Budgeting Basics - Goal Setting
An important part of effective budgeting is setting goals and using your budget to help you achieve them. Your goal might be as simple as saving up enough money for tickets to a basketball game or as lofty as retiring by 50. Or it might be both! Budgeting makes it easy to establish both short- and long-term goals and track your progress toward them.
The following are some ideas for how to use your budget to help you meet your goals:
Get Beyond the Next-Paycheck Mindset
When you're always thinking about the arrival of your next paycheck, that probably means you're burning up your current paycheck and spending the next one (whether by mentally accounting for where it will all go or by putting purchases on credit cards) before you even get it. If this situation describes you, it's likely that you're living beyond your means. Since no job is truly guaranteed, and thus neither is your next paycheck, making it a goal to fit your expenses into your current income is an important one. This way, even if you lose your job tomorrow, at worst you'll be starting at zero - you won't already be in a hole.
Substitute for the Short-Term
For a short-term goal, such as being able to afford tickets to a basketball game next month, you may simply be able to substitute one expenditure for another. If you normally go out to eat, maybe you can trade a meal for a game. If your budget is tighter than that, you may have to take a more drastic measure like cutting your grocery bill by eating lots of pasta- and rice-based dishes and cutting back on more expensive items like meat and cheese.
Calculate Your Long-Term Needs
For a long-term goal, such as retiring by a certain age, find an online retirement calculator that allows you to enter variables, such as your age, amount currently saved, expected rate of return on your investment and age you want to retire by to find out how much you need to save per month to reach your goal. Note that online calculators can produce varied results, so it's best to try several and get a general sense for the amount you need to save. Then, start considering this savings amount as a non-negotiable monthly "expense" and adjust your other spending as needed to make room for the new amount. (For more, see Unexpected Bumps That Can Derail Retirement.)
Start a Rainy Day Fund
To make sure that unforeseen expenses don't cause your goals to careen off track, build up some cash reserves. Three to six months' worth of expenses is a good cushion. This will help protect you from a sudden loss of income, an unexpected car repair bill or the like. (Have a better budget now, read Six Months To A Better Budget and Build Yourself An Emergency Fund.)
Save for Fun Things, Too
If all your savings are going toward dreary activities like paying off debt and saving for unexpected car repairs and medical bills, your only incentive to save might be the fear of what will happen if you don't. Fear is a great motivator, but it's not very fun. So even if you're in debt up to your eyeballs and are committed to getting out as quickly as possible, it's a good idea to plan some rewards into your savings program. You may think that a $750 vacation is setting you back, but consider what would happen if you didn't take that vacation. You might go on a spending binge one day to compensate for how deprived you've been feeling under an avalanche of bills, and not only might it cost more than the vacation would have, but you won't get the several days of relaxation that a vacation could have brought. (For related reading, see Enjoy Life Now and Still Save For Later.)
Pay Off High-Interest Debt
Any debt that costs more than you can earn from your investments after taxes should be paid off as quickly as possible. As a general rule, the only low-interest debt is student loans and mortgage debt. This is considered "good debt" since your money can earn more for you if you invest it than what you'd save by paying off the loan. If your mortgage interest rate is 6%, your credit card rate is 20% and your investment return rate is 10%, pay off your credit card first, then invest anything remaining.
Use automatic withdrawals to stick to your savings goals. By having money automatically deducted from your paycheck and invested in your company's 401(k) or 403(b) plan, or by setting up your own automatic monthly transfer from checking to savings, your money will be out of sight and out of mind. For long-term savings, put the money somewhere illiquid, like a 401(k), so you won't be tempted to steal from your future self.
For short-term savings, you'll need to keep the money accessible, but don't make it too accessible. For example, if your checking and savings accounts are at the same bank, it's all too easy to rapidly transfer money from your savings into your checking account. If you have these accounts at two different institutions, the transfer will take time, and that time delay may be enough to cause you to rethink your decision if you're trying to spend your savings on something you shouldn't.
Reduce Spending in a Particular Category
Remember how we said that budgeting isn't about deprivation, it's about putting your money to its highest and best purpose? One of your new budgeting goals might be to reduce your spending in a particular category, now that you know where your money is going, so you can put that money toward something that is a higher priority for you.
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