Top 5 Budgeting Questions Answered


Budgeting has negative connotations, but it can do wonders for your overall financial picture and it takes very little effort to create and maintain a budget. Think of a budget as simply a tool for organizing cash flows. You are, in essence, a CEO on a smaller scale who is taking steps to ensure your company's (or family's) cash flow is monitored each month. In this article, we'll cover five of the most commonly asked questions with regards to budgeting, and show you how it really is possible to save money, pay off debt and still enjoy life.

1. How much should I set aside for investments?

When deciding how much you should put aside to save or invest, there are many factors to consider, including your age, disposable income and liquidity needs. Your age will help determine not only your asset allocation (younger investors should have higher equity allocations than older ones) but also how much money should be put toward future goals like buying a home or retirement.

Disposable income is independent of all your costs that need to be paid out in order to survive. You can spend it on toys or stash it away in savings. The amount of disposable income you have will determine how much fun you can have now, and how much fun you can plan for later in life. Liquidity means how fast you can convert your assets to cash. Your level of liquidity will generally determine what kind of interest rates you will receive or how fast you will be able to access your own money.

While there is no magic dollar amount that defines how much should be saved or invested, 10% of your net income is a desirable target (but starting at 5% is still admirable). It is essential that any money set aside for investing should be free and clear of any monthly or annual expenses. It should also only be considered if you have a "cushion account" of emergency funds that can be accessed quickly, such as in a savings account or Treasury bill


2. How much should I allocate to debts like credit cards or car loans?

Some of our debt, such as car financing, comes with specific repayment schedules, but rolling debt instruments like credit cards can generally be paid off according to one's personal ability to pay. The ruling maxim here is this - don't allocate money to taxable investment accounts if you have existing credit card balances.

Some fixed-period loans will allow for overpayment, while others will not. You should evaluate the interest rate being paid to determine if paying a fixed debt off early is the right path. If you have existing credit card debt, chances are that this is costing you more in interest than an auto loan for example.

Some fixed-period loans will allow for overpayment, while others will not. You should evaluate the interest rate being paid to determine if paying a fixed debt off early is the right path. If you have existing credit card debt, chances are that this is costing you more in interest than an auto loan for example.

3. Should I overpay on my mortgage (if allowed)?

Your mortgage is often the cheapest source of debt you have (assuming that it is a conventional mortgage and not subprime), but it could still make sense to overpay on your monthly payments. First and foremost, all of the higher interest debt that can be settled should be done so first, before considering this option. Any money that is considered for overpayment should be money that would otherwise go into a savings or an investment account, meaning that all other budget categories are fully funded for the time being.

While it is possible to earn more on an investment than would be saved in mortgage interest, it does expose you to the increased risk of market fluctuations. Many people would rather pay a couple of hundred extra dollars per month towards their (typically) largest source of debt than subject a small investment account to possible losses in the markets. The more favorable your interest rate is on your mortgage, the more the scales tip in the favor of keeping the extra money to invest instead. (To read more about paying off your mortgage early, see Be Mortgage-Free Faster)

4. How should I maintain and update my budget?

In the first few months, it's essential to review account statements regularly and see exactly how much was spent on various expenses. These aggregate figures should be compared to the amount set up in your budget and any adjustments should be made to reflect the reality of your life. This is the best and easiest way for your budget to remain relevant in your financial life.

Inevitably you will come across "one time" expenses that you may wish to add up over the course of a year rather than per month. It would be better to add up all of these sporadic expenses to arrive at an annual figure for "home maintenance" or similar category in your budget. Remember, however, if you find that you've budgeted too harshly and have left little room for fun, you will not stick to this budget. If you find that you are covering bills, decreasing debt, filling your emergency fund and savings accounts, but just can't stand missing out on the latest movies or parties with friends, then you should re-evaluate your budget to reflect your new goals.

5. Why do I always seem to have expenses or wants that don't fit into my budget?

One reason why some people stop using a budget is because there are many expenses that don't seem to have a place in it. This is partly to be expected, and is easy to fix. Any good budget will have a "miscellaneous" category for all disparate expenses that come up in a given month or year.
Sometimes the answer is a simple as re-evaluating your original budget for any missing categories or places where you might have underestimated how much should be budgeted. Otherwise you'll always find yourself with expenses that don't have a home in your budget, and this could discourage you from sticking with the process. Over time you'll find that your budget more closely reflects your spending patterns, so long as you are honest with yourself about where the money goes. (See also: Six Months To A Better Budget and Get Your Budget In Fighting Shape.)

Bottom Line

Good budgeting may seem like a humbling or constricting endeavor, but it can actually be very freeing if approached with an open mind and with future goals in place. After all, the goal of any budget should be to maximize what can safely be spent on the things we want and need, while at the same time planning for a solid financial future. Following a good budget can lower debt, increase funding for investment accounts and reduce the overall stress that comes from not knowing how much money is needed from month to month.

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