Budgeting and Managing Your Spending

Saving money is just as important as not running out of money. Unless you have an almost unlimited supply of money, the only way to get a handle on your spending is to have a budget and stick to it.

You create a budget by looking at your income and your expenses and making sure that at the end of your pay period, you have enough to cover everything. If the numbers don’t line up—in other words, if you spend more than you make—that’s when you need to budget and work to manage your spending. You do this by cutting down expenses in some areas (such as dining out or entertainment) so you “make ends meet” each month, and hopefully have something left for savings.

You can view the transcript for “Consultant | My budget & planning for the future | Part 3 | Khan Academy” here (opens in new window).

One way to organize your budget is to allocate funds to fixed expenses like rent and car payment first, and then to have another section for discretionary spending, like eating out and entertainment.

Another budgeting technique is the 50/30/20 rule. It involves dividing your monthly income into three ”buckets”:

• 50% (or less) goes to necessities such as housing, student loans, and utilities. These are expenses you have to pay every month.
• 30% (or less) goes to nice-to-haves, such as entertainment, hobbies, and travel.
• 20% (or more, if possible) goes toward savings and paying down debt.

Budgeting won’t do you any good if you don’t monitor your actual spending against your budget and then make adjustments to your spending habits as needed. There are some online budgeting resources and apps, but the simplest way to track your budget may be a spreadsheet.

Also, don’t forget to budget in saving for emergencies, such as temporary job loss. While it can be a hard goal to reach, it’s recommended to try saving up at least two full month’s worth of expenses in a savings account that is for that purpose only. Set up a separate savings account for things like luxury purchases, vacations, appliance replacement, and other large, non-recurring items.

Most people like to know how much money they currently have, which means they check it on a regular basis. While you are doing that, take a few extra minutes to verify charges and to update your budget. You can do that daily or weekly, but at the very least you should do it monthly.

It doesn’t matter what system you use, as long as it works for you. The test will be how much your savings account increases over time—and how much your debt decreases. If you are getting further in debt, or if your savings is dwindling, you’ll need to get more serious about your budgeting and find a better tool. If you are already deep in debt, you’ll have to take that into account when you build, update, and monitor your budget.

Credit

Establishing and building up good credit over time is an important element of sound financial health. If you travel, you’ll need a valid credit card to make a room reservation, and if you are on the road and a tire goes flat in the middle of the night, you might need a credit card to get a tow and pay for a new tire.

The most common ways to establish credit are to apply for a credit card and/or a car loan. But beware, you have to make all the payments on time, or you’ll be in worse shape than you would have been without those loans.

You can view the transcript for “The 5 Strategies That Raised My Credit Score From The 500s to The 800s” here (opens in new window).

Avoiding Credit Trouble

The only thing easier than building credit is mismanaging it and getting in trouble. According to a recent report by the Federal Reserve, Americans owe nearly $1 trillion in credit card debt, and the past-due amount is rising, especially among young people.

Certainly, having a bad credit rating is a bad thing, but the flipside is that having a good credit rating is a good thing. Someday you may want to buy a house, start a small business, or even buy some income-producing real estate, and you’ll want to have established credit to do that.

For credit cards, the best practice is to pay off the balance every month. Don’t use them to buy something you can’t afford. Especially for new borrowers, interest rates on new accounts can be upward of 25%, which means if you run up your balance to $1,000 and only make minimum payments, it could take you years to pay off the debt and the interest you end up paying could easily end up being even more than the original purchase.

If you are already in over your head, you’ll first have to make some hard budget decisions to free up money to pay down your loans. Most people who have successfully paid down debt use the “snowball” method, where you pay down the smallest outstanding balance first, and then use the money freed up from paying off that debt, plus the extra money you freed up in the first place, to pay down the next lowest balance, and so on, until you are out of debt. Another way is to attack the highest interest rates, paying those off first to save money in the long run. Either way, once your credit cards are paid off, be careful in your spending so you don’t run up the balances again for unneeded expenses.

Credit Scores

A credit score is a three-digit number, typically ranging from 300 to 850, that is the result of an analysis of your credit file. It gives lenders an indication of your potential credit risk and ability to repay loans. Credit scores consider various factors from your current and past credit accounts, such as payment history, length of credit history, and total credit available.

Credit scores are generally classified as:

• Very poor: 300–579
• Fair: 580–669
• Good: 670–739
• Very good: 740–799
• Exceptional: 800–850

A higher credit score means you are more likely to qualify for a loan with a lower interest rate.

The simple act of checking your credit score is one way you can improve your credit. If you notice a dip in your score, it may alert you to potential fraud or errors on your report. Checking your score monthly may help you catch issues early and get a head start on resolving them. You can check your scores through the major credit reporting agencies and through some financial advisor sites.