How To Budget For The Best Savings
People who know how to budget have a solid understanding of the best ways to use their earnings for long-term financial growth. They know that they need to make money to save it, and save money to invest it. We can’t invest money we don’t have. If our ultimate goal is to multiply our wealth and allow our money to work for us, we have to establish a practical savings plan. Everyone, regardless of their financial position, can benefit from a firmer grasp on their spending habits. Here are four steps to take to start budgeting effectively:
What do you make?
The first step in learning how to budget is to determine how much money you earn on a monthly basis. You can generate income through your primary career, side hustles, or current investments. It’s important to look only at your actual take home, which is your total monthly income minus taxes, benefits, contributions to retirement plans, and anything else that’s deducted from your paycheck. Some people don’t have a solid grasp on this figure because they place more value on how much they make per year. While yearly income is important, we need to know what we earn at a more granular level to budget our money most effectively.
Budgeting gets slightly more complicated for people who are self-employed or whose income relies most heavily on tips or commissions because their monthly income varies from month to month. The best way for this group to determine monthly income will be to use earnings from prior months or quarters as a baseline and make a conservative estimation based on those numbers. Regardless of our income structure, we should all have a decent feel for how much money we have to spend over the course of one month.
Live example: Anna is a 25 year old woman who rents a two bedroom apartment in the city with a friend. Her take home income is $4,000 per month.
What do you need?
Once we’ve determined how much money we make per month, we should identify the things that we need to pay for on a monthly basis to survive. For the most part, these expenses are predictable and non-negotiable. The easiest way to reliably track all of these costs is to record them each month. We use Excel for our budgeting.
Housing and food costs, like groceries, rent or mortgage payments, and HOA or condo fees, are the most important necessities. You’ll also need to factor in renters or homeowners insurance, as well as any umbrella policies. Along with housing costs come utility expenses like water, sewage, electric, gas, cable, and internet, as well as things like trash and recycling, snow removal, and landscaping. After you’ve considered every expense related to food and shelter, you’ll probably need to pay for things like your cell phone and transportation. If you don’t have a car, you may need to purchase monthly public transportation passes and if you do have one, you’ll have insurance, monthly car payments, gas expenses, and parking fees.
Live example: Anna and her friend split everything evenly, so listed below are her half of the non-negotiable expenses.
Rent = $1,000
Renter’s insurance = $20
Groceries = $300
Monthly subway pass = $100
Cable/internet = $50
Water/sewage = $30
Electric = $50
Gas = $40
Cell phone = $100
Monthly total = $1,690
Next comes debt.
Immediately after we’ve thought about our non-negotiable monthly expenses, we need to factor in debt. Of course mortgages and car loans are considered debt, but we’ve already accounted for these in the last step. If you have outstanding credit card debt, pay it off before you do any sort of avoidable spending. Late fees and interest rates are brutal, and they will really hamper your long-term ability to save. The harsh reality is that any money you have is not truly yours if you’re in debt, and you don’t want to make unnecessary purchases without first paying it off.
People in their twenties and thirties might also need to consider student loans. If you’re able, pay more than the monthly minimum. It’s the fastest way to eliminate your debt and avoid heavy interest payments. People who are really serious about eliminating education debt will pay it off as quickly as possible, even if that means sacrificing any potential short term savings. Again, loaned money isn’t truly yours.
Live example: Anna has $300 in monthly student loans, but she pays $360 each month to pay down her debt more quickly. That leaves her with a new monthly total of $2,050.
Set your budget and execute.
This is what separates the people who save money from those who barely break even. In order to set an attainable savings goal, you first need to understand what makes you the happiest. If traveling and going out every weekend with friends fall into that category, then you’ll probably need to reserve your savings goals for your late 30s and 40s. If you are like us and get more satisfaction out of delayed gratification, then you’ll want to make sacrifices early to get where you want to be in the long run. It’s important to note that neither approach is better than the other. Happiness is both paramount and priceless. Figure out what you value the most and stick to it.
When we first started earning income after college, we spent significant time researching how much money we should aim to save. Some sources say 10% of your income, some say 20%, others say something else. We are by no means experts or financial advisors, and the amount you should save depends on a variety of factors including where you live, how much money you make, and your lifestyle. But, we did follow a very simple system that really helped us to build up our savings over the past 7 years.
We chose not to stick to a certain percentage or dollar amount. We felt that if we capped our savings goal at a fixed percentage each month, we wouldn’t push ourselves to do better over time. After accounting for our non-negotiable expenses, we consistently followed these 3 steps:
1. Each month, generate a list of all unnecessary monthly expenses. Be frugal, but realistic.
2. Stick to that budget. There will be exceptions, but be as accurate as you can.
3. Move everything else to savings. Building up your savings account is one of the best ways to generate wealth in your twenties and thirties.
It’s a simple method, but adhering to it hinges on your willingness to delay some temporary pleasure for more delayed gratification. The key is to challenge yourself to avoid consumerism and frivolous spending as much as possible, which is difficult for most people in their twenties and thirties. Unnecessary monthly expenses can include things like gym memberships, subscription services, entertainment, and shopping. If you have a longer list, we’d suggest ranking each expense by what makes you the happiest. This will force you to take a hard look at any recurring monthly subscriptions that you don’t use anymore, or how much you’re really spending on Starbucks coffee. It’s amazing how many payments can go under the radar if you aren’t vigilant. The more unnecessary expenses you can eliminate now, the more you will be able to afford later on.
Live example: Anna spends $2,050 per month on necessities, which leaves her with $1,950 leftover. Here is her monthly budget for unnecessary expenses.
Gym membership: $30
Netflix: $9
Spotify: $10
Audible: $15
Entertainment: $600
Shopping: $200
Total: $864
If Anna sticks to this budget, she should be able to contribute $1,086 to her monthly savings, which is just over 27% of her monthly income.
True commitment to this approach will ultimately lead to an opportunity to invest the money you’ve saved. Your strategy will depend on the amount of money in your savings, your risk tolerance, and your long-term goals. Real estate investing is our primary strategy, but we also invest in stocks, mutual funds, CD accounts, and bonds.
Smart investing is the best way to build wealth, but you can’t put the cart before the horse. If saving money is a priority, learning how to budget will unlock many doors. Use our approach as a guideline and experiment to determine what works for you. Trial and error is the best teacher. Budgeting will take some effort and saving money won’t happen overnight, but like with all other great things in life, it will be well worth the wait.
For more content, visit: kimandroy.com.
