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PFPlanning.com
Part 1:
Introduction to Budgeting
Why You Need a Personal Budget
In today's world there are very few people who take the time to create
a personal budget. Some people do not see the value in doing so;
other people simply have no desire to restrict their spending habits.
With this in mind, it should surprise no one that the number of personal
bankruptcies has reached an all time high. People have reached a point
in our society where they buy on impulse with no thoughts to the consequences.
In order to reverse this trend people need to become more responsible with
their patterns of spending. One of the best tools to help an individual
accomplish this behavior is the personal budget.
A personal budget is a financial plan which sets
limits on the amount of money that will be spent on each category of
expenses in a given month. A good budget will take into consideration
such factors as: the amount of income being received, outstanding debt
to be retired, retirement savings, and an emergency fund.
Many people have no idea exactly where or how
they spend a good portion of their money. How many times have you taken
money from the ATM only to realize a couple of days later that it is
gone? Many times it is difficult to remember how exactly you spent the
money, and often times this money is wasted on frivolous purchases. A
budget will help prevent this from happening by making a person
accountable for the money that they spend. If a person only has $50 left
for monthly food expenses then they may decide to forgo purchasing that
fancy $3 designer cup of coffee.
Another great benefit is that a budget portrays
an accurate idea of how much an individual can actually afford to pay
for various consumer items. Whether it's a house, a car, or a new TV, a
person will be able to determine whether or not a certain purchase will
fit within their monetary constraints. This acts as a safeguard against
getting in over your head financially.
It is important to realize that simply creating
a budget is not enough. This in and of itself will do a person
absolutely no good if he does not discipline himself to stick to it. At
times this will very difficult, particularly if a person has established
the habit of freely spending without a second thought. However, the long
term benefits of financial freedom, debt free living, and a comfortable
retirement far outweigh any potential difficulty.
Creating a Budget
Many people are not fully convinced that they
have a need for a budget. Their reasoning goes something like this.
"All I need to do is spend less than I make, and that's just common
sense, so why in the world do I need a budget?" If this sounds
like something you have said in the past, you probably have a bigger
need than you think. Other people fully realize their need, but they
simply have no idea where to start. With this in mind let's walk through
the basic steps of creating a personal budget.
Budgetary Steps
Create a
list of all of your monthly income. If you have any sources
of income that are received annually then simply divide this
number by 12. It is important to list all sources including
alimony, child support, side jobs, etc. This figure will set
the cap on your total budget.
Create a
list of all your monthly expenses. If an expense occurs less
frequently, simply prorate it to fit a monthly format. Be
sure to include such expenses as; housing, food,
transportation, utilities, entertainment, etc. It is wise to
track your spending for a full month during this stage of
budgetary planning. Save your receipts and each evening
write down your expenses for the day. This is the best way
to gain an accurate reflection of actual expenses.
Determine if your income covers all of your current
expenses. If the answer is no, then expenses need to be
reduced.
Adjust
expenses. This can be done in a variety of ways. Depending
on the amount of the shortfall, it may be a simple matter of
reducing some discretionary spending, such as entertainment,
or food, i.e., the number of times you eat out in a given
month) If the deficit is larger then it may be a matter of
downsizing your vehicle or your living arrangements. If your
income covers all of your expenses then this is still a good
opportunity to trim some of the fat off of your spending
habits. This can help free up extra money for a variety of
reasons ranging from, college educations for the kids, to a
nice anniversary trip with your wife.
Add new
categories if necessary. Three areas that are often
overlooked are 1) debt reduction 2) retirement savings and
3) emergency savings. An emergency fund will ensure that
there is an adequate amount available to cover an unforeseen
even (i.e. the car breaks down) should it arise. This will
prevent the use of credit which can quickly break a personal
budget.
The Advantages of
Living on a Budget
The majority of people today are
not living on a personal budget. The availability of
credit has allowed people to purchase what they want
when they want with little regard to whether or not they
can actually afford it. There is little hope that people
will change these patterns of behavior in favor of
living on a budget until they realize the number of
corresponding advantages.
A major advantage of living
on a budget is that it relieves a great deal of
financially related stress. It's always fun to
spend money at the time of purchase but it is
not nearly as fun when the bill comes do. When
this happens, some people resort to using credit
cards to pay of other cards. Other times people
pay their bills and then choose to obtain
"payday advance loans" to get them through until
the next check. Both of these situations cause a
viscous cycle of debt and growing interest. A
budget can help ensure that an accumulation of
debt is prevented and money will be available
throughout the entire month.
Another advantage
associated with budgeting is that it allows an
individual to regularly place money into savings
plans. This will allow the person to enjoy a
comfortable retirement when that stage of life
rolls around. It will also provide a financial
cushion to cover any emergency situations that
may arise.
Other Budgetary Advantages
Goal achievements.
Most people have set financial goals that
they would like to reach at some point in
the future. Sometimes this may be an exotic
anniversary trip, or it may be a brand new
car or a college education. A budget can
help people save money to make these goals a
reality.
Debt reduction.
Many people are being crushed under a heavy
load of consumer debt. Without a disciplined
pattern of spending it is virtually
impossible to make much headway in reducing
the debt. A personal budget can provide the
framework necessary to begin eliminating
these inflated account balances.
One of the great aspects of a personal budget
is that it does not offer an "either or
solution". If executed properly a budget will
allow a person to simultaneously meet their
expenses, place money into savings, and pay back
outstanding debt. In view of these advantages,
it is truly in all of our best interests to
create and implement a personal budget.
5
Pitfalls That Could Destroy Your Budget
With all of the
advantages that are associated with
living on a personal budget it is no
wonder that many people are beginning to
implement this system into their own
lives. For a great number of individuals
the results over time have been nothing
short of amazing. People are beginning
to work their way out of debt while at
the same time meeting their expenses,
and placing money into savings. However,
it is important to realize that there
are potential pitfalls that may be
encountered along the way. If people are
aware of these hazards then they are far
less likely to be negatively affected by
them.
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Credit Cards. These little
pieces of plastic can often
cause a great deal of
temptation and trouble. It
is not uncommon for a person
to make an unwise purchase,
which they would not
otherwise make, because they
had a credit card handy. The
solution to this problem for
many people is to get rid of
their credit cards and begin
paying by cash or check.
Some prefer to keep one card
for emergency situations but
it is best to keep this out
of reach, and not in their
wallet or purse.
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Impatience. Problems often
arise when people set
financial goals but do not
have the patience to
complete a savings program.
For example, let. s say that
an individual begins setting
money aside for a new car.
However, after a couple of
months they happen to find a
car that they love, and
instead of waiting, they go
ahead and make the purchase.
This could potentially
create some serious
financially strains. It
takes real discipline to
prevent impatience from
breaking your budget.
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Lack of adjustments. A
budget is created using a
set of expenses and income
figures that are current at
that time. As these figures
change it is important that
the budget is adjusted to
reflect these changes. A
failure to do so could lead
to some major deficits.
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Holidays. Unfortunately,
many people do not consider
holidays at the point that
they are creating their
budgets. As a result, a
proper amount of money has
not been set aside for
presents, food, etc. These
items should be factored in
and saved for throughout the
entire year.
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Vacations. Many people
accurately factor in the
transportation and
accommodations, but
underestimate the amount of
money needed for food and
entertainment. Keep in mind that
at any kind of "touristy" or
resort destination, the prices
can easily be 2 to 3 times what
you would normally pay at home.
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