Budgeting Basics: Establishing a Household Budget

Financial literacy is arguably more important now than ever, but there appears to be a large financial literacy gap in the U.S. today. In a survey conducted by the Financial Services Roundtable, 41 percent of U.S. adults gave themselves a grade of C or worse when it comes to their knowledge of personal finance.

It Starts With Budgeting

While there are many different components of financial literacy, it all starts with budgeting. Many people bristle at the mere mention of the “B” word, but budgeting is the first step in gaining control of your personal finances.

The good news is that budgeting usually isn’t as difficult or painful as most people think. At its core, budgeting is a simple process: determining how much money comes into your household each month (or your income) and then basing how much money you spend each month on this amount.

Unfortunately, many Americans today don’t take the time to create a simple household budget that balances their income and expenses. Instead, they simply spend money on pretty much whatever they want, and if their income isn’t high enough to pay for everything, they pay for purchases with a credit card.

This eventually catches up with them if they don’t pay down their credit card balances in a timely manner. Over time, the interest charged on credit card purchases can actually exceed the amount of the original purchases. If they only pay the minimum amount required on their credit cards each month but continue charging more purchases, individuals can find themselves in financial trouble very quickly.

Three-Step Budgeting Process

One best way to help avoid this trap is to create a budget—and then stick to it. Here is a simple three-step process for creating a household budget that will help you get a handle on your current financial situation and start to match your expenses to your income.

1. Determine your monthly income.This includes your take-home salary as well as any bonuses, alimony or other types of payments you might receive.

2. Determine your monthly expenses.These can be broken into two main categories: essentials and non-essentials. For most people, essential expenses include their mortgage or rent, utilities, transportation (car payments and gasoline or public transportation), groceries and insurance. Clothing is also essential, though it doesn’t usually have to be purchased every month.

Non-essential or discretionary expenses are everything else: eating out, going to concerts or movies, buying “toys” like big-screen TVs and new computers, going on vacation, cable TV and cell phones bills, credit card payments, etc. The amount of essential expenses should be fairly consistent from month to month, while the amount of discretionary expenses will likely vary. For budgeting purposes, place essential and non-essential expenses in separate categories.

3. Subtract your essential expenses from your income. Hopefully this will result in a positive number. If so, you’ll see exactly how much money is left over for non-essential expenses and saving. If not, you need to look for ways to reduce some essential expenses—like moving into a less-expensive home or buying a less-expensive car, for example—or increase your income.

Assuming your bottom-line number is positive, the next step is to establish a monthly budget for non-essential spending and saving. To do this, go back and add up all the money you spent over the past year on non-essentials like those listed above and divide it by 12. Then add this amount to your essential expenses and subtract your total monthly expenses from total monthly income.

If this is a positive number, congratulations! You are likely living within your means and may be able to start saving and investing some money, if you’re not already. If this is a negative number, you should look for ways to reduce your non-essential spending in order to bring your budget into balance and, ideally, save some money as well.

In our next article, we will look at the basics of investing.

 

 

By Martin Walcoe, SVP, David Lerner Associates

Material is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. (DLA). This material does not constitute an offer or recommendation to buy or sell securities and should not be considering in connection with the purchase or sale of securities

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