The beginning of a new year is the perfect time to take a panoramic look at where we stand and where we want to go. By now, we have spent time reflecting on the events of the past year and have even set new year’s resolutions. With those reflections and resolutions in mind, this is the moment to take broad goals and transform them into action plans. First, we must look at our current resources. Whether the goals we want to achieve are short-term, long-term, tangible, or far-fetched, the resources at our disposal are key in getting us there. In terms of personal finance, this means regularly taking a close look at our income and our expenses.
Everyone’s financial situation is different. A poor financial situation can sometimes lead to turning a blind eye and digging a deeper hole. For this reason, awareness is the first step to making a change. On the other hand, if a person’s financial situation is comfortable and overspending is not an issue, then they may not see a reason to keep track. In this case, it is possible that their money is sitting in accounts without earning interest. On both sides of the spectrum of financial wellness, preparing a personal financial statement can help us take note of the resources available to us and the potential obstacles in achieving our goals. Depending on the complexity of your situation, creating a personal financial statement may look as simple as jotting down our assets, or the funds in our checking and savings accounts, and our liabilities, the debt we owe. By gaining full awareness of our financial situation, not only do we begin to organize our accounts and ensure that we can meet our obligations, but we confront our past financial behavior, sparking further reflection about the necessary steps towards improvement.
Once you know where you stand and understand how you got there, you are ready to optimize your finances to meet your goals. This is where budgeting comes in. Budgeting can get a bad reputation because, by definition, a budget sets rules on a person’s spending. However, budgeting is just postponing instant gratification for a more meaningful reward in the future. One effective budgeting style is called zero-based budgeting. This style allocates every dollar you earn towards a spending or savings goal.
To start your budget, calculate your monthly income. Then, list your monthly expenses. Begin with expenses that are hard to adjust such as your mortgage, rent, and other bills. Then, move on to estimating the more flexible monthly expenses, such as groceries, home supplies, dining out, gym membership and shopping. Brutal honesty with yourself about flexible expenses is crucial to producing a helpful budget. The magic of budgeting happens when you subtract the estimated expenses from your income to reveal whether you are overspending or have extra funds to save or pay down debt. Once your budget is complete, take the time to review each monthly expense. A mortgage, rent, or loan payment are difficult to adjust without making drastic life changes such as moving or refinancing. The best areas to tackle are flexible expenses such as groceries and other discretionary purchases. Very often, we are unaware of how much we really spend on groceries, or how many monthly services we subscribe to without considering their value. By analyzing our flexible expenses, we can find extra money in our budget and reallocate the funds towards our goals.
Once we determine how to lower our monthly expenses to allow for extra money each month, it is time to allocate that money for the future. Unfortunately, this not only means saving money for a house or a vacation. Saving money for the future starts with creating an emergency fund to support you in irregular circumstances. Life happens and it is impossible to budget for every situation. An emergency fund is a cushion in your monthly budget to ensure that an unexpected expense does not have to be covered by your rent or grocery money, vacation savings, or high-interest rate debt. The savings goal for an emergency fund is six months’ worth of monthly expenses in the event of job loss or an accident. With any extra money found in your budget, comes great responsibility. It is up to you to decide what percentage of those funds go to funding an emergency fund, paying down debt, and the other more exciting savings goals. At the end of your budgeting session, you should have zero dollars left, as all your dollars have a job, whether that is to pay your rent this month or to sit in your account in case of an emergency.
When we spend money without a plan, we are at the whim of our obligations and our immediate desires. Active budgeting ensures that we spend our hard-earned money intentionally in an effort to improve our situation. The objective of managing your money and budgeting is not to accumulate wealth for the sake of wealth. Budgeting is an exercise in taking small incremental steps towards your goals, while providing you with financial peace along the way.