Money is a funny topic for people. Some see it as the solution to all their problems. Some see it as a precious finite resource and watch every penny. Others see it as a way to buy all the material things they’ve ever wanted. Whatever your motivation, you need to know how to create a budget in order to use your money for whatever you want.
To me, money is a tool to help attain freedom and time. As a result, I learned how to create a budget to achieve my financial goals.
Here are 5 basic rules I follow:
- 28/36 rule – This is the rule that your housing costs shouldn’t exceed 28 percent of your gross income and your overall debt shouldn’t exceed 36 percent. This might not be realistic for those of you that live in major cities with high cost of living. If this is the case, the rest of your budget will get squeezed that much tighter.
- 20/4/10 rule when purchasing a car: How do you know if you can afford the car you like? You need to have 20% to pay for a downpayment, be able to afford payments on a 4 year loan, and your monthly payment + car insurance payment should not exceed 10% of your monthly net income.
- Save 20% of your income on retirement. This can be tough to do because you’ll want to pay down bills and spend after you get your paycheck. Direct deposit into retirement vehicles like Roth IRA, 401k, etc. You won’t miss what you never had.
- Pay down bad debt – Prioritize paying off credit cards that have the highest interest rates. Credit card interest can get up to 30% so make sure you start with those. Focus on one bill at a time and then move on to the next one.
- Leverage low interest debt as a tool to make you money. For example, use a mortgage towards a rental investment that will bring in positive cash flow.
Everyone’s budget pie chart will look different for many reasons. Maybe you live in New York City and spend 50% of your income on housing and don’t have as much left over to save. Some of you might be saving 50% of your income on retirement. Whatever your ratios look like:
Ask yourself why. Why are you working? What are your financial goals? Are those goals aligned with your husband or wife? Do you have kids you need to plan for?
For my family, our financial goals are (in no particular order):
To always be able to provide a safe, stable, home in a safe neighborhood with good schools.
Always be able to put food on the table and clothes on our backs.
Have 6 months worth of bills covered in case of emergency.
Be able to take annual international vacations.
Save and invest for my kids’ secondary education so they don’t start their adult lives with a mountain of student debt.
Have passive income streams to supplement my income, from my career, and increase those to the point that we can live off that income if needed.
Have a contingency plan for our family if my wife or/and I die. (enough life insurance)
Have the financial ability to retire at 55 if I want and have enough passive income to sustain our lifestyle.
Hope to afford a vacation in a tropical place.
Write your goals down. Be honest with yourself. Then calculate how much money it will take to reach those goals and how you plan on getting there. Download a compound interest calculator to help you determine how much and how often you will need to invest, to get to your financial goals.
When it comes to investing and taking advantage of compound interest, the most critical asset is: TIME. Start yesterday. If not, today is good. Don’t worry about how much you can invest. $20 is better than nothing.
Investing in your financial goals will take sacrifice. You might have to cut back on Amazon Prime and trips to Target. Can you handle that?
Let me know what your methods are for budgeting in comments below.