It’s time to make your current personal budget. If you followed my instructions listed here, you have saved all the receipts and proofs of payment for every expense that you incurred during the month. Overall, you will need the following to complete this exercise:
- A month’s worth of receipts for everything you have purchased and paid
- Your monthly income, payroll deductions, and 401(k) plan contributions
- Notepad and pencil
- A calculator
- A printer to print the instructions to make the budget, and later on to print your budget and view it
- A tasty beverage, as this may take some time and well, you might as well have something nice to drink, in my opinion. Of course, it is optional
- Less optional is … time. You will need about an hour to finish this and read the additional notes that will help your personal budget overall
- Finally, if you are one of those people incapable of opening a worksheet without starting to figure out the ins and outs of it, how its formulas work, you will need a ruler. To smack yourself on the hand every time you feel like not sticking to the plan and tampering with the worksheet...
If you have all of those handy, let’s get started.
First, please access these two files. One is the actual budget worksheet, which you should download onto your computer’s desktop, or some other place easy to find, and the Instructions for the exercise, which you may save, or print directly. Please read the instructions before starting.
As it says on the worksheet’s very first line, you will only be filling out information in those fields highlighted in blue. Among them, there will be fields that you will not need to fill as they will not apply to you. I have entered many possible kinds of income and expenses. There may, however, be no place for a specific expense that you have. The instructions explain what to do if that is the case.
Note that this is a personal budget that is adjustable to work for a household. If you are
Next, we are going to go on the premise that you are going to spend the next half hour filling out the fields on the worksheet, double-checking it, and then saving and printing.
Now you have your budget in front of you. Let’s take a look at the second page, the one with the chart.
The overall picture
The first report shows you your Income and Expenses. This is a basic breakdown of your money. What you make, where it goes, and how much is left at the end of the month. This last figure, listed as Amount remaining to save or invest, is what is left at the end of the
Ideally, Amount remaining to save or invest should represent above 5% of your income. Above 20% means that you have a very good control on your finances. Either way, you should, at the end of this month, divide this amount into various savings accounts (I will touch on this later), and clear it off your checking account so that you do not include it as part of next month’s income.
Some expenses
The next mini-report is titled Breakdown by category, and as its name indicates, it breaks your expenses into major significant categories that are worthy of individual consideration: what you spend on food, housing, utilities, fun, medical, and even staying healthy.
According to the latest (2013) US Bureau of Labor Statistics Consumer Expenditure Survey on household expenses, here are averages for various expenses; they will help you figure out if you are doing better, equal, or worse, than your average American:
Percentages of net income spent on:
- Housing: 33.8%
- Food: 13%
- Utilities: 7.5%
- Entertainment: 5.2%
- Health (medical plus fitness): 6.7%
Also, I understand that you may not live in the United States. If that is the case, look online for similar statistics in your country, every government compiles these statistics and reports on them.
Debt and debt ratio
Next on our small report we have two different debt breakdowns that are key figures:
- Secured debt: how much of your debt is going to pay your secured loans) mortgage and real estate loans, plus car loans).
- Unsecured debt: personal loans, and credit cards.
You see, the same way that you always hear that you should be setting 10% of your take home salary to savings, there is a percentage of your income that has an allowed maximum: how much goes to paying debt. This is known as the debt-to-(gross) income ratio.
What is interesting in this figure is that it does not show how much money you owe overall. Rather, it shows what you are paying on your debts each month. Certain amounts are healthy and acceptable. Higher percentages may cause concern. Extremely high ratios indicate that you need financial counseling and severe debt management measures.
So let’s talk about these two ratios.
I understand that not everyone owns their home. However, most of us fall into the categories
Note that, as listed above, and according to the US Bureau of Labor Statistics, the average household spends 33.8% of their income on housing. That is their housing debt-to-income ratio. Is your ratio higher or lower than that? Keep that in mind when looking at the next ratio…
The total debt to income ratio includes all your debts: credit card, housing, car loan, and all other loans, and it’s the most important figure of your budget.
Why you should care
The reason why your complete debt-to-income ratio is so important is that it indicates what else you can afford. If your ratio is high, it means that you are spending a lot on housing and loans, and that you may be nearing a saturation point after which you could not make ends meet. A low ratio means that you have little to no debt and are likely making it comfortably to the end of the month.
This ratio is so important, that is it one of the five factors that comprise your FICO score. Do you remember this score? I mentioned it already in an article a couple of months back, about credit reports. It evaluates your credit worthiness in one sweep, in a number from 150 to 950.
Furthermore, if you rent and are looking to buy a home, the loan officers appraising your application will calculate your debt ratios including their proposed payment on your future mortgage, to see where you would stand; it helps them determine how much loan you could afford, or if you could afford a loan at all.
The acceptable debt ratios, for most lenders are: a maximum of 33% for the housing one, and a maximum overall, including real estate loans, of 48%.
Knowing this, how do you feel about your own ratios? Are they comfortably lower, close to limit, over the limit? This will help you get a very good idea of how you are managing your finances.
Finally, there is one more ratio I have not mentioned before, but have listed as the last on
the report, your Non-housing debt to net income ratio. It shows how much of your take-home pay goes to paying the minimum payments on outstanding debts, your credit cards and loans. You should never allow this figure to rise above 20%, as that would indicate that you would almost be living beyond your means already.
Back to your end of month balance… Start saving
I want to go back to your end of the month balance, what it means and what to do with it.
If this amount is under 5% of your budget, you are making ends meet but have little room for error.
If it’s over 5%, you are doing well. Remember, the sheet included a small field for Other savings accounts. If you are directing money monthly to those extra savings, the following information on savings may not apply to you.
While you may have investments, 401(k) or similar plans, or buy bonds, I believe firmly that everyone should have two additional savings accounts. I know that you usually hear about one account, but I believe in the old adage, divide and conquer. These two accounts will take in the infamous” 10% always to savings” that I we have all heard about:
Start paying to save more
If you have over 10% left every month, it also means that your account balance grows a little
more at the end of each month. If this is the case, examine your credit card and loan debt, and find accounts where you can pay extra, starting with the ones with higher interest rates. Whatever debt you pay off ahead of time is money saved from interest. Put that extra money to work for you, instead of leaving it on your account.
Finally, I am going to make one last suggestion, because there is one product at the credit union that oftentimes goes unnoticed, and it is to me one of the niftiest. I am referring to the Holiday Account.
When I worked at the credit union, I used to have an automatic monthly transfer of $60 to my holiday savings account. Then, the week before Thanksgiving, every year, poof, $720 dollars (plus a few dollars of interest) materialized on my regular share account for me to start my holiday shopping. I absolutely loved that feeling. Then, the next month, the new transfers would start for my shopping the following year. I loved this. If you have never tried this account and have trouble buying presents for everyone in December, I strongly recommend that you try it. It is painless and extremely rewarding.
The reason why your complete debt-to-income ratio is so important is that it indicates what else you can afford. If your ratio is high, it means that you are spending a lot on housing and loans, and that you may be nearing a saturation point after which you could not make ends meet. A low ratio means that you have little to no debt and are likely making it comfortably to the end of the month.
This ratio is so important, that is it one of the five factors that comprise your FICO score. Do you remember this score? I mentioned it already in an article a couple of months back, about credit reports. It evaluates your credit worthiness in one sweep, in a number from 150 to 950.
Furthermore, if you rent and are looking to buy a home, the loan officers appraising your application will calculate your debt ratios including their proposed payment on your future mortgage, to see where you would stand; it helps them determine how much loan you could afford, or if you could afford a loan at all.
The acceptable debt ratios, for most lenders are: a maximum of 33% for the housing one, and a maximum overall, including real estate loans, of 48%.
Knowing this, how do you feel about your own ratios? Are they comfortably lower, close to limit, over the limit? This will help you get a very good idea of how you are managing your finances.
Finally, there is one more ratio I have not mentioned before, but have listed as the last on
Back to your end of month balance… Start saving
I want to go back to your end of the month balance, what it means and what to do with it.
If this amount is under 5% of your budget, you are making ends meet but have little room for error.
If it’s over 5%, you are doing well. Remember, the sheet included a small field for Other savings accounts. If you are directing money monthly to those extra savings, the following information on savings may not apply to you.
While you may have investments, 401(k) or similar plans, or buy bonds, I believe firmly that everyone should have two additional savings accounts. I know that you usually hear about one account, but I believe in the old adage, divide and conquer. These two accounts will take in the infamous” 10% always to savings” that I we have all heard about:
- One account is intended for the future, for large expenses that you plan on having in life: buying a home, education, retirement, a dream vacation, wedding, whatever. This is the money that you simply do not plan on touching unless you have a very good reason to do so. This savings have not set goal, but to grow steadily and you will be dipping into them now and then to purchase big ticket items in your life.
- And then there is what Americans like to call their rainy day savings. The money saved for emergencies: a broken television, a broken tooth for that matter, an emergency trip, whatever. Emergencies, you don’t really need me to tell you what they are, I am sure you have lived one at some point. It feels good to feel that you have money set aside to help with those contingencies in life. They cannot be avoided, but this money helps you cope with them. I believe that you should give yourself a set amount, and save towards that goal, and when you reach it, leave it there for whenever it’s needed.
Start paying to save more
If you have over 10% left every month, it also means that your account balance grows a little
Finally, I am going to make one last suggestion, because there is one product at the credit union that oftentimes goes unnoticed, and it is to me one of the niftiest. I am referring to the Holiday Account.
When I worked at the credit union, I used to have an automatic monthly transfer of $60 to my holiday savings account. Then, the week before Thanksgiving, every year, poof, $720 dollars (plus a few dollars of interest) materialized on my regular share account for me to start my holiday shopping. I absolutely loved that feeling. Then, the next month, the new transfers would start for my shopping the following year. I loved this. If you have never tried this account and have trouble buying presents for everyone in December, I strongly recommend that you try it. It is painless and extremely rewarding.
Conclusions
I hope that this article and exercise were of help to you. I remember that my first budget exercise was a huge eye-opener inasmuch that it led me to straighten up own finances.
I understand that every person is different, as are each person’s financial circumstances. However well or not well you may be doing, knowing where you stand, exactly, will always help you see if there is some area in which you might want to make some changes. If you are doing great overall, then this was a nice pat on the shoulder for you!
As I mentioned before, if you have any comments or questions, you can always use the comment section below, or email me at blog@oasfcu.org.
I hope that this article and exercise were of help to you. I remember that my first budget exercise was a huge eye-opener inasmuch that it led me to straighten up own finances.
I understand that every person is different, as are each person’s financial circumstances. However well or not well you may be doing, knowing where you stand, exactly, will always help you see if there is some area in which you might want to make some changes. If you are doing great overall, then this was a nice pat on the shoulder for you!
As I mentioned before, if you have any comments or questions, you can always use the comment section below, or email me at blog@oasfcu.org.
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