By David Koch, CFP®, AIF®, CFA, Director of Portfolio Management/Senior Wealth Advisor
Budgeting is a fundamental financial skill that involves creating a plan to manage your cash flows – keeping track of how much you earn (after taxes), and how much you spend.
It shouldn’t go without noting that living within your means helps you to achieve your long-term financial goals. By creating a plan, after you pay your expenses, you can start to allocate funds towards your goals, like a large purchase in the future, funding your retirement savings, or debt repayment.
A well-crafted budget may provide peace of mind and help you sleep well at night, knowing you have control over your finances.
Expense Tracking
The first step in creating a budget is expense tracking. By recording all your expenditures you can understand where your money is going. You can use a spreadsheet in Excel or Google Sheets, or an app like Credit Karma. For an app to work, you do need to connect all your accounts. That way the app can see everything in one place and even categorize items for you like travel, food, and entertainment.
Categorizing your expenses helps identify areas where you might be overspending so you can make necessary adjustments. One reason why I use Credit Karma is to have some limited credit monitoring that the app provides as well.
Debt Management
Debt management is critical; high-interest debt, like credit card debt, can quickly spiral out of control if not managed properly. You should allocate a portion of your budget each month to pay down your debts. There are two strategies to approach this:
The first strategy is called the Debt Avalanche Method. This is where you pay down the debt with the highest interest rate first, and then the next highest rate, and so on. Be sure to continue paying the minimum required payment on all of them, but focus on paying as much as you can on the debt with the highest interest rate. This method could likely save you more in interest over time.
The second strategy is called the Debt Snowball Method. This is where you focus on those debts with the smallest balances first. If you pay those off first, then you’ll have more funds each month to pay off the larger debts.
Which one to use, the Avalanche or the Snowball, can be nuanced. If your balances are relatively equal in size, but there are big differences in interest rates, you could consider the Avalanche as a potential option. If you have significant differences in the size of debt, but not significant differences in the interest rates, consider the Snowball Method.
Emergency Fund
An emergency fund is a financial safety net that can help cover unexpected expenses, such as medical bills, car repairs – or rent if you were to lose your job. How much to keep on hand is a very personal decision. On one hand, sure, an emergency fund is important; but on the other hand, these are funds that could have been used to pay down debt or add to your retirement accounts. You don’t want to have to go further into debt when unforeseen expenses arise.
Think about your personal situation. Do you have a mortgage, six kids, four dogs, and live in a rural area where there are not many jobs? You should probably have a relatively large emergency fund that covers at least six months of living expenses, maybe 12 or more. Are you young, educated, healthy, and living with your parents in a big city? You may not need an emergency fund, instead you may need to save up to get an apartment!
Savings Goals
Whether you’re saving for a vacation, a new car, or retirement, having specific goals can help you stay focused and, most importantly, motivated. It isn’t difficult. Determine how much you need to save and by when, then break this down into manageable monthly amounts. Sometimes it makes sense to put savings for specific goals into a different account, even if it is just optics for motivating yourself to hew to these goals.
Budgeting Strategies
There are various budgeting strategies you can use to help manage your finances effectively. One popular method is the 60/30/10 , which allocates 60% of your income to needs, 30% to wants, and 10% to savings and debt repayment. Or, use 50/30/20 if you are carrying high-interest debt that you need to pay down quickly, like credit card debt. Another strategy is called Zero-Based Budgeting, where every dollar of your income is assigned a specific purpose, ensuring that your expenses match your income. Experiment with different budgeting strategies to find the one that works best for you.
Automate, Automate, Automate
Automating paying your bills can prevent you from missing a payment, which negatively impacts your credit score and avoids late fees. Set up automatic payments for recurring bills, such as rent, utilities, and insurance. Even if you only set up a payment for the minimum amount, like on a credit card bill, and then manually pay more, just this auto-pay setting can help keep your credit from getting hurt for something as trivial as, for example, a $25 minimum payment. Again, automating bills not only saves you time but also reduces the risk of damaging your credit score.
Automating your savings is equally important. By having funds in your checking account instead of going into a retirement or savings account, you’re more likely to spend them. Set up automatic transfers from your checking account to your retirement and/or savings accounts each month. Most investment accounts, like through Fidelity and Schwab, allow you to set these up. There are also a variety of apps, like Acorns, which do the same.
Good Habits Could Pay Off
They say that in order to start good habits, you need to stop bad ones. I would argue that taking the initial time to track your expenses and create a budget, and then taking the time each week – or at least each month – to monitor it is well worth the effort. If you’re like most people, you’re going to take a loan out to buy a car or a house. But try and keep credit card debt to a minimum.
You should pay down your debts at a reasonable pace. If you can afford to pay more than the minimum due, you could save a lot of money in interest charges. Lastly, automate as much as you can. While setting up automatic payments and automatic savings may require some initial time up front, but it will generally save you so much more time in the long run.
Disclosure:
Halbert Hargrove Global Advisors, LLC (“HH”) is an SEC registered investment adviser located in Long Beach, California. Registration does not imply a certain level of skill or training. Additional information about HH, including our registration status, fees, and services can be found at www.halberthargrove.com. This blog is provided for informational purposes only and should not be construed as personalized investment advice. It should not be construed as a solicitation to offer personal securities transactions or provide personalized investment advice. The information provided does not constitute any legal, tax or accounting advice. We recommend that you seek the advice of a qualified attorney and accountant. All opinions or views reflect the judgment of the author as of the publication date and are subject to change without notice. All information presented herein is considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted.
