habits, budget accurately, and try your hardest to stay within budget.
Eventually this will become second nature to you. As you learn your spending habits, you will be able to create your monthly budget quicker, and you'll see where your problem areas are. After a few months of keeping a budget you'll likely know where you are overspending, and you can begin to focus on saving more in these categories.