Setting up a budget that works!

So you've done the following:

1. Monitor your income and expense for about 3-6 months
2. You have a set of goals for savings and investing
3. You are pretty good spending less than what you've earned

The next step is to set up a budget. List the major sources of income and expense for an entire year, pre-tax, tax, and post-tax. Be sure to include items that occur every quarter, 6 months, annually or bi-annually,... Then using data that you've collected in the previous 3-6 months, you can guess at how much you earn and spend on a monthly basis in several major categories.

The idea behind a budget is to group expenses together into categories so that you can monitor the flow of money through each category. I like to group my necessities into categories: mortgage/rent, utilities, groceries, car/transportation, tax, and insurance premiums.

The major problem that I've encountered is that I don't like getting hit with a big bill every 6 months, 1 year, or 2 years, for insurance premiums, maintenance fees, excise fees, and/or taxes. My solution is to create a savings account that I deposit money into on a monthly basis, because that's how I've divided up my annual budget into 12 monthly budgets. By setting my own escrow funds for paying periodic bills, I have accomplished two things: 1. my monthly budget is stable so I don't have periodic spikes, and the most best motivation of all, 2. I earn a high-yield interest by depositing it into an online savings account. Email me if you want recommendations.

Now that you have allocated money to spend in each category, be sure to reserve some extra funds to the following: 1. emergency fund (savings only to cover expenses for at least 6 months), 2. retirement fund (for savings and investing), and most important of all, 3. fun fund. The last one is an up-to-date tracking of my projected difference between incomes and expenses after I have allocated funds for both (1) and (2). Then I know how much I can spend for the rest of the month!

The reason this is important is that for many people, they can simplify this by carrying that much cash with them. But with credit cards and ATM's so readily available, we have a tendency to spend more by just swiping our cards to pay for impulse purchases. If I know how much I can spend collectively using all those payment methods, I can restrain myself if I were about to make an impulse purchase.

Furthermore, any left over from the previous month, I can save them up for trips, vacations or major purchases in a high-yield online savings account. I may go into how I subdivide that account in future posts. After all, the reason for budget is to divide up how we allocate our money so that we can achieve our financial goals.