To develop a realistic budget, you must start by analyzing how you are currently spending money. If budgets are unrealistic or unattainable, they will not work.
Analyzing your monthly outlays by type and category is a great place to start. Look at each of your monthly expenses as a percentage of your take-home pay. Assign each expense or outlay to one of three categories:
- Essentials: things such as rent, transportation, groceries, utilities, insurance, and the like
- Savings and debts: establishing an emergency fund, saving for retirement, and paying off debts
- Everything else: travel, entertainment, shopping, gifts
Totaling each category – essentials, savings and debts, and everything else – is an excellent diagnostic tool. It shows how you are spending your money and where you can make changes to improve your situation. Take a close look at your nonessential expenses. These are often tied to lifestyle choices and are easier to revise.
Some financial planners suggest that you budget 50 percent for essential expenses, 20 percent for savings and paying down debt, and 30 percent for nonessential expenses. This practice is often referred to as the 50/20/30 rule. (Some people categorize items based on “needs” for essential outlays and “wants” for nonessential things.) Other planners simplify the rule and suggest that you aim to use 20 percent of your take-home pay for savings and paying down debt. The 20 percent rule may be easier to implement, but I prefer the 50/20/30 rule because it distinguishes between needs and wants.
