With consumer debt at an all time high, we need to drill down and secure our futures by saving for a rainy day. No matter what your monthly income is, you can do something to put yourself in a better financial position.
The points in this article we will talk about are: Stretching your paycheque, budget options, ways to reduce you spending, and easy goals you can complete.
The overall consumer debt in American according to America’s Debt Help Organisation was approaching $14-trillion in the second quarter of 2019. Of which:
- Housing debt = $9.4 Trillion
- Auto debt = $1.3 Trillion
- Student loan debt = $1.48 Trillion
- Credit card debt = $1.1 Trillion
Now, housing and student debt is low interest and can be managed. But if you are getting high interest credit cards and not paying off the balance every month you will soon find yourself in a huge abyss without any hope of getting out. Lesson 1... Your credit card should be for emergencies only!
Budgeting can help even the most far gone spenders. Setting aside a small amount of money each month just to pay down a loan, or reduce your credit interest can not only help you financially, but mentally as well. Seeing the numbers go down can give you a massive boost in motivation to keep going, or give you peace of mind so you can have a good night's sleep.
I will outline my method of creating a budget. But first I just want you to understand what percentages you are trying to change for the better.
Here are a few statistics for you:
- Over 75% of Americans are in some sort of debt
- The non-housing debt in America has reached an all time high of over $4.1 trillion
- Over 90% of university and private college graduates have student loans to repay
- The average household has 4 credit cards they can’t pay for
- Around 15% of American households admit to living beyond their means
- 43% of debt in the average American household is credit card interest
These statistics are meant to scare you. If you are one of the people suffering from anything on that list you need to sit down and think about your future.
But why am I telling you what you already know? You wouldn’t be here if you didn’t want to plan a budget. Number 1 is to educate you on the massive problem that most Americans face, you are not alone. Then number 2 is to help you find a way out of the percentage pool.
The solution… Make a budget, then stick to it!
My 8 step budgeting making method
1. Set yourself a goal
Whether you want to save for a holiday, get out of debt, or just track your monthly outgoings you need a budget to do so. A clear goal helps you focus on the task at hand. Industry experts recommend having a cushion of cash stashed away which is at least 3 months of income, just in case you lose your job. But your goal could be to pay down your mortgage by 10% in 1 year.
2. Write down your monthly income
If you work on commission or via a contract, just take an average of your income over the last 12 months. If you income isn’t regular you might want to take this into account when prioritising your bills.
3. List your regular monthly expenses
Print off your bank statements and go through 3 months checking off regular expenses such as car payments, rent or mortgage payments, your phone and internet bill, and any loan payments etc. Total the month amount.
Then go through and calculate your variable expenses, be honest with yourself, nights out and sushi is not a variable expense.
However, food shopping or fuel for your car is considered variable because you have control, you could buy big brand label apples for a small fortune, or generic store apples for a lot less. Think about what you're buying, then research if you can get it cheaper somewhere else.
Another thing you will need to list is your other liabilities. These are things like motorcycles, campervans, and other regular payments for things you own that cost money.
4. Prioritise your bills
Start with bills you need to pay, such as rent, electricity, car payments. This ensures you have money for the most important things in your life.
Work your way down the list, give every expense a rating out of 5, 5 being a must have, and 1 being a luxury. Pay the 5’s first, then see how much money you have left to spend on the 1’s.
5. Add the occasional enjoyable expense
The occasional guilty pleasure isn’t a bad thing, Friday night pizza, or Sunday breakfast at the local cafe keep you from going insane. But your daily $10 coffee can be swapped with instant.
6. Plan for the unexpected
Having an emergency fund is a good idea, because you don’t know what’s coming around the corner. Having a cushion to fall back on helps stamp out future debt, and give you peace of mind for any out of the blue bills.
7. See if it works
This is the easy part. Total all of your expenses and see if it’s lower than your income. If you have income left, fantastic you’re in a surplus. If your expenses outweigh your income, you're unfortunately in a shortage, you will have to modify how much you spend to make the budget work.
Another option if you’re in a shortage of cash is to make more money, start a side hustle, or get a second job. The best way to do so is to develop a passive income source.
8. Revisit your goal
You should set yourself a long term goal, maybe for the next 2 to 3 years. Where do you want to be? How much do you want to have in the bank? I set a goal for myself when I was 17, saying I wanted to have any amount of money invested in the stock market before I was 21, I killed that goal and now I have a wide investment portfolio spread over 3 accounts.
The long term goal did not help me get to where I am, the short term goals did. Based on my 4 year goal, I could have turned up 3 years and 364 days later and put £100 into a trading account. The short term goals I set to get me in the market were:
- Save at least $200 per month
- Spend 2 hours every Sunday learning how to invest
Long story short, I spent most of my time at university learning about stock market investing, and was in the market before I was 18.
If you plan short term goals that build to your main challenge, it will make it easier to stay on track.
Which debt to pay off first
You should always pay off your high interest debt first, whether that be a credit card, payday loan, or overdraft. This is the type of debt that will cause you to become unacceptable in the eyes of the banks if you apply for any sort of account or credit.
High interest debts are also the biggest reason people become bankrupt because they can’t afford the interest never mind the capital.
After you’ve got your high interest loans under control, a good secondary goal is to pay off short term debts such as car loans, phone payments, or small personal loans. These are hopefully quick wins under $1,000 which can be paid off in under a year.
The main thing to do when paying off debt is to take a balanced approach. You’ll be paying all of your debts at the same time, so you will need to see what you can afford. The more you can pay off the better, overpaying on your 3% mortgage by $100 per month is a good idea, but if you have 15% maxed out credit card, you might want to use that $100 to pay that off.
How to avoid debt in the future
The first way to avoid debt is to obviously not take out loans or credit cards, but in the real world we need to. Debt isn’t always a bad thing, unmanageable debt is!
Living within your limits and not making impulse purchases help massively. You should never spend money you don’t have, nor should you agree to financing terms in store. Calculate the purchase and evaluate your options. But on top of this here is my list to live by to avoid debt:
- Don’t get more than 1 credit card
- Pay with cash wherever possible
- Interest free financing offers only postpone debt so think about it
- Transfer credit balances to a lower rate card, making sure the low rate applies to the balance of the transfer
- Choose credit cards that offer a grace period on purchases
- If you can’t avoid borrowing money, go to a regulated high street bank that offers the lowest rate at the time, don’t choose a variable rate and don’t choose a payday loan. Variable interest rates change everyday meaning you don’t know what you’re paying, and payday loans are not regulated, so they can offer up to 1495% APR.
Check my other article on how you can build your wealth so you don't have to worry about debt.
Small tips that increase your willpower to save
There are a few ratios people use to budget their expenses, they might work for you, or you might have to adjust them.
One is the 50/30/20 rule. Using this technique you’ll allocate 50% of your income towards necessities, 30% towards your hobbies or discretionary items, leaving 20% to go straight into a savings account. This might seem unreasonable if you already have a stretched paycheck, but it’s worth a try if you can afford it.
The other is Incremental budgeting. This is where in month 1 you save a nominal amount you can afford, then next month you save 5% more, then 5% more, and so on and so on. It is a great way to save if you struggle to resist temptation. Slowly reduce your spending and you’ll not even feel it.