Personal Budget

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A Personal Budget is a plan to manage money effectively by keeping track of income changes and monitoring expenses.

Everyone has to balance spending between housing, health care, car, recreation and many other things. A budget is a useful tool to balance these needs and avoid getting into debt.

article titlebold textitalic text'italic text==Setting up a Personal Budget== Goal setting is the first step to creating a budget.^[1] Having a long term vision defines the kind of savings plan that someone might have, and hence the savings per month. The most common goals set are buying a house, or a car or becoming a millionaire by a certain age. Others also include retirement planning and savings for college education for their children. A goal defines the amount of savings, hence defining the nature of the budget.

Assessment

In order to assess a budget, main points of consideration are assets, liabilities, sources of income and expenses. Assets could be a car, a house or money in the bank. Liabilities could include debt, loan obligations, rent payment or mortgage. The later two form the basis of any personal budget as advised by most financial planners. That helps in understanding how to interpret a budget and derive use from it.

Creating the budget

Things to consider while structuring the budget^[2]:

• A Timeline is essential in defining whether the budget is short term or long term. The most common one is a monthly budget, since most bills are monthly in nature. However, there are daily, weekly and yearly budgets as well. Another practice is to forecast monthly budgets and compare them to the actual budget when it matures. Excluding unforeseen circumstance, this comparison allows for preparation in order to pre-empt further cash outflow.

• Cash flow
  • Income includes anything that could increase net cash flow in favor of the subject.

The graph shows us the sources of household income in the United States in 2007 ^[3]

• Primary source of income includes wages from an individual's main job. The average income in the United States in 2007 was $85,803^[3]. The primary wage constituted 81.9% of it^[3].
• Income through interest is the money made through the interest rate provided by banks where cash can be deposited. This is generally significant for High Net Worth Individuals (HNIs) who have a significant sum of money in their bank accounts. In 2007, income through interest and self employment came to 6% of the total wages for families in the United States^[3].
• Investment Income: is inclusive of capital gains from sale of investment products, dividends and income from interest through coupon payments. This income on an average came to 2.5% of the total income for any family in the US^[3].
• Miscellaneous sources of income are generally income through rent, food stamps, selling a house, supplemental security income, unemployment, veterans benefits and worker's compensation. Other income including social security constituted close to 10% of the total income for a family in the United States^[3].
• Income Taxes:: This could include federal tax, state and local and Social Security in the United States.
  

The graph shows us the average breakdown of household expenses in the United States in 2007 ^[3]

• Expenses: encompass everything which could possibly result in outflow of cash.
  • Home expenses made up 32.6% of total expenditures for families in the US in 2007^[3]. These generally include mortgage payments, rented or other property, property insurance and tax and home repairs or improvements.
  • Automobile Expenses refer to the money spent on purchase, upkeep and regular repairs for automobile(s) owned by the individual or the family. This would include automobile insurance and gas expenditure as well. Total automobile expenses in the United Stated for 2007 was 18.1% of the total household expenditure^[3].
  • Utilities and Food budgeting involves payments for telephones, electricity, gas, sewer and water on a monthly basis. Grocery shopping on regular basis and eating out comprise expense on a daily basis and are categorized under this umbrella. In 2007, the total of expenses, that people spent on food and utilities was 20.3% on an average in the US^[3].
  • Health and Medication: includes insurance payments for medical or dental expenses. Unforeseen emergency medical expenses would come under this bracket as well. People who pay for gym membership or any other activity which involves health benefits, classify it as a health expense. The Bureau of Labor Statistics in the United States estimated in 2007, that health care expense for a family was approximately 6%^[3].
  • Family expenses cover obligations such as alimony or child support. It could also include education expenses, day care or any money spent on children.
  • Recreation and Shopping includes money spent on clothing, shoes, toiletries and items of daily use. Recreation covers cable, wireless, movie rentals, money spent on socializing and vacations. An average US household spends approximately 11% of their total expenses on recreation and shopping^[3].
  • Miscellaneous section covers any other expense that might not have been or could not be classified. Debts, student loans, gifts or donations would be categorized here.
• Savings: would be the net of income minus the expenses. Average annual expenditure in the US comes close to about $64,104^[3]. Savings define any budget plan, it's structure and how much one can spend given fixed sources of income. It also defines the nature of a budget. Aggressive budgets are generally high on savings while budgets focusing on retirement funds go easy initially.

A Budget Table

Here's a good example of what a budget should look like:

Allocation guidelines

• The 60% solution: Following every expense is hard and most of the times, one of the main reasons why people stop following their budget. Richard Jenkins^[4] suggested that allocating approximately 60% of your income to fixed expenses allows enough savings. Fixed expenses include things like tax, Social Security, phone bills, utilities, etc. The rest of the money is divided up into 401(k), savings, recreational and contingency expenses.
• Set up an emergency or a contingency fund, in order to provide for various foreseen and unforeseen circumstances.
• Allocation for housing: 25% of the total income is generally the recommended amount set aside for housing expenses and mortgage payments. This round figure can rise or fall, depending on the location. In states like California and Florida, it could go up to 30%.

Events that affect financial planning

• Getting married amalgamates two financial plans into one, both spouses have to plan in consideration of the other individual as well. Every aspect of budgeting is revised post-marriage. Life, Health, Casualty and Automobile insurance is revised and accounts are shared as well. If there are children involved, a college savings account is set up as well.
• Similarly, death of a spouse involves major changes in insurance coverages and re-distribution of the assets. If the spouse was the main income source for the family, the budget and expenses need to be cut down dramatically to accommodate for this event. Social Security checks account for "survivor benefits" that provide monthly payments for the person left behind. Designated beneficiaries take over the 401K plan if the main beneficiary passes away.
• Retirement is generally at the age of 59 1/2 years, changing a few aspects in the budget. Primarily, the 401K plan matures and becomes the main source of income and possible increases in health care expenses are some of the things that need to be taken care of.
• A birth of a child is a time to review all insurance coverages and plan for further expenses. The budget needs to accommodate for another person, especially since, income will not increase. Health care insurance might not cover pregancy and maternity care. Moreover, serious consideration needs to be given to disability insurance, so that it covers substantial amount of expenses in case the earning spouse has a mishap. Having a child also begets the question of their education and making adequate provisions.
• Losing a job or disability reduces significantly or eradicates the main source of income. Disability Insurance covers for medical expenses and provides replacement income, this depends on the premium being paid. Losing a job, especially the main source of income entails major expense cuts in the budget in order to save money, although people are eligible unemployment benefits such as a regular stipend.
• Medical Expense for a unforeseen situation, especially if uninsured, strain many budgets. Setting up a contingency fund to pre-empt such major expenses are the best to mitigate the possibility of busting a budget.

Tools to setting up personal budgets

• Manually making the budget- the paper and pencil method.
• Spreadsheets - Microsoft Excel and Apple Numbers application have various templates that assist in budgeting.

Most financial sites provide free tools and tutorials to kickstart personal budgets. Some of the popular ones on the internet provide vertically integrated plans for people to understand various aspects of personal finance, evaluate savings and debt and set up a plan.

• Google's Personal Finance directory^[5] aggregates all useful links from the web onto its directory page which filters the most popular PF pages in order of their pagerank.
• MSN Money and Microsoft Money Managing software^[6] was one of the original sites to bring Personal finance to the internet and provide various free solutions and information for users. They provide premium accounts which have added functionality for budgeting for users.
• Mint.com^[7] and Yodlee^[8] are account aggregating tools, to keep track of savings and expenses. They map out historical expenses to provide a trend analysis of expenses for individuals.
• Piggy Banks ^[9] is software that, in addition of aggregating accounts, also walk you through setting up your personal budget and sticking to it.
• wikiHow contains good instructions on how to budget, working budgets, and saving money^[10][11][12]
• AOL Walletpop website^[13] provides various budget calculating tools that assist in decision making and setting up budgets.
• About.com^[14] provides a vertically integrated knowledge base for financial planning and budgeting.
• Kiplingers^[15] is another site that provides calculators for expenditure, finding the right mutual funds or finding the right stock. They also have a how to invest section detailing how to pick up the right stocks, funds or other investment products for people who want to start investing.

Balancing your Budget

The term "balancing a budget" is used by federal and state governments meaning that spending cannot exceed the revenue that has been collected^[16]. That implies old debts need to be paid off, without taking on more debt. A balanced budget is important because, by spending more money than that is available, individuals can go bankrupt. Thus, it is important to constantly monitor debt and expenses in order to stay out of debt.

Monitoring budget balance

There are several ways to monitor and balance money:

• Keeping a log book or a daily diary to monitor expenses
• Direct Deposits for transactions especially for income. Direct transfers from accounts can be done through ACH transfer which many established banks allow. However, it is harder to monitor these transactions, they only come up in bank statements on a monthly basis.
• It is much easier to check bank accounts online. Mint and Yodlee allow you to check all your accounts in one place, making it very convenient.
• When paying your bills, log in dates and the amounts spent. The dates assist in identifying transactions over time and understanding expenses better.
• Monitor debit and credit card expenses. It is very easy to whip out a card, spend some money and forget that you did so.

Good Practices

Apart from the monitoring techniques suggested, there are some good practices recommended by financial advisers^[16].

• Subtract expenses immediately from balance in your accounts, this way its easier to understand how much money you still have in your account.
• Prioritize fixed expenses and bills before other expenditure. This could include recreation, clothing, traveling, etc. In other words, make a list of necessary versus unnecessary expenditures and then reduce the unnecessary ones. ^[17]
• Figure out financial health and live within your means. This does not mean tracking every dime, but being honest about how much one can spend and sticking to that goal.

Importance and Pitfalls of Budgeting

How is Budgeting useful?

• Every consumer tries to maximize utility from the quantity of various commodities that they derive value from, given their fixed income. A personal budget is a great way to achieve that goal based on his budget constraint.
• Used properly, a budget can identify the amount of money that one would require at a certain point of time in the future and help one achieve and set goals.
• Good budgeting helps understand expenses and know where the money goes. Budgeting is a great way to realize possible avenues of minimizing expenditure. It provides room for contingencies and room for unforeseen circumstances.
• Budgeting helps set discretionary income apart. Nowadays, many personal budgeting tools online come with ways to use discretionary income to invest in various stocks, options, bonds, commodities and currencies offered by brokerage firms. This is a source of auxiliary income to supplement their wages in order to be able to spend more.

What are the pitfalls of budgeting

Personal Budgeting can make someone with limited or no prior budgeting experience feel 'squeezed,' especially if their partner is a more committed budgeter. Thus, some people may be wary when it comes to setting up a budget for their households. Major points to talk about with your partner (or a trusted friend if you are having trouble with your own budget discipine):

• A budget needs to be flexible so that any unforeseen changes can be accommodated in the plan. For a first-time budgeter, one suggestion may be to calculate general monthly needs, then add an additional 30-50% to that as a 'cushion' until you have a better grasp on your spending habits. This cushion can help make up for the items you may not think of when budgeting (such as car repairs & gifts), which are generally necessary expenses but may have unexpected timing. The absence of such a cushion may result in you "busting the budget," ^[18] which will likely strain both your funds and the relationships which depend on them.
• A budget needs to be simple. Trying to evaluate every single detail can complicate many issues, possibly making a budget untenable. The right balance with detail and simplicity needs to be achieved.
• A budget must be adapted to your specific cash flow circumstances. I have a friend who lives on her credit card between her large sales commission checks. She may technically spend less than she makes on an annual basis, but she carries a very high average credit card balance which may affect her credit, and with which she may be stuck if she loses her job. Further, the very high interest payments on her credit card balance must be taken into account as an additional expense. Also, she may have greater difficulty disciplining her spending since adding a few more dollars on the card can be much easier than pushing down against the amount of cash in her account. A general recommendation for such highly variable cash flows is to keep an even larger cash cushion than otherwise. Families with sporadic income sources run out of cash primarily because they do not have a fixed cash inflow. This could happen, even though they take their average cash inflow into consideration while budgeting.

References

1. ↑ How to develop a financial goal
2. ↑ About.com Basic Budget Worksheet
3. ↑ ^{3.00 3.01 3.02 3.03 3.04 3.05 3.06 3.07 3.08 3.09 3.10 3.11 3.12} Average US consumption Statistics
4. ↑ Richard Jenkin's simple way to save money
5. ↑ Google Directory ->Home->Personal Finance
6. ↑ MSN Money Central
7. ↑ About Mint
8. ↑ Yodlee Company Overview
9. ↑ Piggy Banks
10. ↑ How to budget
11. ↑ How to save money
12. ↑ How to create a working budget
13. ↑ AOL Wallet Pop Budget Calculators
14. ↑ All about family budgets
15. ↑ Kiplinger Budget making tool
16. ↑ ^{16.0 16.1} Money Matters 101
17. ↑ [1]
18. ↑ Financial Planning