Everyone started somewhere.
Most of us started at zero... in our savings account.
Then at some point, a series of decisions moved us into the negative. One step forward, two steps back.
I remember when I got my first paycheck straight out of college. I went to Best Buy and bought a flat screen and an X-box 360 ($1000). Then a couple weeks later, I moved into a snazzy apartment overlooking the Washington Monument and Capitol Hill ($2000). The crazy thing is that I was only taking home $3000 a month at the time. I had just graduated with a finance degree but had no idea about personal finance. And I soon found myself living paycheck to paycheck.
Do you have a budget?
The key to regaining your financial fitness is to know exactly where the problem areas are. A personal budget is the tool of choice for assessing your current financial situation. I don't remember if I had a budget or not back then, but clearly whatever I was doing was not working. So my question for you is, do you have a budget? Is it written down or is it in your head? For the record, budgeting in your head doesn't count. If I asked you how much you spend on food each month, would you know?
A monthly budget is helpful in nailing down where your money is coming and where it is going. Creating a budget is something you should consider doing if you are looking to reach financial health. Before beginning the budgeting process, make sure you have recent pay stubs, bank and credit card statements.
The first step is determining where your money is coming from. If you have a 9-5 job, then it's pretty easy to calculate your monthly take home wages (after taxes). But if you do freelance work, it could be a little difficult estimating monthly income. One strategy is to average a couple months of income, adjusting for seasonality if necessary.
The next step is tracking where your money is going. This is probably where you will spend the bulk of your time. You can start out with fixed expenses: rent, phone, cable/Netflix, loan payments, charitable giving, etc. Anything in this category is consistent and predictable.
Estimating variable expenses will be trickier. These expenses can fluctuate throughout the year. Typical major variable expenses are food, transportation, clothes, and entertainment. To get a handle on these, make sure you track it for at least 3 - 6 months. This will allow you to see normal monthly fluctuations and account for them.
Anything left over?
Once you created a comprehensive list of expenses, you will have to add up the amounts and subtract the total monthly expense from the estimated income. Is there anything left over? If so, you are well on your way to building wealth. If you are in the red, you have some work to do.
How to fix your busted budget
Every household budget should have a bottom line of zero or some money left over. If it is negative, that is a problem. So why isn't your budget working? Getrichslowly.com laid out a helpful list of things to consider:
- Are you underestimating your expenses?
- Did you capture all income and expenses in your budget?
- Did you account for an emergency fund?
- How are your expenses relative to your income, are they too high?
- Are you tracking your expenses month to month?
- Are you making a conscious effort to stay within budget?
As you go through this list, you will notice specific items that are messing up your budget. Maybe you didn't account for that annual magazine subscription. Or you thought you spend $500 on groceries but in reality, you spent $1000 last month. As you see issues, feel free to tweak your budget periodically. It will take time to get your budget just right, but it will be well worth it.
We will go into more depth in part 2. See part 2 here.