Finances 101 – Part 3: A Balanced Budget

Create Balance

Everything you have been doing up to this point has been in support of balancing your budget so that your income exceeds your necessary expenses each month. Although this would seem to be an obvious thing to do, it’s still worth reviewing ways to accomplish this. And, once you have achieved a balanced budget, you can choose what step(s) to take next.

But, why?

The answer can be summed up in two words: The Future. Balancing your budget today creates the framework to improve your financial situation. This allows you to create positive momentum for your finances. Once you have momentum, you can plan for things that will occur in the future. This could be buying a car, buying a house, getting married, a vacation, and retirement. And, let’s be honest – retirement is a time where you have expenses and virtually NO income (or at least no control over your income as it will be fixed). If you aren’t thinking about how to finance your retirement right now, how do you know when you can actually retire?

“Trim the fat!”

How many times have we heard (or said!) this phrase or one very similar? The basic idea is to find unnecessary expenses and eliminate them. It’s a simple task on the surface but can feel very difficult to actually execute on. This article will guide you through identifying expenses that you don’t need and planning to remove them.

Want vs. Need

In the previous article in this series, I outlined a process you can use to create your budget. Once you have gone through the process of identifying what you are spending money on, you have to go back and label every single items as either “Want” or “Need”. Rent and Mortgage are examples of items that will get labeled “Need”. Taking the family to the movies is always a “Want” item.

It is imperative that every item be labeled correctly in order to move to the next step in the process. And, since everyone’s actual needs can be different, there is no “master list” of expense labels that works for everyone. You must do this on your own, and you have to be 100% honest with yourself when you decide what labels gets attached to each expense. Anything less, and you might as well stop reading now and not bother doing anything more to improve your financial health.

Categories vs. Specifics

In addition to needing to properly label all expenses, you must also be certain to identify these expenses at the proper level of detail to avoid mis-categorizing at least some of them. For example, you may be tempted to use an expense called “Rent” and not bother to evaluate whether or not you are renting the proper place. Is there a less expensive area of town that you could rent in without decreasing your square footage? Are you renting the proper sized apartment or are you renting too much space? Does your rent include some/all utilities or are those your responsibility outside of the rent payment?

As you drill down into various categories, you will be able to identify how individual expenses should be labeled. One way to approach the labeling of expenses is to assume that everything is a “Need”. Then review and identify those expenses that should actually be labeled as “Want” instead. It’s necessary to have everything properly labeled before moving to the next step in the process.

Evaluate Needs Against Income

Does your monthly income at least meet your bare minimum needs? Once every expense is labeled, add up all of the items that are labeled as “Need” to get a total. Add up all of your regular, monthly income. Compare the two totals. If your income does not exceed your required monthly expenses, you have some hard decisions to make. And, you likely have to make them quickly. You need to find a way to increase your income, reduce your monthly required spending, or both.

If you are not working, consider getting a job. If you are working but not full time, consider looking for a job that offers you full time hours. You could also consider looking for a better paying job, one that’s closer to home, or even getting a second job. These are all possible ways to increase your income.

On the other side of the equation, reducing expenses is a worthwhile effort whether they exceed your income or not. Since most of your required expenses are likely to be large compared to your income, make sure you evaluate the total cost of making a change along with the savings gained. For example, don’t move if you’re going to save $25/month. The cost of moving could easily make it difficult to recoup that money in less than two years time. Don’t trade in your car for one that “gets better MPG” until you understand how much it actually costs to operate the current one AND the new one (newer cars cost more for insurance, for example).

More Balance

After maximizing income and minimizing necessary expenses, One of the most important things to do after getting your finances balanced is deciding how much of your free cash to spend on unnecessary expenses versus necessary ones. One of the absolute worst things that you can do is remain in a fully locked-down mode once your budget has been made and everything in balanced. It’s demoralizing as it makes you feel as though your efforts produce no rewards.

It is completely ok to allow yourself some occasional, small rewards during this journey. Buy yourself that coffee and bagel again, but maybe only do it twice per month and maybe on a weekend – make it feel like a reward because it is.

Don’t forget that you still have to work to do and that means continuing to be diligent with controlling your spending. Re-invest your disposable income back into yourself to reduce debts further and create a larger gap between your income and necessary expenses as you move forward.

Summing It Up

Put in the work to balance your budget so that your income exceeds your necessary expenses. Determine how much of your disposable income you will “dispose of” versus re-invest in yourself. Continue to re-evaluate your circumstances and plan to go forward, and make changes as needed.

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