Personal budget
Encyclopedia
A personal budget is a finance plan that allocates future personal income
towards expense
s, savings and debt
repayment. Past spending and personal debt are considered when creating a personal budget. There are several methods and tools available for creating, using and adjusting a personal budget.
Average annual expenses (2007) per household in the United States are:
Pencil and paper
A simple budget can be written on a piece of a paper with a pencil, and optionally, a calculator. Such budgets can be organized in three-ring binders or a file cabinet. Simpler still are the pre-formatted household budgeting or bookkeeping
forms that creates a budget by filling in the blanks.
Spreadsheet software
Spreadsheet software, including Microsoft Excel
, iWork Numbers
or OpenOffice.org Calc
, helps to arrange budgets according to need and performs calculations easily with rudimentary formulas. For example, budget spreadsheets are used to keep track of income and expenses. The major reason most people discontinue using budget spreadsheets that don't offer date-shifting is that the information needs to be reentered or moved at the end of each month. Spreadsheets are still excellent for complex budgets and planning.
Money-management software
Some software is written specifically for money management. Products such as Fortora Fresh Finance
, Moneydance
, Quicken
, Microsoft Money
(discontinued), and GnuCash
are designed to keep track of individual account information, such as checking, savings or money-market accounts. These programs can categorize past expenses and display monthly reports that are useful for budgeting future months.
Money-management websites
Several websites, such as Mint.com
and Thrive
, have been devised to help manage personal finances. Some may have a privacy policy
governing the use and sharing of supplied financial information.
Spending-management software
Spending-management software is a variation of money-management software. Unlike typical budgeting that allocates future personal income towards expenses, savings and debt repayment, this type of software utilizes a known amount of money, the cash on hand, to give the user information regarding what's left to spend in the current month. This method eliminates some of the guess work associated with forecasting what a person might receive for income when it comes to allocating budgeted money. Like money-management software, some spending-management software packages can connect to online bank accounts in order to retrieve a current status report.
Purpose
A budget should have a purpose or defined goal that is achieved within a certain time period. Knowing the source and amount of income and the amounts allocated to expense events are as important as when those cash flow events occur.
Simplicity
The more complicated the budgeting process is, the less likely a person is to keep up with it. The purpose of a personal budget is to identify where income and expenditure is present in the common household; it is not to identify each individual purchase ahead of time. How simplicity is defined with regards to the use of budgeting categories varies from family to family, but many small purchases can generally be lumped into one category (Car, Household items, etc.).
Flexibility
The budgeting process is designed to be flexible; the consumer should have an expectation that a budget will change from month to month, and will require monthly review. Cost overruns in one category of a budget should in the next month be accounted for or prevented. For example, if a family spends $40 more than they planned on food in spite of their best efforts, next month's budget should reflect an approximate $40 increase and corresponding decrease in other parts of the budget.
"Busting the budget" is a common pitfall in personal budgeting; frequently busting the budget can allow consumers to fall into pre-budgeting spending habits. Anticipating budget-busting events (and underspending in other categories), and modifying the budget accordingly, allows consumers a level of flexibility with their incomes and expenses.
Budgeting for irregular income
Special precautions need to be taken for families operating on an irregular income. Households with an irregular income should keep two common major pitfalls in mind when planning their finances: spending more than their average income, and running out of money even when income is on average.
Clearly, a household's need to estimate their average (yearly) income is paramount; spending, which will be relatively constant, needs to be maintained below that amount. A budget being an approximate estimation, room for error should always be allowed so keeping expenses 5% or 10% below the estimated income is a prudent approach. When done correctly, households should end any given year with about 5% of their income left over. Of course, the better the estimates, the better the results will be.
To avoid running out of money because expenses occur before the money actually arrives (known as a cash flow problem in business jargon) a "safety cushion" of excess cash (to cover those months when actual income is below estimations) should be established. There is no easy way to develop a safety cushion, so families frequently have to spend less than they earn until they have accumulated a cushion. This can be a challenging task particularly when starting during a low spot in the earning cycle, although this is how most budgets begin. In general, households that start out with expenses that are 5% or 10% below their average income should slowly develop a cushion of savings that can be accessed when earnings are below average. Whether this rate of building a cushion is fast enough for a given financial situation depends on how variable income is, and whether the budgeting process starts at a high or low point during the earnings cycles.
The other 40% breaks down as follows, with 10% allocated to each category:
If an individual has a high amount of non-mortgage debt, Jenkins advises that the 20% apportioned to retirement and long-term savings be directed towards paying off debt; once the debt is paid off, the 20% (Retirement + Savings) is to be immediately redirected back into the original categories. According to Jenkins, tracking each individual expense is unnecessary, as the balance of his primary checking account is roughly equivalent to the amount of money that can be spent in this plan.
Software designed to easily set up and track a 60% Solution Budget is built in to the "deluxe" and higher versions of Microsoft Money 2007 and Microsoft Money Plus.
especially applies to families moving to new housing; if a house payment for a $300,000 house, plus taxes, will result in a $2,000 monthly mortgage bill, will it take up too large a portion of the budget? (To calculate, find income level, tax rate and mortgage interest rate.)
In housing markets with exceptionally high prices, such as California
, New York City
, or Boston, Massachusetts, in the early 2000s, this rule of thumb may be difficult to follow. A high percentage of income spent on housing will necessitate lower percentages in other categories.
One of the critical factors that many people overlook during the budgeting process is the "supplier-replacement cost-cutting technique". This is the process of scrutinizing each current expenditure, comparison shopping and replacing with a lower cost, equal quality alternative. The newfound savings is then reapplied to debt, savings accounts and enjoyment spending.
is a method of budgeting where on a regular basis (i.e. monthly, biweekly, etc.) a certain amount of money is set aside for a specific purpose, or category, in an envelope marked for that purpose. Then anytime you make a purchase you look in the envelope for the type of purchase being considered to see if there are sufficient funds to make the purchase. If the money is there, all is well. Otherwise, you have three options: 1) you do not make the purchase; 2) you wait until you can allocate more money to that envelope; 3) you sacrifice another category by moving money from its associated envelope. The flip side is true as well, if you do not spend everything in the envelope this month then the next allocation adds to what is already there resulting in more money for the next month.
With envelope budgeting, the amount of money left to spend in a given category can be calculated at any time by counting the money in the envelope. Optionally, each envelope can be marked with the amount due each month (if a bill is known ahead of time) and the due date for the bill.
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
towards expense
Expense
In common usage, an expense or expenditure is an outflow of money to another person or group to pay for an item or service, or for a category of costs. For a tenant, rent is an expense. For students or parents, tuition is an expense. Buying food, clothing, furniture or an automobile is often...
s, savings and debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
repayment. Past spending and personal debt are considered when creating a personal budget. There are several methods and tools available for creating, using and adjusting a personal budget.
Sample budget
A budget allocates or distributes expected income to expected expenses and intended savings. The following sample illustrates how income might be allocated.| Category | Percentage | Annual Amount | Monthly Amount |
|---|---|---|---|
| Total Income | |||
| Taxes | |||
| Net Spendable | |||
| Percentages below are for percent of Net Spendable | |||
| Net Spendable | |||
| Housing | |||
| Food | |||
| Automobile | |||
| Insurance | |||
| Debt Repayment | |||
| Entertainment and Recreation | |||
| Clothing | |||
| Savings | |||
| Medical/Dental | |||
| Miscellaneous | |||
| School/Childcare | |||
| Investments |
Average annual expenses (2007) per household in the United States are:
| Category | 2005 | 2006 | 2007 | % Change 05-06 | % Change 06-07 |
|---|---|---|---|---|---|
| Food at home | 3,297 | 3,417 | 3,465 | 3.6 | 1.4 |
| Food away from home | 2,634 | 2,697 | 2,668 | 2.3 | -1.0 |
| Housing | 15,167 | 16,366 | 16,920 | 7.9 | 3.4 |
| Apparel and services | 1,886 | 1,874 | 1,881 | 7.9 | 3.4 |
| Transportation | 8,344 | 8,508 | 8,758 | 2.0 | 2.9 |
| Health Care | 2,664 | 2,766 | 2,853 | 3.8 | 3.1 |
| Entertainment | 2,388 | 2,376 | 2,698 | -0.5 | 13.6 |
| Personal Insurance and pensions | 5,204 | 5,270 | 5,336 | 1.3 | 1.3 |
| Other Expenditures | 4,823 | 5,129 | 5,060 | 6.3 | -1.3 |
| Avg. annual Exp. | 4.3% | 2.6% |
Tools
Several tools are helpful for constructing a personal budget. Regardless of the tool used, a budget's accuracy is only as good as the accuracy of the updated budget data; an old budget that does not reflect actual income or expenses is of little use to a current budget. Computer generated budgets have become commonly used as they replace the need to rewrite and recalculate the budget every time there is a change.Pencil and paper
A simple budget can be written on a piece of a paper with a pencil, and optionally, a calculator. Such budgets can be organized in three-ring binders or a file cabinet. Simpler still are the pre-formatted household budgeting or bookkeeping
Bookkeeping
Bookkeeping is the recording of financial transactions. Transactions include sales, purchases, income, receipts and payments by an individual or organization. Bookkeeping is usually performed by a bookkeeper. Bookkeeping should not be confused with accounting. The accounting process is usually...
forms that creates a budget by filling in the blanks.
Spreadsheet software
Spreadsheet software, including Microsoft Excel
Microsoft Excel
Microsoft Excel is a proprietary commercial spreadsheet application written and distributed by Microsoft for Microsoft Windows and Mac OS X. It features calculation, graphing tools, pivot tables, and a macro programming language called Visual Basic for Applications...
, iWork Numbers
Numbers (software)
Numbers is a spreadsheet application developed by Apple Inc. as part of the iWork productivity suite alongside Keynote and Pages. Numbers 1.0 was announced on August 7, 2007 and thus it is the newest application in the iWork Suite. Numbers runs on Mac OS X v10.4 "Tiger" or newer...
or OpenOffice.org Calc
OpenOffice.org Calc
OpenOffice.org Calc is the spreadsheet component of the OpenOffice.org software package.Calc is similar to Microsoft Excel, with a roughly equivalent range of features. Calc is capable of opening and saving most spreadsheets in Microsoft Excel file format...
, helps to arrange budgets according to need and performs calculations easily with rudimentary formulas. For example, budget spreadsheets are used to keep track of income and expenses. The major reason most people discontinue using budget spreadsheets that don't offer date-shifting is that the information needs to be reentered or moved at the end of each month. Spreadsheets are still excellent for complex budgets and planning.
Money-management software
Some software is written specifically for money management. Products such as Fortora Fresh Finance
Fortora Fresh Finance
Fortora Fresh Finance is personal finance software developed by Fortora LLC. The software is available in two versions, one for Windows and another for Mac OS X. The software tracks accounts, loans, bills, investments and budgets. It imports data from QIF, OFX, QFX and CSV files...
, Moneydance
Moneydance
Moneydance is a personal finance software application developed by Reilly Technologies, USA. Written in Java, it can be run on many different computers and operating systems...
, Quicken
Quicken
Quicken is a personal finance management tool developed by Intuit, Inc.Quicken runs on Windows and Macintosh systems. Previous versions ran on DOS. An online version is also available. The last version of Quicken for Macintosh computers was Quicken Essentials for Mac released in February 2010...
, Microsoft Money
Microsoft Money
Microsoft Money was Microsoft's personal finance software. It was designed for computers using the Microsoft Windows operating system, though versions for Windows Mobile were also available .The last version, released in August 2007, was called Microsoft Money Plus and came...
(discontinued), and GnuCash
GnuCash
GnuCash is a free and open source accounting software program that implements a double-entry bookkeeping system. It was initially aimed at developing capabilities similar to Intuit, Inc.'s Quicken application, but also has features for small business accounting...
are designed to keep track of individual account information, such as checking, savings or money-market accounts. These programs can categorize past expenses and display monthly reports that are useful for budgeting future months.
Money-management websites
Several websites, such as Mint.com
Mint.com
Mint.com is a free web-based personal financial management service for the US and Canada created by entrepreneur Aaron Patzer. Mint originally provided account aggregation through a deal with Yodlee, but has since moved to using Intuit for connecting to accounts...
and Thrive
Thrive (website)
Thrive or Justthrive.com, was a free, web-based personal financial management application offering personalized financial advice and specifically targeting people in their 20's and 30's...
, have been devised to help manage personal finances. Some may have a privacy policy
Privacy policy
Privacy policy is a statement or a legal document that discloses some or all of the ways a party gathers, uses, discloses and manages a customer or client's data...
governing the use and sharing of supplied financial information.
Spending-management software
Spending-management software is a variation of money-management software. Unlike typical budgeting that allocates future personal income towards expenses, savings and debt repayment, this type of software utilizes a known amount of money, the cash on hand, to give the user information regarding what's left to spend in the current month. This method eliminates some of the guess work associated with forecasting what a person might receive for income when it comes to allocating budgeted money. Like money-management software, some spending-management software packages can connect to online bank accounts in order to retrieve a current status report.
Concepts
Personal budgeting, while not particularly difficult, tends to carry a negative connotation among many consumers. Sticking to a few basic concepts helps to avoid several common pitfalls of budgeting.Purpose
A budget should have a purpose or defined goal that is achieved within a certain time period. Knowing the source and amount of income and the amounts allocated to expense events are as important as when those cash flow events occur.
Simplicity
The more complicated the budgeting process is, the less likely a person is to keep up with it. The purpose of a personal budget is to identify where income and expenditure is present in the common household; it is not to identify each individual purchase ahead of time. How simplicity is defined with regards to the use of budgeting categories varies from family to family, but many small purchases can generally be lumped into one category (Car, Household items, etc.).
Flexibility
The budgeting process is designed to be flexible; the consumer should have an expectation that a budget will change from month to month, and will require monthly review. Cost overruns in one category of a budget should in the next month be accounted for or prevented. For example, if a family spends $40 more than they planned on food in spite of their best efforts, next month's budget should reflect an approximate $40 increase and corresponding decrease in other parts of the budget.
"Busting the budget" is a common pitfall in personal budgeting; frequently busting the budget can allow consumers to fall into pre-budgeting spending habits. Anticipating budget-busting events (and underspending in other categories), and modifying the budget accordingly, allows consumers a level of flexibility with their incomes and expenses.
Budgeting for irregular income
Special precautions need to be taken for families operating on an irregular income. Households with an irregular income should keep two common major pitfalls in mind when planning their finances: spending more than their average income, and running out of money even when income is on average.
Clearly, a household's need to estimate their average (yearly) income is paramount; spending, which will be relatively constant, needs to be maintained below that amount. A budget being an approximate estimation, room for error should always be allowed so keeping expenses 5% or 10% below the estimated income is a prudent approach. When done correctly, households should end any given year with about 5% of their income left over. Of course, the better the estimates, the better the results will be.
To avoid running out of money because expenses occur before the money actually arrives (known as a cash flow problem in business jargon) a "safety cushion" of excess cash (to cover those months when actual income is below estimations) should be established. There is no easy way to develop a safety cushion, so families frequently have to spend less than they earn until they have accumulated a cushion. This can be a challenging task particularly when starting during a low spot in the earning cycle, although this is how most budgets begin. In general, households that start out with expenses that are 5% or 10% below their average income should slowly develop a cushion of savings that can be accessed when earnings are below average. Whether this rate of building a cushion is fast enough for a given financial situation depends on how variable income is, and whether the budgeting process starts at a high or low point during the earnings cycles.
Allocation guidelines
There are several guidelines to use when allocating money for a budget as well. Past spending is one of the most important priorities; a critical step in most personal budgeting strategies involves keeping track of expenses via receipts over the past month so that spending for the month can be reconciled with budgeted spending for the next month. Any of the following allocation guidelines may be used; choose one that will work well with your situation.The 60% Solution
The 60% Solution is a budgeting system created by former MSN Money's editor-in-chief, Richard Jenkins. The name "The 60% Solution" originates from Jenkins' suggestion on spending 60% of a household's gross income (before taxes) on fixed expenses. Fixed expenses includes federal, state and Social Security taxes, insurance, regular bills and living expenses- like food and clothing, car and house payments.The other 40% breaks down as follows, with 10% allocated to each category:
- Retirement: Money set aside into an IRAIndividual Retirement AccountAn individual retirement arrangement is the blanket term for a form of retirement plan that provides tax advantages for retirement savings in the United States...
or 401(k)401(k)A 401 is a type of retirement savings account in the United States, which takes its name from subsection of the Internal Revenue Code . A contributor can begin to withdraw funds after reaching the age of 59 1/2 years...
. - Long-term savings: Money set aside for car purchases, major home fix-ups, or to pay down substantial debt loads.
- Irregular expenses: Vacations, major repair bills, new appliances, etc.
- Fun money: Money set aside for entertainment purposes.
If an individual has a high amount of non-mortgage debt, Jenkins advises that the 20% apportioned to retirement and long-term savings be directed towards paying off debt; once the debt is paid off, the 20% (Retirement + Savings) is to be immediately redirected back into the original categories. According to Jenkins, tracking each individual expense is unnecessary, as the balance of his primary checking account is roughly equivalent to the amount of money that can be spent in this plan.
Software designed to easily set up and track a 60% Solution Budget is built in to the "deluxe" and higher versions of Microsoft Money 2007 and Microsoft Money Plus.
Housing as 25% of spendable income
Another allocation principle is that housing expenses (mortgage or rent) should be limited to 25% of spendable income. This rule of thumbRule of thumb
A rule of thumb is a principle with broad application that is not intended to be strictly accurate or reliable for every situation. It is an easily learned and easily applied procedure for approximately calculating or recalling some value, or for making some determination...
especially applies to families moving to new housing; if a house payment for a $300,000 house, plus taxes, will result in a $2,000 monthly mortgage bill, will it take up too large a portion of the budget? (To calculate, find income level, tax rate and mortgage interest rate.)
In housing markets with exceptionally high prices, such as California
California
California is a state located on the West Coast of the United States. It is by far the most populous U.S. state, and the third-largest by land area...
, New York City
New York City
New York is the most populous city in the United States and the center of the New York Metropolitan Area, one of the most populous metropolitan areas in the world. New York exerts a significant impact upon global commerce, finance, media, art, fashion, research, technology, education, and...
, or Boston, Massachusetts, in the early 2000s, this rule of thumb may be difficult to follow. A high percentage of income spent on housing will necessitate lower percentages in other categories.
One of the critical factors that many people overlook during the budgeting process is the "supplier-replacement cost-cutting technique". This is the process of scrutinizing each current expenditure, comparison shopping and replacing with a lower cost, equal quality alternative. The newfound savings is then reapplied to debt, savings accounts and enjoyment spending.
Following a budget
Once a budget is constructed and the proper amounts are allocated to their proper categories, the focus for personal budgeting turns to following the budget. As with allocation, there are various methods available for following a budget.Envelopes
Envelope Accounting or the Envelope SystemEnvelope System
The envelope system, also known as the envelope method, is a popular method for visualizing and maintaining a budget. The key idea is to store the cash to meet separate categories of household expenses in physically separate envelopes....
is a method of budgeting where on a regular basis (i.e. monthly, biweekly, etc.) a certain amount of money is set aside for a specific purpose, or category, in an envelope marked for that purpose. Then anytime you make a purchase you look in the envelope for the type of purchase being considered to see if there are sufficient funds to make the purchase. If the money is there, all is well. Otherwise, you have three options: 1) you do not make the purchase; 2) you wait until you can allocate more money to that envelope; 3) you sacrifice another category by moving money from its associated envelope. The flip side is true as well, if you do not spend everything in the envelope this month then the next allocation adds to what is already there resulting in more money for the next month.
With envelope budgeting, the amount of money left to spend in a given category can be calculated at any time by counting the money in the envelope. Optionally, each envelope can be marked with the amount due each month (if a bill is known ahead of time) and the due date for the bill.
Spreadsheet budgeting with date-shifting
Budget spreadsheets with date-shifting, like Budget-Master.com, typically offer a detailed view of a 12 month, income and expense, plan. A good way to follow and manage a budget when using a spreadsheet that offers date-shifting is to set the current month a few months before the current month along the 12-month cycle, month 4 for example. In this way previous expenses and results can be viewed when creating or adjusting the budgeting planning.See also
- Debtors AnonymousDebtors AnonymousDebtors Anonymous is a twelve-step program for people who want to stop incurring unsecured debt. Collectively they attend more than 500 weekly meetings in nine countries...
- Envelope SystemEnvelope SystemThe envelope system, also known as the envelope method, is a popular method for visualizing and maintaining a budget. The key idea is to store the cash to meet separate categories of household expenses in physically separate envelopes....
- Personal financial management
- Zero-based budgeting