Money management and budgeting plays a crucial role in a family’s financial health. In recent years, the debt-to-income ratio has improved somewhat for Americans. Unfortunately, most Americans are accumulating debt faster than they are saving for retirement. By taking control of your household budget, you can make informed decisions about how much money you can spend each month. Once you understand the fundamentals of budgeting, you should find that you can make positive changes.
Importance of Budgeting
Setting a budget will help your family save money and avoid debt. Without a budget, you can only make guesses about how much you can afford to spend on necessities, entertainment, and other expenses. When you don’t have a functional budget, you’re more likely to:
- Accumulate debt.
- Face higher interest rates when borrowing money.
- Have loan applications denied.
- Fail to save for emergencies.
- Not meet long-term savings goals.
Best Practices on How to Budget
Before you can create an effective budget for your household, you need to know how you currently spend money. You can use computer software that helps you track your expenses; online budget calculators that force you to include expenses like entertainment, groceries, and savings; or smartphone apps that give you up-to-date info on your spending.
Regardless of the tools you use, make sure you include every item that you spend money on. Every cup of coffee and snack from the vending machine should get recorded.
After you track your spending for a few weeks, you should know how much money you spend during the typical month. Compare that amount to your household income. If you are spending more than 90 percent of your income, then you either need to reduce your spending or increase your income.
Other best practices include:
- Lowering your debt.
- Setting aside money for your average utility bill.
- Using a worksheet to make sure you include all expenses.
- Including money for unexpected expenses.
- Differentiating between your wants and needs.
- Calculating how much money you need to save before you retire.
Calculating Your Total Income
The way you calculate your total income depends on how you get paid. Some people receive weekly, biweekly, or monthly checks. Others get paid irregularly (such as those who work for tips or own their own businesses). Try the following to determine your income:
- Use a worksheet that gives you the flexibility to enter your unique information.
- Use an online calculator that converts your hourly pay into your annual income.
- Review old tax returns to find your annual income.
Estimating and Planning for All Expenses
Estimating expenses allows you to plan for future payments even when you don’t know their precise amounts. If, for instance, you have your utility bills from the previous year, you can add the payments together and divide by 12 to get your estimated monthly bill.
Other expenses aren’t so easy to estimate since you cannot predict when an emergency will force you to spend money on things like healthcare and home repairs. Losing your job could also force you to reconsider how you spend money. Even though you cannot know the exact amount of these expenses, you can still plan for them by:
- Setting aside enough money to pay expenses for at least three months.
- Contributing money to a Health Savings Account (HSA).
- Saving money in high-interest accounts.