For most of us, money management was not taught in school…or at home. In fact, for most of us we learn about managing money through the school of hard knocks…trial and error. And boy, those errors can be difficult to overcome.
There are many different money management strategies to choose from, some of which can be very sophisticated. Let’s start with an extremely simple strategy called the 50-30-20 Strategy which sets up simple rules for how to allocate your paycheck:
- 50% is allocated to your basic living expenses including items such as mortgage or rent, basic bills (utilities, insurance, etc.), food, minimum consumer debt payments and basic personal expenses (haircuts, laundry, clothing). Let’s label this as our ‘needs’…bills that you essentially have no choice but to pay.
- 20% is allocated to savings based on both short and long-term goals. Shorter-term goals might include saving for the down payment on a home, saving for a big vacation trip or new car. Longer-term goals might include investing in your company retirement plan, an IRA or Roth IRA. Let’s label this our ‘future’.
- 30% is allocated for the fun stuff like eating out, entertainment, weekend vacationing. Let’s label this our ‘wants’…things that are fun but not absolutely necessary.
To get started, get a piece of paper and draw 3 columns down the page. Label the first one NEEDS (50%), the second one WANTS (30%) and the final one FUTURE (20%). Grab several months’ worth of cancelled checks and credit card statements and split up your actual expenses into the appropriate categories. Total one month at a time and determine what percent each category represents of your total monthly paycheck. If your NEEDS category is more than 50%, review each item and see where you might cut expenses. For example, if I ‘cut-the-cord’ on cable TV, I could save $1,500 per year. Keep working towards the 50-30-20 target allocations using expense cutting, pay raises and bonuses until you reach the target allocations. Obviously, your WANTS category is a great place to cut expenses if you’re determined to increase savings for such goals as an early retirement or a dream vacation. There are so many entertainment options that costs little or nothing. For example, City of Mtn. Brook is having Citizen Appreciation Day on May 4th where our first responders will be grilling hamburgers and hotdogs for a free lunch plus fun stuff for kids and a chance to ‘touch-a-truck (firetrucks, etc.)…all free!
If you want a more sophisticated/automated strategy, consider a budgeting system such as MINT.com.
Good money management doesn’t have to be complicated but you’ll need to invest the upfront time to get used to a system and a bit of time each month to track your progress. This is what families of self-made wealth do. If you’d like to be like them one day, start your money management system today.