To plan for the short- and long-term, you'll need to have a rudimentary understanding of your finances. In this section, we'll give you the kick-start you need to begin your budget bootcamp.
Know Your After-Tax Monthly Income
Everyone knows his/her hourly wage or monthly salary, but not many people can tell you how much they take home after taxes. It's important to know this number because taxes significantly reduce your paycheck, especially if you have to pay state and/or local taxes.
The easiest way to find out how much you really make is to look at your last pay stub, but if you don't have one handy, you can calculate your take-home pay using an online calculator like the ones found at PaycheckCity.com. Or, if you want to understand the formula that the Internal Revenue Service (IRS) uses, check out the federal tax rate schedules.
A comprehensive understanding of taxes isn't necessary to keep a good budget, but if you're curious, here's how income tax works:
Let\'s suppose you\'re filing as a single person and your salary is $40,000 a year. According to the IRS 2007 federal tax rate schedules, your marginal tax rate is 25%. In this scenario, your first $7,825 is taxed at 10%, the next $24,025 is taxed at 15% and the remaining $8,150 is taxed at 25%. On top of these federal taxes, you\'ll also pay Social Security at a rate of 6.2% on earnings up to a certain threshold ($97,500 in 2008) and Medicare at a rate of 1.45% on all earnings, along with any state or local taxes. (For related reading, see Cut Your Tax Bill With Permanent Life Insurance.)
Ensure That Necessities Fall Within After-Tax Income
Once you know how much you really make each month, start by listing all of your necessary expenses, like rent and utilities, and making sure their total cost is less than your take-home pay. If it isn't, can you cut back somehow? Housing expenses take up the largest chunk of most people's budgets, so that's the best place to think about reducing your expenses if you're having trouble making ends meet. If you can't reduce the cost of your necessities, it's time to figure out how to get a higher-paying job, which may involve a longer-term strategy like obtaining a vocational or college degree. (To learn more about investing in your education, read Invest In Yourself With a College Education.)
If you can, consider savings as one of your necessities. This will make you more likely to save because you'll think of it as a necessary "expense" rather than an optional one. As the saying goes, "pay yourself first." This will help keep you from running up your credit when the unexpected occurs, and it can help you achieve your life goals faster.
Some Required Expenses Don't Occur Monthly
Costs like car insurance and visits to the doctor may not be monthly charges for you, but rather expenses you pay only once or twice a year. Nonetheless, you have to pay them, so don't forget to factor them into your necessities. One way to do this is to make a list of all your expenses that only occur a few times a year, add up their total cost, divide it by 12, and add the result to your required monthly savings. This will ensure that you have enough cash on hand to pay these bills when they are due.
Check Your Breathing Room
Hopefully, you still have some money left over after meeting your basic necessities. Make sure you know what this amount is so you won't exceed it. If you're not satisfied with how much fun money you have, use the ideas in the last section to increase your cash flow. Since not having as much fun money as you'd like isn't as dire of a situation as not being able to pay for food or shelter, you can consider short-term strategies to increase your income, like acquiring a temporary second job or selling some possessions you no longer use.
Some Discretionary Expenses Also Aren't Monthly Costs
Expenses like gym memberships, vacations and gifts are not actually required expenses and they may not be the same price each month. So, if you want to be able to afford them, you should again make a list of all these optional expenses that only occur a few times a year, add up their total cost, divide that sum by 12 and add the result to your optional monthly savings. This way, you won't be tempted to go into debt or have to skip out on these items.
Calculate Long-Term Costs for Necessities and Discretionary Spending
To determine whether your spending in a certain category is really worth it to you, think of it in terms of yearly rather than monthly cost. Maybe $1,700 a month for a luxury apartment seems like an acceptable price, but how about $20,400 a year? And that's after tax. If that luxury apartment is in
Now let's move on to part 5, where we'll share some tips for managing and staying within your budget.
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