For many young people graduating high school or college and entering the working world for the first time, the future seems practically unlimited. "The world is my oyster," is how Shakespeare put it more than 500 years ago. Fast-forward to the rock era and Rod Stewart wrote, "Optimism is my best defense."
Whether you prefer classic literature or classic rock, the message is the same: to secure one’s future, optimism isn't enough. One must also gain an understanding of some basic financial planning concepts. And the most essential of these concepts is learning how to create and live on a budget.
Unfortunately, some young people bristle at the mere mention of the word "budget." To many, it implies rigidity and inflexibility, taking away their ability to be spontaneous in their spending and enjoy their new independence to the fullest.
In reality, budgeting provides the bedrock foundation for a solid financial future. This is true whether you are a wide-eyed Millennial just starting your first job out of high school or college, a middle-aged mom or dad trying to make sure all the bills get paid every month, or a Baby Boomer planning for a comfortable retirement. Let the free Retirement Planner by MoneyTips help you calculate when you can retire without jeopardizing your lifestyle.
Getting Started on Your First Budget
The first step in creating a budget is to make a commitment to yourself — or for you and your significant other to make this commitment together, if you are partnered — that you will take budgeting seriously. This means you have to take the time and expend the energy necessary to dig into your finances, face your personal financial reality head-on, and make some tough choices if you have to in order to make the budget work.
Start with a commitment to a basic financial planning concept — the idea that you will plan your expenses based on your income, not the other way around. Many young people — heck, many people of all ages — do the opposite, spending money without much regard for how much income they have. Our credit-based society has made this easy: If you don't have enough income to pay for everything you've bought, you can just charge the difference on a credit card, right?
This is a dangerous way to think, especially if you are young and just starting out financially. Excessive credit card debt will be like an albatross around your neck, dragging you down financially and severely limiting your financial flexibility.
Once you have decided that you are going to live on (or below) your income, it’s time to put pencil to paper and start creating your first budget. Here are three broad steps to follow:
- Add up your monthly income. Write down (or enter into a spreadsheet) the amount of your after-tax income from various sources. This starts with your salary, of course, but don’t forget to include any other income you might be bringing in. This might include commissions and bonuses, tips, child support, alimony, government payments and income from a freelance business if you operate one. Adding all of these up will tell you exactly how much money is coming in every month to meet your expenses.
- Determine your monthly expenses. On the other side of your ledger, write down all of the things that you spend money on every month. Start with essential expenses like your mortgage or rent, utilities, transportation (car payment and gas or public transportation), insurance, groceries and debt (if you have any). These are mostly non-discretionary expenses that stay pretty consistent from month to month, so they are fairly easy to put into your budget. If you want to reduce your interest payments and lower your debt, try the free Debt Optimizer by MoneyTips.
Next, write down your non-essential monthly expenses in a separate column. Basically, these are everything else on which you spend money. For many young people, this includes cell phones and cell phone bills; TVs, stereos and MP3 players; computers and tablets; clothing; and eating out and other entertainment. Some of these expenses could be considered essential; for example, you have to wear clothes, and cell phones have practically become essential in today's society. So don’t get too hung up on essential vs. non-essential — just make sure that you've identified and written down everything you spend money on each month.
- Find out if you are living within or above your means. Here's where the budgeting rubber meets the road. Subtract your expenses from your income to see whether you are spending more or less money than you make. If the number is positive, you are living within your means. You can now make decisions about how to save or invest the money that is left over at the end of the month.
If the number is negative, you need to figure out where you can cut your expenses. It is easier to look at non-essential expenses first, especially things like entertainment and eating out. If you cannot whittle enough off of your non-essential expenses, you might have to look at taking more drastic steps like moving into a less expensive home or apartment or buying a less expensive car. Hey, we didn’t say this was going to be easy!
Planning Future Spending
The budgeting process will obviously be easier if you’re currently living within, instead of above, your means. Regardless, you need to plan your future spending based on the figures revealed in your budget.
Doing so will require discipline. But learning early on how to create and live on a budget will serve you well financially for the rest of your life.