This article is part of Financial Literacy Month.
I’ve never been a budgeter. Budgets seem too prescriptive to me — I prefer to use a “spending plan” instead. But after a month as a full-time writer, I suspect a budget may be in my future. My income is fine, but it’s highly variable. I’m accustomed to a steady, consistent paycheck, and I don’t have that anymore. I also have some savings goals that I’d like to achieve, and budgeting may help.
While poking around for budget tips, I found an old Liz Pulliam Weston article about how to build your first budget. Though this piece is targeted at recent college graduates, the information is applicable to anyone trying to develop a budget for the first time. Weston writes:
Putting together a…budget is crucial if you don’t want to spend your way into serious problems. You’re also developing a habit that can serve you well throughout your life. “You’re committing to managing your money instead of letting your money manage you,” said economist Kathy McNally, head of financial literacy for the National Foundation for Credit Counseling. “The earlier you start, the better.”
You’ll probably find it helpful to first track how you’re spending money now. Review one of your recent bank statements to get an idea of your current monthly expenses and your monthly take-home pay. Then track every dime you spend for the next three or four days to learn where your discretionary money goes.
Weston recommends the 60% solution budget (which I mentioned in one of my first posts). With this method, you divide your gross monthly income as follows:
- 60% to Committed Expenses such as taxes, clothing, basic living expenses, insurance, charity (including tithe), and regular bills (including things like cable).
- 10% to Retirement.
- 10% to Irregular Expenses such as vacations, major repair bills, new appliances, etc.
- 10% to Long-Term Savings/Debt — money set aside for car purchases, home renovations, or to pay down substantial debt loads.
- 10% for Fun Money to be used for dining out, hobbies, indulgences, etc.
I’m still not convinced I’m ready for a budget, but I’m giving it serious consideration. Maybe I could start by creating a budget just for the business.
[MSN Money: How to build your first budget]
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I’m more of a “make it automatic” kind of guy when I budget. I have most of my bills set on autopilot and that makes me be pretty careful when it comes to pulling out cash for, well, anything.
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Thanks for the great article. I myself have been bad about creating any sort of budget at all. And, I realize that without creating a proper, workable budget, I’m just living with uncertainty, going from paycheck to paycheck, so I need to put some fire under my seat… and this article surely helps. Thank you.
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Well step one would be track your spending for a couple months. Step two is then to identify your goals, and step three would be to realign the spending to match the budget.
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I agree with the “make it automatic” strategy. If we try to save 10% each month for retirement without making it an automatic process, most of us will fail.
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If you don’t want to call it a budget, call it a “this is how much money I should spend this month” plan. Just the simple knowledge that, at minimum I make X dollars per month. Usually, my expenses are Y. I should have Z left over. If I don’t have Z, there’s a problem somewhere. Perhaps I should investigate.
I’m also putting up a post tomorrow better (hopefully) explaining how my wife and I budget. Maybe it will be useful to some of your readers. Maybe not. There are pretty images involved…
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I think I wrote a blog post somewhere about budgeting
.
Let me know if you have any questions, JD.
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I have tried to set a budget and I am a recent college grad. A specific budget or spending plan has never been very effective. I found a plan that works for better for me. I have two checking accounts. One for discretionary spending such as food, gas, entertainment, BEER, etc. Another account is for monthly expenses, such as rent, car insurance, cell phone. Every pay check (every other week) I withdraw in cash half the sum of my monthly expenses plus $25 and literally walk across the street to my other bank and deposit this money into my other account. All my monthly bills are routed to my credit card which I pay off with this account. This plan is fairly new with me but, at the end of the year will have an extra 1000-1500 dollars that I was not budgeting for (since I budget the withdraw amount for 24 paychecks even though I get 26).
The remainder after this withdrawal, my savings contribution, and Roth IRA contribution, is my discretionary amount that I can spend on whatever I want.
I still try to not spend all my discretionary amount every two weeks.
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How is this your gross you’re dividing. Don’t you have to, y’know, pay taxes and stuff with gross?
Methinks you should be dividing your Net
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This is where my deep and abiding love for personal finance programs comes in (I use Moneydance). Budgets become sooo much easier to make, EDIT, and check against your actual spending. Or I guess I should say check your actual spending against the budget.
Instead of committing to one budget for several months straight, we edit our budget each month depending on what’s coming up–extra or reduced income, expenses, etc. I think many people are put off by a perceived inflexibility of budgets, but by re-calculating each month (not a lot, but just enough), we gain enough flexibility that keeps us on track for the long term without feeling like we’re beholden to a soulless, mechanical system.
We’re getting ready to pay off one more loan next month and will do my favorite kind of adjustment that gives us a little more breathing room for savings while starting to tackle the last non-student, non-mortgage loan. Woo hoo!
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@ Jeff
The taxes are included in the 60% portion of the budget, thus the gross is what you use to the do the math. I use Microsoft Money, and they have this concept built into their budget…at least in the 2007 version.
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I can certainly relate to having a variable income, as I work on straight commission and my husband’s work is seasonal. Our salaries can (and do) vary wildly. It’s sorta easy to break your budget down into percentages on paper, but it’s sorta hard to actually make that happen in reality – at least, it has been for us. “Budget” is a strict word that doesn’t leave much breathing room for paychecks that can vary by 500% from month to month. I have seven automatic&specific mini-savings accounts set up through HSBCDirect, but have to adjust them frequently to compensate for the swings in our cashflow. There are no set 10%/10%/20%s in our budget – our expenses are low enough to be covered (just) by our smallest paychecks and any additional is used to 1)pay down debt 2)save 3)invest 4)treat ourselves, loosely in that order and completely dependent on what number I think would look prettiest as the balance
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“Spending Plan”, I like it!
Most people associate “budgets” with having money problems but in fact nearly 50% of the millionaires in “The Millionaire Next Door” make monthly budgets.
I have tried many different variations of budgets and have a pretty good system that works for my family. But it wasn’t easy.
It is hard to come up with budget advice that suits a wide range of peoples’ needs.
Automating as much as possible was one of the keys for me.
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I found that our first few budgets were difficult since we didn’t know what we were spending each month on groceries, gas and personal, but after we started budgeting and keeping track we got the hang of it. Using money envelopes helped us stick with it, too.
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I’m more of the set and forget type too. I can’t budget all that well, but if my direct deposit is split into different buckets, I never miss what I didn’t have.
If you can’t beat your own brain by budgeting, beat it by limiting your brain’s access to money.
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Well let me tell you if I could do that I would be happy. But honestly my bills already go above 60% of my income and there isn’t really anything I can do to change that. Anyone else in the same boat?
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I used to hate the entire concept of a budget. We make a good income, we’re not in debt (except for the mortgage)and we’re saving a significant amount for retirement. However, I was always stressed at the end of the month because the last week before payday we were always down to something like $20 in our checking account. I kept having to dip into savings because of “cash flow” issues. I couldn’t understand how we could be doing everything “right” and still seem to be running out of money all the time. I finally decided to try a budget of some sort and looked through all sorts of options. I found one that worked for me (there are lots of them out there…you just have to try them until you get one that does it the way you want — or create your own)and I can’t even explain to you what a huge different it has made in our financial lives. I don’t find it strict or confining like I thought it would. I actually find it liberating to know where the money should be going. The best part is that there is always money in the checking account now and I no longer have to time expenditures the way I used to.
I highly recommend everyone at least give it a real try. It takes a couple of months of working with one to really see the benefits. You can’t try it for a few weeks and then decide it doesn’t work. That isn’t giving it a real chance…
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I totally agree with the “track and tweak” spending plan and automating all savings. We use multiple accounts to make saving automatic, and spending savings hard.
We had a tendency to be too optimistic and yet draconian with our budgets (“we only spend $100/month on food (ha!); we will only spend $20/month on fun” (boo!), etc.) and we just found them discouraging. We do better looking at what really happened, talking through how our expenses align with our values, and deciding to change things from there (or not). Evolution, not revolution.
We do use budgets (still based on tracked info), but pretty much for decision-making only. We use our tracked info to make estimated budgets when we’re looking at a big change in expenses or income. We use it to make the semi-permanent choices like housing, telecom commitments, commute choices, seasonal recreational and entertainment choices, annual vacations, investment choices, insurance choices, and so forth.
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I use a spending plan and just started tracking my expenses on mint.com. Between those two things I now have a good ‘mental picture’ of my finances. It made me realize how much I spend on eating out, and I’m working on that to increase what I put into saving.
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@logislayer (#15)
Actually there a many things you could do to change that situation, but they fall mainly into two camps:
1) reduce your bills
2) increase your income
The site is loaded with info on both. Don’t be defeatist! You can do it.
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I use the 60% budget (based on my net income) that you mentioned, although I save more than 10% for retirement. With that said, I readjust my other numbers and they work out. I have 10% for fun money. Sometimes I use it all in a two week period, sometimes I don’t. Sometimes I spend more on groceries/house stuff, and sometimes I’m under. I do love tracking my spending in an excel worksheet by pay period, and when I’m under, I’m happy. When I overspend, I just say ‘oh well..better luck next time’, but tracking things make it easier to see where you spent extra $$ and where you saved.
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I’ve found it easy to use a “reverse budget”, basically what i do is ensure my retirement savings and mortgage prepayments happen first, then the rest of my money is a free for all, pay bills, go out, pay debt, whatever it doesnt matter. As long as my long term goals are being met there is no need to concentrate on day to day finances.
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I’m also a big fan of the reverse budget. I actually have trouble making myself spend money, so the reverse budget is a good way to tell myself it’s okay to spend the money I have left over after all the required savings and bills are paid. Ironically, I still sneak extra money into my retirement savings every so often. It’s a good compulsive habit to have, though.
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Not sure I like the breakdown. Primarily, I think 60% for expenses is very high (and encourages wastefulness). Also, 10% for fun (and an additional 10% for vacations, which I would also classify as fun) is way too much. Essentially your ‘fun’ money is twice your retirement savings in that scenario, and that’s a formula for failure. Here’s a preferable breakdown:
40% expenses
10% fun and vacation
20% pre-tax retirement accounts
20% post tax long-term early retirement savings
10% long-term savings for auto, children, education, home
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While I like GEMillers (#23) breakdown in terms of that-sounds-optimal, logicslayer’s problem (#15) is more my problem too. 60% might sound like too much to some for their expenses and encourage wastefulness, but my expenses lurk somewhere around 80% — due to my income (career choice that I am happy with, so I’m not complaining!) not my outgo which is pretty low. However, the basic idea of the 60-40 rule still applies even when the 60 is 80. Just make 5% contributions to the other categories instead of 10%, or as in my case set which categories are a priority and give more to those and shortchange (or fully neglect) the others.
So, the 60% isn’t some hard and fast number that if you can’t hit you should just throw the concept out the window. A budget is individual, so the numbers will be too.
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@G.E. Miller – It really depends where you are in your savings goals. If you are just starting out, maybe your mix is a good idea for a year or so to get settled into a routine. If you have already established saving patterns, I see nothing wrong with 10-15% retirement savings. Remember that your retirement will increase in value over time with our lovely friend compounding, whereas your fun money is spent real time, and is only worth todays dollars. You will end up saving much more than you even if you only save 10% to a 20% fun. Or else what are we saving for?!?
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I’ve been following a similar system for years. I heard it called 10/20/70. 10% off the top for retirement. 20% for what you are calling Irregular Expenses and Long-Term Savings/Debt. The remaining 70% covers all your other expenses and you spend all of it without reservation.
It has worked very well for us.
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That seems like the wrong approach to building a budget. What good does it do to write down arbitrary percentages and try to make your financial life fit those numbers?
I make my budget each month based on my actual income for the month, my actual expenses for the month, and balance it all out at the end. Works quite well and it’s actually possible to maintain.
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I’m with Trent, if you dont’ like to budget then don’t. Just make sure to “pay yourself first”, then the rest is yours to spend.
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No Debt Plan wrote:
If you don’t want to call it a budget, call it a “this is how much money I should spend this month” plan. Just the simple knowledge that, at minimum I make X dollars per month. Usually, my expenses are Y. I should have Z left over. If I don’t have Z, there’s a problem somewhere. Perhaps I should investigate.
That’s sounds like my “budget spreadsheet,” though that title may be a bit of a misnomer.
I’ve divided 2008 into pay periods which start on the pay date and end on the day before the following pay date (and so on). For each period, all of my anticipated income and spending is listed, apart from the specifics of what I spend my cash on. For expenses which cannot be perfectly predicted, like groceries, I leave an estimate until I actually spend the money. In any event, I have a pretty good idea of the balance of my chequing account from now until December. Thanks to that long-range outlook, I’ve cut the expenses I’ve needed to cut in order to end up with a positive cash flow. It’s a beautiful thing.
Financial peace of mind: priceless.
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J.D.,
I really enjoy your website. Budgeting is difficult but the peace of mind you will have knowing that you will always be able to pay your bills on-time, you have a plan for savings, and you will be able to analyze trends to see where you should really focus to save money. Within the first two months of budgeting, we reduced our cable TV expenses by switching to another service, changed telephone and Internet providers, reduced our eating out expenses, and began saving for known upcoming expenses that are irregular in nature (auto registration, excise, auto repairs, water, sewer, etc.). I would suggest that you try a very simple and straightforward solution we discovered after trying way too many software programs – http://ideaharbor.org/peachbudget/. Best of all, it is free and customizable. We are seriously considering donating money to the creator though because they did such a great job. Best of luck J.D.!
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This is all very helpful. I’ve been working hard on cutting down my compulsive spending and need to take the next step of developing a spending plan/budget. I get overwhelmed when I get to this point and give up. But I’m going to keep trying. The post and everyone’s comments are very helpful.
Thank you.
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Many people hate the word budget because they begin to think about restrictions. For a while my fiancee would not not do a monthly budget even though her spending was out of control. Once she started to write down what she spent her money on, she was in shock in where her money is going. I told her that if she doesn’t feel comfortable doing a budget, how about don a monthly money plan/goal sheet. She has been doing this for almost a year, and has become a smart spender/saver.
The funny thing is that she was doing a budget. We just changed the name to something that didn’t hold the same stigma.
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I also don’t do percentages. They are fine for comparing myself to others to get some insights on where I might be able to improve, but that’s it.
You start, for example, with the housing you have. Each time you move, you get the best deal you can, compromising between what you want, what you can afford, and what is available. Same with getting a new job. After that, the percent of the latter spent on the former is what it is.
So, I second the notion of recording what you’re spending now to see how your current budget lies. If you have money, you have a budget, even if you don’t write it down or know what it is.
Sometimes just making some categories and seeing how they compare to each other can make it obvious that one or two easy changes can make a big difference.
I especially like budgets for expenses that are not constant from month to month like utilities, car repairs, and car insurance (if you pay it once every six months to save money). After a while, you can get a pretty good idea of how much you need to sock away each paycheck to make sure you’ll have enough when you need it. For example, you may pay extra into your utilities savings in the spring and fall and pull that money out in the summer and winter.
I also like budgets for stuff that’s fun. I make separate categories for long-term (expensive) fun things like vacations, electronics, and furniture, and for short-term fun like going out, clothes, and lessons. Then I can spend guilt-free in those areas once I have saved enough in them. Parents propose a trip to Disney World? Yes, I can come if I have some savings for that.
Another thing I like budgets for is that I can borrow from one category for an emergency in another category. So one category may show a total savings that is a negative number for a while. Which is why we learned to deal with negative numbers in school. So long as all the numbers add up to a positive number, you’re okay.
And when you notice that one number has been negative for a long time, that’s a hint that you aren’t allocating enough to that category or that you are overspending in that category (or some combination).
This going negative part won’t work if, for example, you use different subaccounts at ING to keep track of different savings categories, but you really can put the money wherever you want, and then keep track of the categories separately.
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I love the philosophy behind You Need a Budget (YNAB). (If you scroll down the main page past the testimonials it gives you a summary of the principles). I have a variable income as well, and it works especially well for that. If I hadn’t been using that system when I got sick a few months ago I would have been in deep trouble.
Oh, and the software is great too! I’ve tried everything from MS Money to Quicken to building my own database in MS Access–and YNAB is my favorite. I use the Excel version of YNAB, but they have a stand-alone program too.
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Welcome to the world of irregular incomes. Here’s a reminder of my system: http://www.getrichslowly.org/blog/2007/09/19/budgeting-with-an-irregular-income/
Recently, I’ve been sending money *back* to my savings because I just didn’t spend everything in the checking. I’m still meeting all my other goals, and the cash cushion helps alleviate stress. Find your own path.
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I have a feeling that in high cost areas that 60% of your gross pay leaves you well short of your unavoidable expenses. For instance, I live in San Francisco and after paying 40% of my gross in taxes, the 20% that is left doesn’t even cover my rent and car expenses (payment plus gas to get to/from work).
Fortunately for me I get a bonus twice a year, since month-to-month I probably work a little bit in the negative (after a 401k contribution, but still).
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My personal “budgeting” procedure has always consisted of trying to hold expenses down as much as possible and tracking my spending carefully. I then know if, in any given period, I’m spending a lot or a little based on my own standards. I’ve found that not imposing a “limit” on my savings is the best way to save a lot. I simply try not to buy stuff I don’t need.
By the way, about the above comment, I live in LA and I find that it’s possible to save a large portion of my income, which is not very high. I think it’s all about being resourceful and reducing costs as well as knowing what is a “want” and what is a “need.” For example, in San Francisco you can pretty much get by without a car. Well, you could do that even in LA, but it’s easier to do up north.
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Count me into Gross being a really bad basis for this. After all, with any budget, it should be in some way possible to shift the numbers up and down – putting more into a 104k or IRA to raise savings; moving to a cheaper place to lower rent. Income taxes, however, are generally pretty much set in stone for most of us – and certainly don’t appreciably lower. I’m never going to see that money… so why bother including it in a budget?
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I’ve been following this 60 percent budget for a while. I originally saw it here:
http://tinyurl.com/pwz56
I find it to be a good, if broad, policy for handling finances at the macro level. I have a hard time faulting any system that can get you saving 30+ percent of your income.
I’m not sure I could swing this budget if I were single, however.
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What I have found to work is what I call a concurrent spending plan in an excel workbook. The left column outlines the expense and what portion of the budget it consumes. Then the next columns are broken into 4 weeks each month (since im on a bi-weekly pay period). The middle section basically breaks down what I will spend on which expesen during which week. Its really effective and simple.
-Instead of saying “OH NO I WENT OVER $100 for my groceries I say “Here is what I have to work with for week 1, week 2, etc.
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I personnaly use instead a 70% method.
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Sorry if this has been asked… I didn’t read all the comments. For those of us who are aggresively trying to pay down debt, what should the ratio look like? Paying only 10% means it will take me a long time to be debt-free. Is this 60% plan more designed for those without significant debt?
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Sarah, it’s important not to be slavish to any budget. If paying down your debt is your priority, then create a budget that reflects that. I think the 60% budget is designed for somebody who has stabilized her financial situation. Other people need to make adjustments until they’ve reached a point that this can work for them. Does that make sense?
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The book titled The Richest Man in Babylon covers a very similar budget plan. It was written decades ago, but it’s great to see someone arrive at about the same percentages independently.
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Thanks, J.D., that does make sense. I am new to this budgeting this and am going to try some new ideas to see what fits best for me. Love the blog!
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In setting my percentages I found it extremely eye-opening and helpful to use the prior year actuals as a starting point. I literally went through every bank statement and categorized every transaction. It took a lot of time and effort, but those numbers don’t lie about what is realistic.
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If you had a regular income, it would indeed be easier to build a budget, but with an irregular income, you have to plan using averages. I did create an Excel workbook (free at the link) to assist in planning a budget. Not sure, though, that it would work for you.
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I agree that using personal finance software makes it incredibly easy to build a budget. Not sure it would be very accurate if I tried to do it on paper only.
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The 60% solution is a great starting point. Depending on your income and cost of living where you live, you will have to make some adjustments. But the 60% solution is a pretty good rule of thumb to get a budget started. Although I don’t use it any more for my budgeting, it’s how I started out, and it worked pretty well for me.
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@logicslayer:
Yup I have that same problem, where my “committed expenses” or bills are already 90 percent of my income. So… the other 10 percent usually gets eaten up by those “irregular expenses”, and I don’t save anything, or build a retirement account, or pay off old debt. Woe is me.
So, that plan isn’t going to work for you or me. The solution I am working on is to reduce the bills and increase the income. Get cheaper insurance, drop your phone plan down a level, don’t buy ANYTHING you don’t need. Trade maintenance work for a break on your rent. Get a more fuel-efficient car, or ride your bike. Clip coupons and sale shop for food. Get the kids clothing, toys, etc. at Goodwill. For income: Sell stuff on eBay. Have a rummage sale. Return aluminum cans for cash. Sell plasma (that’s how my fiance makes almost $200/month)
It will pay off… the two of us have saved up about $700 over two months by doing only some of the above, and we’re still looking for more ways to stretch money further and earn a little more here and there. In a few years, we should have enough for a mortgage down payment, we hope. That’s how our parents did it and it’s still the way it works. Then with that savings (way cheaper than rent!) we can start saving for retirement.
As far as how we budget: we just pay the bills and then figure out how to spend the leftovers (Usually on groceries, sigh.) How we save: a literal piggy bank. We withdraw the extra in cash from the bank and put it in the pig. Old-fashioned, hey?
It works for us, though. It’s hard to get it back out of there! And it is satisfying to see the results in cold hard cash.
@JD
Enjoy the blog very much. I don’t always know what you’re talking about, but I like your sensibility.
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