Step one to smart personal finance is making sure you’re spending your income wisely. But that can be difficult if you don’t have a good grasp on where your money is going.
The solution is setting up a budgeting system that tracks your income and expenses and helps you identify your financial priorities.
For many people, the idea of paying attention to every dollar can be daunting — but it doesn’t have to be, says financial advisor Kathryn Hauer.
We asked her to offer tips on taking the first steps toward building a budget and to discuss the positive snowball effects that can result.
What’s the first step you should take if you don’t have a budget?
Sometimes people put off making a budget because it seems so complicated. It doesn’t have to be. Creating a budget can be a simple back-of-the-envelope estimate in which you count up how much money comes in each month and how much goes out. Just getting an idea of where you are is a great start. It doesn’t have to be exact.
Take a look at your income after taxes and any automatic deductions like insurance or retirement savings plans. Then list your monthly expenses, and estimate how much you’re spending on other things, like shopping and entertainment.
From that you’ll have a general sense of what you’re spending and about how much extra is left over — or how much you’re short. Once you start keeping casual track of your cash flow, you’ll be encouraged to make changes that will improve your financial situation.
A fancy, perfect budget isn’t necessary or reasonable for most of us who can barely pull our records together once a year for doing taxes, much less write down in specific detail everything we spend money on 365 days a year.
Simple awareness goes a long way.
How can a budget help your personal finances?
A budget gets you to plan what you’re going to spend and keep track of what you actually do spend. Its collateral function is to wake you up to the fact that you may be spending too much, often on frivolous things — like Starbucks and shoes, in my case.
Being aware of your spending is crucial to reducing your spending. Many of your expenses, like rent or a mortgage, are nonnegotiable, but you can rein in others if you’re paying attention. Even informal budgeting will help make your financial life better.
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What kinds of accounts should you use?
It works best to use a checking account to pay your monthly bills and a savings account to hold your emergency fund and other savings. That savings account can function as protection if you accidentally overdraw your account, but it’s separate from your checking account so that you don’t use it for things you haven’t budgeted for. As the balance in your savings account grows, you can consider moving some of the money to an investment or retirement account.