A budget should evolve as your circumstances change. Don't expect the budget you made at 25 to still work for you at 35, or even 27. Your income and expenses will change over time, often annually. You might also face a major financial setback, a major change in expenses related to buying a house or having a child, or a major change in income related to a promotion or career shift. Any time one of these events occurs, you'll want to update your budget accordingly. In this section, we'll discuss some common changes to your life and how you might want to adjust your budget as a result.
1. Getting a Raise
When you get a raise, you should consciously choose how you will spend the extra money. First, keep in mind that if you get a raise of $200 a month, it won't be nearly that much after taxes. If your marginal tax rate is 25%, an extra $200 a month will leave you with $150 after federal taxes, even less after Social Security and Medicare taxes, and still less if you also pay state income taxes. Let’s say your raise nets you $120 a month. Just like you've done with the rest of your money, decide what the best use of your new income will be. Do you want to save it, and if so, for what purpose? Saving it is a good way to avoid the lifestyle inflation that tends to accompany raises. Do you want to reward yourself by using part of your raise to improve your cable lineup? Go out to eat more? If you don't decide what you want to do with the money, it might evaporate without your knowing where it went. (Learn more in When Is the Best Time to Ask for a Raise? and How Getting a Raise Affects Your Taxes.)
2. Losing Your Job
If you lose your job, you'll almost certainly need to scale back your spending.
Examine your budget to see where you can cut back. You may be able to cut out a particular category entirely, like going out to eat, and easily save $200 a month (though you’ll have to increase your grocery budget a bit to make up for the lack of restaurant meals). Or you may be better off making smaller cuts in several categories, like decreasing your grocery bill by $20 a month. You may not be able to reduce your expenses enough to fit the reduced amount of money you have to spend, but because you've been budgeting, you should have at least some money stashed away for emergencies. This is the time to use it if you need it.
If you haven't started to budget yet and you've lost your job, then picking up a part-time, temporary or freelance job can help to cover bills as you hack and slash your spending and look for full-time work. (See Losing Your Job: From A to Z.)
What if you've been at a company so long that you receive a generous severance package that enables you to maintain the same quality of living for an extended time – say, six months’ worth of your salary and health insurance? You’d still be wise to cut back as much as possible, for several reasons. You don’t know how long it will take you to find another job. You don’t know if your new job will pay as much as your old job. You don’t know if your new job will offer better or worse benefits than your old job. You might have to go back to school to acquire the skills you need to get rehired. In a best-case scenario, you’ll get a new job quickly and can use your remaining severance to bolster your savings.
A smaller severance package or state unemployment insurance can help tide you over, but neither will provide you with the kind of income or financial stability you're probably used to. In any case, losing your job should mean revising your budget to plan for lower spending. (For more on severance, read Negotiating Severance Agreements.)
3. Having a Financial Emergency
Losing your job could certainly count as a financial emergency, but it's not the only one you might encounter. Your beloved 1998 Honda might suddenly sputter its last breath – or at least the last breath it's willing to take unless you want to pay for some costly replacement parts. If you don't have good public transportation where you live or a friend, relative or coworker who can take you to work, you'll need to find a new vehicle fast, and probably rent one in the meantime. Again, your emergency fund is a good place to look for the money for a new car. If you don't have an emergency fund, you'll have to find the money elsewhere in your budget. Even if you do have an emergency fund, you'll need to adjust your budget so you can replenish it over the upcoming months after buying your replacement vehicle. Yes, you could get an auto loan, but unless you qualify for an extremely low interest rate – say, 0% to 3% – we would advise against taking on debt to buy an asset that declines in value. (See 5 Apps to Help Build a Financial Safety Net.)
4. Making A Big Purchase
Adjusting your budget so you can afford a major purchase, like a down payment on a house, is similar to adjusting it when you lose your job or have a financial emergency. You'll need to find significant ways to cut back in one or more spending categories and perhaps a way to increase your income as well. The difference is that since you're cutting back for something you’ve chosen, it won't be as painful. It’s also often possible to plan for major purchases several months to a year or more in advance, making them easier to fit into your budget without making major lifestyle changes.
5. Incurring a Major New, Ongoing Expense
If you buy a house, have a child, send a child to college or send yourself to college, you'll need to make long-term changes to your budget. This life change may require you to rethink every aspect of your earning and spending. For example, is there a way you can make more money? Do you really need cable TV? Why on earth do you still have a land line? Do you need that $70 a month cell phone plan when you could go with a low-cost carrier for $30 per month? Can you become a one-car household for a while?
To prepare yourself for the change and make sure you can afford it, adjust your budget several months to a year in advance and pretend as if you already have the new expense. This way, if you find out you can't meet all your obligations, you won't incur any real damage and you'll have time to fix things before the real expense kicks in. (Check out 6 Cost-Effective Tips for Raising Your First Child.)
6. Overhauling Your Social Life
If you used to spend all your weekends at home and you suddenly have a new group of friends to go out with, your financial situation will likely change. Also, starting to date someone new can shift your finances for better or for worse depending on the financial habits of the person you’re seeing, what you do for dates and who pays. (Read 5 Ways to Date on a Budget.)
7. Changing Your Habits
Any time you change your habits, you will see a corresponding change in your finances – sometimes giving you more money, and sometimes less. Deciding to start eating healthier may not equate to healthier finances in the short run, for example. If you’re trading in boxed mac and cheese for fresh fish, fruits and vegetables, your grocery bill is going to increase. If you’re trading in seven nights a week’s worth of take-out meals for healthy home cooking, on the other hand, you’ll probably save money. In either case, you’ll need to adjust your budget. (See 7 Habits That Can Lead to Future Wealth and 10 Habits of Successful People.)
8. Becoming Seriously Ill or Disabled
Getting diagnosed with a major illness or experiencing a major injury is one of the worst things that can happen to your finances, especially if it means you can’t work for months or years. Few people will come out of such situations unscathed, since their medical expenses are increasing exponentially while income has dropped to zero. Still, there are a few things you can do to minimize the damage. One, you should always carry health insurance and private disability income insurance. Two, you should take full advantage of the money you might have in a health savings account or flexible spending account. Three, you can be proactive about reducing your medical bills by questioning the need for every procedure and test and getting things done in network whenever possible. Four, you can claim Social Security Disability Income if you’re eligible. (For more ideas, see 10 Ways to Prepare for a Personal Financial Crisis and 20 Ways to Save on Medical Bills.)
9. Getting Rid of a Major Expense
If you've finally finished putting all your children through college and they've all moved out and acquired jobs, not only will you no longer have tuition expenses, you'll be free of paying for someone else's food, clothing, medical bills and other costs. Paying off your mortgage is another time in your life when your expenses will significantly decrease. What will you do with all this extra money? Your budget's goals can guide you. Maybe you'd like to work less and enjoy life more, take a major vacation or ramp up your retirement savings.
As you can see, multiple factors can change your financial situation from month to month and year to year. It's important to be flexible and adjust your budget to reflect these changes so that you'll be able to continue making the best possible use of your money no matter what’s going on in your life.
In the final section of this tutorial, we’ll review what you’ve learned about how to budget.
Budgeting Basics - Conclusion
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