As a financial planner, it's my job to help my clients bring discipline to their spending and create a budget that helps them meet their financial goals. In this guide, I've distilled my budgeting advice into an easy-to-follow, simplified process, much like the one I use with my clients. Follow this, and I guarantee you will be on the path to financial significance by the time there’s frost on the pumpkin in 2022.
Step 1: Name Your Goals
Too often, people try to tackle financial planning without goals in place. This is a fool’s errand – without knowing what you want to achieve, you will never form a strategy for how to get there.
So first, name your goals. These vary widely from person to person, but they often include one or multiple of the following:
- Reduce/Get rid of debt
- Put money toward an emergency fund
- Purchase a home
- Purchase a car
- Purchase a big-ticket item
- Save for retirement
- Put money toward an education fund
Maybe you have a vague idea of your goals but are confused about what to prioritize. Every situation is different, however we commonly see this prioritization of goals:
- Pay down high-interest debt – any loans or credit cards that have a 10% or higher interest rate should be paid down first.
- Put money toward an emergency fund – having an emergency fund can protect you from making drastic and harmful financial decisions down the line. Keeping six months of living expenses as an emergency fund is a good rule of thumb.
- Save for Retirement – it’s good to start saving for retirement as soon as possible, especially if your employer offers employer-sponsored matching. Saving 20% of your gross income is a good target to shoot for; although, again, each situation is different.
- Purchase a home – this goal is dependent on many factors, but if home ownership is important to you, and this rent calculator determines that purchasing a home is a good economical move in your circumstance, then you could place it at priority #4.
- Put money toward an education fund – depending on what matters to you and your situation, you might prioritize saving for your children’s or grandchildren’s education above other items. However, this goal should definitely come after items 1-3
Step 2: Translate Goals from Qualitative to Quantitative
Goals tend to be named in qualitative, or non-financial, terms: “I want to pay off my credit cards by mid-2022;” “I want to have half of a down payment toward a home by the end of 2022;” “I want to retire by 55.” To reach these goals, you must determine what they mean from a financial standpoint.
After you’ve named your goals, figure out the monetary amount attached to each one:
- If you want to pay off credit cards, review your credit card statements and total how much the charges are and how much interest you’re paying.
- If you want to have half a down payment toward a home saved, research the price range for homes in your purchase area and calculate 20% of that price range (a 20% down payment is a good rule of thumb when buying a home).
- If you want to retire by 55, find out how much you currently have saved toward retirement, then use a retirement calculator to determine how much you need saved by 55 to live comfortably when you’re done working.
And so on. The point is to make sure you can turn these goals into a tangible strategy by having dollar amounts to work toward.
Step 3: Understand Your Time and Money Allocation
Now you must look at your income and expenses. However, the money you bring in and spend is often impacted by how you allocate your time, so it’s important to calculate your time as well.
Start by calculating all your monthly income streams. These could be:
- Earnings from employment
- Earnings from rental properties you own
- Alimony or child support income
- Income from dividends on stocks you own
Next, calculate your monthly expenses. Account for:
- Mortgage or rent payments
- Utility bills
- Car payments
- Credit card payments
- Meals and entertainment
- Gas for car/commuting expenses
- Medical expenses
- Outstanding debts
- Childcare costs
Now, look at how you allocate your time throughout the week (or month). Because your time impacts your earning and savings power, you need to understand where it goes.
For example, my colleague Josh who runs F5 Financial's Venice, FL office used to live an hour away from the office. Monday through Friday, he spent one hour each way on his commute. This impacted the childcare expenses he had to pay out - an extra hour in the morning, and an extra hour in the evening. There are other "extra" expenses you may need to consider simply because you are unavailable, like paying someone to walk the dog, or ordering take-out often because you don’t have time to cook when you get home.
This exercise will help you see that these 10 hours of weekly commuting cost an extra $300-$400 dollars every week. This may motivate you to ask for more days working remotely or find a new job that offers remote work or is closer to home.
Step 4: Create Your Budget
By Step 4, you will understand:
- Your financial goals
- How much money you need to reach your financial goals
- Your income and expenses
- How your time is spent and its impact on your finances
Now you need to create your budget. You can take a top-down approach to this – start with a high-level budget, then create a more detailed budget, then create a budget that looks at each and every transaction you make.
High-Level Budget: Figure out how you need to allocate your time and money, and how to reduce expenses or increase your income, to ensure you’re working toward your goals while the net money in your checking account is always on the plus side.
Detailed Budget: Write down a steadfast amount you will allocate to each goal every month, and a strategy for reducing expenses and/or increasing income, and track where you are toward reaching your goals every month.
Transactional Budget: Use an accounting tool like Mint or YNAB (You Need a Budget) that you can connect to your bank and credit card accounts and uses charts to show how your budgeting impacts your goals.