Welcome to the first real Personal Finance post! Last week I introduced you to Phase Five's series "Personal Finance." This week, I'm starting the series off with the basic form of personal finance: budgeting. This may seem like a pretty simple idea, but when I went to learn about the best ways to start, I was overwhelmed by all of the options and sources, so I thought it might be helpful to compress some of that information!
To start off, here's a challenge for you: over the next 1-2 weeks, (if you don't already) track every penny you spend, what you spent it on, and how much it left you with. Eventually, this will be a really good habit to have so you can make sure your financial statements reflect what you've actually spent, but for now it can be an eye opening exercise to show you where your money really goes...I know my results were frightening!
The journey to healthier money habits and a wallet that works for you starts with budgeting, so let's jump right in!
What is Budgeting?
Most of you probably know what budgeting is, but understanding what it includes is important, too. Budgeting is dividing your money up proportionately to cover all of your needs first, increase your savings for emergencies as well as the future second, and then cover some of your wants third. Trust me, that's not the hierarchy I prefer or have followed for much of my adolescence...and I certainly haven't maintained it since entering early adulthood... but if I don't learn to "adult" now in regard to budgeting, I have a feeling I'll be in for a pretty stressful ride in the future.
What do people mean when they say "live within your means?"
"Living within your means" translates to exactly that, adjusting your living standards and expectations to the money you actually have, not the money you want. I 100% agree that this isn't fair for many people in this country because that often means going without stuff they need, even when they work hard at full time jobs. I want that to change as much as anyone, but until then, living within your means is the only option. For those with extra spending room, my Godmother said it best when she told me that living within your means also translates to only spending extra money in one spot, meaning "you can't have it all." You can buy a coffee everyday to treat yourself, or you can buy a new outfit every few weeks, or you can save up for travel, but unless you've got a lot of money, you can't have it all and still have a healthy financial budget.
As a college student who gets paid an average maximum of $150 monthly for nine months out of the year (thanks to my college's work-study program and my lack of a car for an off-campus job), I find the idea of "living with your means" to be extremely helpful in making sure I have what I need. Unfortunately, it also means that I might not be able to make more money during college because my "means" do not cover a car payment and insurance, which translates to: no extra income for me! Sometimes a budget can make you feel like you are stuck and that that is the reality of our economic system for so many hard-working individuals. What's more frustrating, is that "stuck" feeling often lets you know that you are just staying afloat, which means you might have to stay stuck for a while to survive. Even so, there are small things you can do every day to improve your financial state such as learning about personal finance (which you are doing right now!!!) and even just analyzing your spending and finding out if you can cut anything even for just a few months to increase savings for something that can help you, like a car to get to work.
Speaking of savings: Do I really need an emergency fund? I'd rather buy these new shoes or this video game!
Not everyone has the funds to be able to start an emergency fund even though they are so important. That said, in the midst of this pandemic I hope people are starting to see for themselves the importance of having an emergency fund that covers a few months of your essential expenses. Things like injuries, illnesses, natural disasters, death, and pandemics often happen with little to no notice, but cost more than what most people have lying around and can put you out of a position to make money for months at a time. That is why it is imperative that anyone who has extra money past their initial expenses should contribute to an emergency fund before any other savings, even if it's just a small amount every week or month.
How much your fund should be worth depends on how much it costs you to live month to month, and how much outside aid you can get in a crisis - such as living with or receiving money from your family or friends. It's always good to be proactive and discuss this option with those people in your life before something happens. After accounting for that aid - or however much money it saves you - you should put away about 3-6 times what's left. That way, if you are ill or injured you are better prepared to pay for treatment, and/or if you lose your job, you have time for government aid to kick in and supplement what you've saved while you search for another or get better. You definitely don't have to put all of this money away at once, but starting asap and putting in even just a little at a time can make a huge difference later.
What other savings should I try to account for?
I think the biggest other form of savings is a retirement fund, which we will talk about more in-depth in another post! In general, for someone my age, it seems like putting as little as $10-$20/week (about $40-$80/month) into these accounts and investing it is enough to get pretty large payoffs later! As you get older and make more money, these payments should definitely increase.
Other than that, the other extra savings include putting away money for a place to live or a new car (this is different if you don't have a car and need one to work, or if you need to pay for further education for a job, etc...those are considered needs), but that really varies by person and by goal. Overall, you should make sure that saving for these goals does not interfere with your monthly needs or you emergency and retirement savings. Saving for big goals like houses is an exciting journey, but you should only do so when you're financially able, which means you should hold off until you can save for that in addition to surviving, having a full emergency fund, and continuing to make regular deposits into a retirement fund.
But Sierra, what about saving for traveling?
Traveling is a huge passion of mine, and I don't think we have to wait to experience a new place until we have filled our emergency funds. Instead, I like to think of traveling as a mix between a want and a need. Traveling is a want because it is fun and exciting, but it's a need because in order for me to truly be happy, I need to pursue my passions, and happiness is a definite need. That's why I tend to put a little more money into the "want" part of my budget each month even though my savings has higher priority (meaning if it comes down to picking just one, I need to prioritize savings over wants!). Then, when I want to eat out or go shopping, I make sure I live within my means by deciding whether I want a new pair of shoes or an experience in a new country.
Overall, "passion savings" as I like to call them, come out of the wants portion of budget each month, but to account for the fact that pursuing passions is essential, I put a little extra money into it. Therefore, each month, I can choose to spend my "want" money or save it for traveling. There is no right or wrong way to do this and I do a little bit of both every month!
Different ways to budget
There are so many different ways to budget and help yourself stick to it. Some people use apps that track their spending, some use spreadsheets to plan for the month, and some do something else entirely. The most important thing to remember is that while there are guidelines for budgeting, everyone's financial situation is vastly different and as such, we shouldn't take these as "one-size fits all," but instead tailor their concepts to work for our own needs. On that note, it is important that you account for variable expenses in your category such as textbooks, occasional social functions like weddings, and replacing essential items such as broken pots and pans.
50/30/20 Budget (Click for source, more information, and a budget calculator) Take the well-known 50/30/20 budget, for example. This budget model, popularized by Senator Elizabeth Warren, asserts that you should spend 50% of your post-tax income on needs (unavoidable costs like bills, groceries, and rent), 30% on wants (such as entertainment, dining out, and travel), and 20% should go into savings.
This model seems simple and straightforward, but it doesn't always work for everyone, especially if their living expenses exceed 50% of their income like mine do. It isn't always possible to cut these expenses, either. Therefore, the idea of proportionality in this "rule" can be taken and applied to percents that make more sense for each person.
For example, if I were to utilize this model, I would subtract my needs from my post-tax income to find what I have left for the other two categories. Then, I would look at the percentages offered by this model: 30% for wants and 20% for savings, and change them to account for 100% of what is left over. In other words, I would turn the proposed 30% to 60% and likewise, 20% to 40% so that the two percentages, when applied to what's left over after my needs, account for 100% of that "excess" money (60 + 40 = 100).
Example of 50/30/20 When Needs Exceed 50%
Monthly income: $2400
Needs: $1800
Leftover $600
60%-Wants $360
40% Savings $240
Left: $0
Zero-Based Budgeting (Click for source and more information)
Zero-based budgeting takes the idea of proportionality from the 50/30/20 budget but makes it more in depth and customizable. Basically, you create several, manageable mini-budgets.
1. First, you'll need to track your spending for a couple months in a spreadsheet.
2. Then, look at what you've spent money on and divide it into categories such as "Groceries," "Going out"/"Social," "Travel Fund," "Debt Repayments," "Retirement," "Emergency Fund," etc..
3. Next, you can look at these categories and how much you spend on them, make cuts where you feel you can, and add that to any money you made that you didn't spend from your monthly income.
4. Take that extra money and distribute it, starting with your important categories that have the least amount of money (the first priority ones being those that are needs - make sure you can cover them all, the second being those that constitute as savings - especially if you currently aren't saving at all, and the last being ones that constitute wants).
5. Lastly, take what you have left and use your spending trends from those spreadsheets to allocate how much you will need every month to maintain each category without having any money left over.
Here is an example of a zero-based budget from NerdWallet.com
This will allow you to account for every penny, but also gives you the benefit of customization and flexibility. In turn, while this method can be time consuming - it can make sticking to your budget easier, especially for beginner budgeters, as long as you continue to track your spending. This last part becomes easier when paired with envelope budgeting.
Envelope Budgeting (Click for source and more information)
Envelope budgeting is the holy grail of strategies for people like me who are way too prone to impulse buying and act like electronically transferred money isn't "real money." Now, don't act like I'm the only one! I am so much less inclined to buy something when the cash it takes is sitting in my hand and I feel that pile dwindle.
The point of envelope budgeting is paying in cold-hard cash. You take out your monthly budget in cash for each category you created through the 50/30/20 rule or the zero-based budgeting system. Then, put it into marked envelopes. For example, if your monthly coffee budget is $30, you'd take out $30 and each time you buy a coffee, it comes from that envelope. Once that money is gone, you literally cannot spend any more. The only place this gets tricky is when you have to shop online or if you don't want to have money out of your bank account for security reasons, both of which are completely valid concerns!
In that case, I would take an empty envelopes for each category with the name of the category and the money left in the budget written on each. Every time you spend, ask for the receipt or save it on your computer in a special folder. Allot 20 minutes at the end of each day to add up your receipts in each category, and update the remaining balance on your envelope. Alternatively, you can keep envelopes with scrap paper and write down what you spend on pieces of paper throughout the day. This does take more self-awareness and discipline as it is easier to overdraft your budget... but I believe in you!
As we near the end of this post, I want to share with you some basic budget spreadsheets. The first two are ones I found and adjusted on Microsoft Excel so you can easily utilize what we discussed if you have Microsoft Office! The second two are on Google Sheets which you can use if you make a free Gmail account! All will allow you to input all of your income and essential expenses and will calculate your monthly budgets for wants and needs as well as how much you should put into retirement savings and how much you should put into emergency savings. It also calculates the maximum amount you should have in your emergency fund. The there are ones on each platform for people whose essential expenses can go no lower and are still more than 50% of their income as well as for people whose essential expenses are less than or equal to 50% of their income. You can add your own stuff to these spreadsheets so you can utilize zero-based budgeting as well as envelope budgeting, but these are just to get you started!
Here are examples of each!
Click either of the links below to be directed to the spreadsheets!
Microsoft Excel Sheets:
For more tips and help on saving and budgeting, consider heading over to Khan Academy and viewing their personal finance course! It's free and you don't even have to make an account. There is a whole unit on Saving and Budgeting that I have found extremely useful. Make sure to also check out NerdWallet.com for any of your personal finance questions!
Alright friends: last thing! I know some situations are literally impossible. I've felt that, I've been there. I, and most people my age in college, make all of our money in the summer. This year I and thousands of other students were sent home early from study abroad, meaning we had to buy one way, international tickets home the week of travel, draining our bank accounts. Then, we couldn't work without risking our lives and the lives of our family due to COVID, and weren't yet qualified for any of the very few remote jobs available. On top of that, most people my age in college aren't eligible for traditional unemployment and college-aged dependents didn't get stimulus money. Now, in comes the school year when my and many others' university pays very little every month, and students with little money have no access to a car for an off campus job. This puts so many people in impossible situations, myself included. If you aren't affected by all these at once, give some grace to the college students in your life...and maybe a hug too if both of you are into that.
For those of you in that situation: I don't have an answer for you, but I wish I did. I struggle with this too. My only advice is be on the lookout for any and every opportunity. Even if you don't think it'll amount to anything, try. Apply for unemployment and Pandemic Unemployment Assistance, the worst that can happen is you wasted an hour and they say no. Best case scenario, you get lucky...somehow I did even though I didn't think I was eligible.
Most of all: try not to stress. Trust me, I know that's easier said than done, and honestly I have a hard time heeding my own advice. But stress will only make it worse. Stress clouds your judgement. Start seeing your university's free counselors or talk to someone who works for your school. You aren't the first student to struggle with this, they might know someone else who has, and might be able to let you know what others have done. I'm sorry I can't do more. Even so, please remember that I'm here for you and I care that you succeed.
Well, that's it for this week! If you have any questions, comments, or additions to this information please drop them in the comments or reach out to me. I am certainly not an expert and I have so much more to learn. Thank you so much for reading this far. I hope you found something useful and are looking forward to more posts like this. Stay safe, stay sane, and stay up to date on Phase Five's Personal Finance series by subscribing now!
See you soon,
Sierra
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