Why Budget?

Budgeting assists households in planning how to allocate their after tax income in the upcoming year between essential expenses (needs), discretionary expenses (wants), and savings. By budgeting a household becomes in charge of their finances rather than just reacting to cash requirements as they occur. The budget plan is developed through answers to the following questions:

• What is the total household employment income and how much will be left after taxes?
• How much other income from sources such as alimony, child support, self-employment or investments should be included?
• How much income must be used to pay for essential expenses such as gas and groceries and financial commitments for housing, debts, insurance, etc?
• How much income should be allocated to discretionary expenses for products and services households want but don’t really need. Two prime examples are vacations and clothes. Households can choose to take no vacation, an inexpensive vacation, or an expensive vacation. Similarly they can choose not to buy any new clothes, buy inexpensive new clothes, or buy expensive new clothes.
• How much income should be saved to pay down principal on outstanding debt and prepare for future expenses such as retirement, college, an emergency fund, new car, new home, etc.?

A budget also provides a basis for reacting to financial problems during the year such as job loss, unexpected expenses, etc. Plans can be revised easily and quickly and an updated plan produced immediately.

Guidelines for Allocating Income

The New York Times bestseller "All Your Worth" by Elizabeth Warren and Amelia Tyagi is an excellent reference source for Dad’s Budget users. Based upon their extensive research on thousands of people they stress the importance of balance in household finances.

• "When your money is in balance, you always have enough to pay your bills, have some fun, and save for your dreams. You spend just the right amount on each of your major expense categories."
• "Once your money is in balance, you can stop worrying about it. Managing your money becomes automatic."
• "Having enough money for savings has little to do with will power. Instead it is about balance."

They suggest allocating after tax income to the three following categories, and emphasize that a household’s finances will not be in balance if “must haves” are much greater than 50%.

Liz Weston in her book "Easy Money" also discusses the importance of balance and offers suggestions on how to achieve balance and simplify your finances.

Budget Monitoring

After completing their budget households must decide how to monitor their plan throughout the year. The selection of a monitoring system is primarily affected by whether a household wishes to monitor their plan by category totals or individual items. Dad’s Budget emphasizes category totals while Mint and Mvelopes focus on individual items.

Dad's Budget Monitoring System

All budget information is separated into six categories with a different payment method used to monitor each category.

It doesn’t matter if a household spends more or less than the budgeted amount for any item within a category as long as they don’t exceed the budgeted category total.

Mint & Mvelopes

Both of these web sites do an excellent job tracking how much a household spends on individual items. For example for discretionary expenses Dad’s Budget only budgets vacations and Christmas and then allocates an amount weekly to spend on any discretionary expenses the household chooses. With Mint or Mvelopes the household would budget how much they want to spend on each discretionary item such as clothes, eating out, movies, books, etc. These web sites then track how much the household spends on each item and provide a report comparing actual expenditures to budget.

Savings Rate

Current Savings Rate

Figure after tax income for the year from your final pay stub by subtracting from gross income the total of Federal and state income taxes and Medicare and social security taxes.

Determine how much you saved last year for the following – retirement, college, emergency fund, new home, new car, future home expenses. (Do not include saving for yearly expenses such as vacation or Christmas.) Add to this total any additional payments to debt principal other than required monthly payments. This amount is your total savings.

To calculate your current savings rate divide your total savings by your total after tax income. Until recently the average savings rate in the United States was about zero.

Set a Goal

Most personal finance “experts” suggest the ultimate goal is to save 20% of your after tax income to pay off outstanding debt and prepare for future expenses like retirement. If you are currently not saving much, set a realistic but challenging goal for the upcoming year. Increase your goal every year until you are saving at least 20%.

Plan to Save

Many people fail to save because they wait to have money left over to put towards savings. Give savings equal weight in the budgeting process when deciding how to allocate your income.

Automatic Transfers for Savings

The savings rate increases when households set up automatic transfers from their paycheck to a savings account. They don’t have to think about it, and will not miss the lost income because they never saw it.

Many banks offer a sub account feature which allows the savings transfer to be allocated to designated accounts such as an emergency fund, new home, new car, etc.

Employers deduct retirement contributions automatically and most financial institutions also allow scheduled automatic transfers for retirement and college contributions.