Personal Budgets: Making your own personal budget
It’s time to make your current personal budget.
If you followed my instructions, you have saved all the receipts and proofs of payment for every expense that you incurred during the month. Overall, you will need the following to complete this exercise:
- A month’s worth of receipts for everything you have purchased and paid
- Your monthly income, payroll deductions, and 401(k) plan contributions
- Notepad and pencil
- A calculator
- A printer to print the instructions to make the budget, and later on to print your budget and view it (optional)
- A tasty beverage, as this may take some time and well, you might as well have something nice to drink!
- Less optional is … time. You will need about an hour to finish this and read the additional notes that will help your personal budget overall
- Finally, if you are one of those people incapable of opening a worksheet without starting to figure out the ins and outs of it, how its formulas work, may I recommend a ruler? To smack yourself on the hand every time you feel like not sticking to the plan and tampering with the worksheet… (kidding! but seriously: stay off it!)
First, please access these two files. One’s the actual budget worksheet, which you should download onto your computer’s desktop, or some other place easy to find. Second, you need the Instructions for the exercise. Please read them before starting, and you can save or print them.
As it says on the worksheet’s very first line, you’ll only be filling out information in those fields highlighted in blue. Among them, you’ll find fields that you won’t need to fill as they will not apply to you. I’ve entered many possible kinds of income and expenses. There may, however, be no place for a specific expense that you have. The instructions explain what to do if that’s the case.
Note that this is a personal budget that’s adjustable to work for a household. If you’re interested in created a household budget for you and your spouse/partner and additional family members, you can add incomes and expenses for each category that applies to your household. It will work; you’ll just have to do a little more math.
Next, we’re going to go on the premise that you are going to spend the next half hour filling out the fields on the worksheet, double-checking it, and then saving and/or printing.
Now you have your budget in front of you. Let’s take a look at the second page, the one with the chart.
The overall picture
The first report shows you your Income and Expenses. This is a basic breakdown of your money: What you make, where it goes, and how much is left at the end of the month. This last figure, listed as ‘Amount remaining to save or invest’, is what’s left at the end of the month. It should always stay above 0. If it is a negative figure, this means that you aren’t making it till the end of the month with your current income, and you have either made a mistake in the worksheet, had extra unexpected expenses, or are in need of financial counseling.
Ideally, this Amount remaining should represent above 5% of your income. Above 20% means that you have very good control on your finances. Either way, you should, at the end of this month, divide this amount into various savings accounts (I will touch on this later), and clear it off your checking account so that you do not include it as part of next month’s income.
The next mini-report is titled ‘Breakdown by category’ and, as its name indicates, it breaks your expenses into major significant categories that are worthy of individual consideration: what you spend on food, housing, utilities, fun, medical, and even staying healthy.
According to the latest (2013) US Bureau of Labor Statistics Consumer Expenditure Survey on household expenses, here are averages for various expenses; they will help you figure out if you are doing better, equal, or worse, than your average American:
Percentages of net income spent on:
- Housing: 33.8%
- Food: 13%
- Utilities: 7.5%
- Entertainment: 5.2%
- Health (medical plus fitness): 6.7%
These percentages vary depending on many factors. However, if any of your figures is much higher than those listed, there might be reason for concern and you should review where that money’s going.
Also, I understand that you may not live in the United States. If that’s the case, look online for similar statistics in your country, every government compiles and reports them.
Debt and debt ratio
Next on our small report we have two different debt breakdowns that are key figures:
- Secured debt: how much of your debt is going to pay your secured loans (mortgage and real estate loans, plus car loans).
- Unsecured debt: personal loans, and credit cards.
While these figures in themselves don’t tell you much, they affect the report that follows immediately, which is one of the most important factors in your finances.
You see, the same way that you always hear that you should be setting 10% of your take home salary to savings, there is a percentage of your income that has an allowed maximum: how much goes to paying debt. This is known as the debt-to-(gross) income ratio, or DTI.
What is interesting in this figure is that it doesn’t show how much money you owe overall. Rather, it shows what you’re paying on your debts each month. Certain amounts are healthy and acceptable. Higher percentages may cause concern. Extremely high ratios indicate that you need financial counseling and severe debt management measures.
The debt-to-income ratios, the cornerstones of borrowing
Not everyone owns their home. However, most of us fall into the categories of either renting, or paying a mortgage. That’s why, for the first ratio we’re going to look at how much you spend on your housing, indiscriminately from if you rent or own.
Note that, as listed above, and according to the US Bureau of Labor Statistics, the average household spends 33.8% of their income on housing. That’s the average housing debt-to-income ratio. Is your ratio higher or lower than that? Keep that in mind when looking at the next ratio…
The total debt to income ratio includes all your debts: credit card, housing, car loan, and all other loans, and it’s the most important figure of your budget.
Why you should care
The reason why your complete debt-to-income ratio is so important is that it indicates what else you can afford.
- If your ratio is high, it means that you are spending a lot on housing and loans, and that you may be nearing a saturation point (after which you wouldn’t make ends meet).
- A low ratio means that you have little to no debt, and are likely making it comfortably to the end of the month.
This ratio is so important, that it’s one of the five factors that comprise your FICO score, which evaluates your credit worthiness in one sweep, in a number from 150 to 950.Furthermore, if you rent and are looking to buy a home, the loan officers appraising your application will calculate your debt ratios including their proposed payment on your future mortgage, to see where you would stand; it helps them determine how much loan you could afford, or if you could afford a loan at all.
The acceptable debt ratios, for most lenders are:
- A maximum of 33% for the housing one, and
- A maximum overall, including real estate loans, of 48%.
‘Knowing this, how do you feel about your own ratios? Are they comfortably lower, close to limit, over the limit? This will help you get a very good idea of how you are managing your finances.
Finally, there is one more ratio I haven’t mentioned before, but have listed as the last on the report, your ‘Non-housing debt to net income ratio’. It shows how much of your take-home pay goes to paying the minimum payments on outstanding debts, your credit cards and loans. Ideally you’d never allow this figure to rise above 20%, as that would indicate that you would almost be living beyond your means already.
The basics of saving
I want to go back to your end of the month balance: what it means and what to do with it. Remember, the sheet included a small field for ‘Other savings accounts’. If you are directing money monthly to those extra savings, the following information on savings may not apply to you.
If your end of the month balance is under 5% of your budget, you’re making ends meet but have little room for error. It’s time to think of setting a set amount to a separate account each month.
If it’s over 5%, you’re doing well.
Other types of saving
While you may have investments, 401(k) or similar plans, or buy bonds, I believe firmly that everyone should have two additional savings accounts. I know that you usually hear about one account, but I believe in the old adage, divide and conquer. These two accounts will take in the infamous” 10% always to savings” that we’ve all heard about:
- One account is intended for the future, for large expenses that you plan on having in life: buying a home, education, retirement, a dream vacation, wedding, whatever. This is the money that you simply don’t plan on touching unless you have a very good reason to do so. These savings have not set goal but to grow steadily, and you will be dipping into them now and then to purchase big ticket items in your life.
- And then there is what Americans like to call their rainy day savings. The money saved for emergencies: a broken television, a broken tooth for that matter, an emergency trip, whatever. Emergencies -you don’t really need me to tell you what they are, I’m sure you’ve had one at some point-. It feels good to know that you have money set aside to help with those contingencies in life. They can’t be avoided, and this money helps you cope with them. Consider setting a balance amount, and saving towards that goal; when you reach it, leave it there for whenever it’s needed.
If you have money left at the end of the month and are not saving, please consider my advice seriously, to divide your remaining balance between these two very rewarding accounts. If, after three months you see that every month you have the same amount left over, then set up an automatic monthly transfer and forget about it. That money will be there whenever you need it. My suggested division of these funds would be 7% to long term savings and 3% to your rainy day fund, until you reach your rainy day goal.
Paying to save more
If you have over 10% left every month, it also means that your account balance grows a little more at the end of each month. If this is the case, why not examine your credit card and loan debt, and find accounts where you can pay extra (starting with the ones with higher interest rates)? Whatever debt you pay off ahead of time is money saved from interest. You can put that extra money to work for you.
Finally, one last suggestion, because there is one product at the credit union that oftentimes goes unnoticed, and it is to me one of the niftiest. I am referring to the Club Accounts.
When I worked at the credit union, I used to have an automatic monthly transfer of $60 to my holiday (Christmas) savings account. Then, the week before Thanksgiving, every year, poof, $720 dollars (plus a few dollars of interest) materialized on my regular share account for me to start my holiday shopping. I absolutely loved that feeling. Then, the next month, the new transfers would start for my shopping the following year. I loved this. If you’ve never tried this account and have trouble buying presents for everyone in December, I strongly recommend you try it. It’s painless and extremely rewarding. Also, if you want to plan for summer vacations, guess what? There’s a Vacation Club account that works the same way, and you get the proceeds mid-May.
I hope that this article and exercise were of help to you. I remember that my first budget exercise was a huge eye-opener that it led me to straighten out own finances.I understand that every person is different, as are each person’s financial circumstances. However well or not well you may be doing, knowing where you stand, exactly, will always help you see if there is some area in which you could make some changes. If you’re doing great overall, then this was a nice pat on the shoulder for you!As I mentioned before, if you have any comments or questions, you can always use the comment section below, or email me at [email protected].