FINANCE FOUNDATIONS:
GETTING BACK TO BASICS
Eliminate financial confusion
by revisiting time-tested
strategies for success

By JUDY ALEXANDER

The world is full of financial opportunities and temptations — some practical, some extravagant. Should you take a vacation in the sun or add to your child’s college fund? Refurnish the house or pay down those stubborn credit card balances? Drive a classy new vehicle or settle for repairs on the old one?

Without understanding your own financial circumstances and priorities, you have no way to intelligently decide what you can and cannot afford.

On the other hand, an accurate financial picture helps you keep track of your money; plan for future needs, desires and uncertainties; and focus on what is most important to you, without getting into a financial sinkhole.

This personal financial picture comes into focus when you use tools that are the foundations of financial management. You will need a workable budget, expense tracking and a spending plan, supported by an adequate emergency fund. Together, they form a sure and strong basis for every other activity in your financial life.

BUILD A BUDGET THAT
WORKS FOR YOU
If you’ve never made peace with the concept of budgeting, your reasoning may sound something like: “All I need to do is spend less than I make. If I just use my common sense, I can make that work.”

The flaw in that thinking is that most of us are out of touch with our money; we have no clear idea where or how we spend it much of the time. Consider this example: How many times have you cashed a check or withdrawn money from the ATM only to discover your wallet is almost empty again the next day? Where did the money go?

It may be difficult to remember exactly how you spent every dollar of that money, and chances are, you have little to show for your expenditures. A budget can help you turn this all-too-common problem into an opportunity by giving you a tool to account for the money you spend.

Still, many of us resist the notion of a budget because it seems too restrictive, too difficult or too time-consuming. Instead of the drudgery you might imagine, however, a budget can free you from the stress of worrying about managing next month’s bills, can keep you from creating new debt you will regret later and can actually speed you toward some of your biggest and best dreams.

As a tool for making smart money decisions, nothing can compare to the basic budget, a wide-angle snapshot of where you stand and where you are headed. Your budget, which describes where your money comes from, when you receive it and how it is spent, can be as simple or as complicated as you want it to be. You may choose to budget on a day-to-day, weekto- week or month-to-month basis.

The more detailed approach is likely to give you the most accurate picture, but most budget counselors say that a monthly approach is the most convenient and adequate enough for most individuals’ needs. An added benefit: Many common expenses (such as housing, utilities, vehicle payments and credit card payments) are already once-a-month obligations.

Work sheets and other budget-related forms available in many popular financial software packages can work well for online budget creation and expense tracking, allowing you to customize and manipulate your budget categories to your heart’s content with relative ease. But if you like a more hands-on approach, a pencil and paper budget is just as effective as online versions. Look for preprinted budget organizers in office supply stores, stationers and discount stores.

No matter how you decide to document your financial information, a budget begins with calculating income.
How much money do you have to work with? Without accurate income information, it is impossible to plan and budget with confidence.

Most of your income comes from earned wages or pay. But don’t forget to include one-time or periodic bonuses, incentives, allowances, interest income from savings, dividend payments from investments, child support and other kinds of income. If you are a student, some of your income may come from grants, student loans and stipends.

Whatever forms of income you can count on, your budget should reflect net income — income you receive after federal taxes (income, Social Security and Medicare) and other deductions, such as automatic contributions you make to a savings account or an automatic loan payment, have been subtracted.

When you have determined your monthly net income, you are ready to take the next step in creating your budget. What are your monthly expenses, and where does your money go? Recording your monthly income is probably an easy exercise; uncovering expenses is a different project altogether.

Specifically, your budget should include:
Fixed expenses: Payments that rarely or never vary from month to month and year to year. They include rent or mortgage payments, insurance, vehicle loan payments, furniture and appliance loan payments, personal loans and credit card payments, Internet and email services and contributions to your savings program, if they are not automatically deducted from pay.

Variable expenses: These expenditures fluctuate and can be at least partially controlled by you. They include food, clothing, utilities, transportation, long-distance and cellular phone service, household supplies, gifts and charitable contributions, personal care, recreation, entertainment and money for other miscellaneous purchases.

To gather expense information, review cancelled checks, checkbook registers, ATM receipts, bank statements, credit card statements and whatever else will tell you how you spend your money. Because some expenses are hidden, with no electronic or paper record to expose them, and others occur infrequently, you may need to track spending manually or with the help of a software program for several months to get the most accurate record of all fixed and variable expenses. If an expense occurs less frequently than each month, simply prorate it to fit your monthly format.

When you have calculated and recorded your income and expenses, you are ready to create a personal budget that becomes your monthly guide. When you total your expenses, they should be equal to or less than your income. If your first attempt is too heavy on expenses, you have three choices: increase income, reduce expenses or do both.

In many cases, the only practical solution is to trim expenses. Consider which of them you can reduce without sacrificing the quality of your lifestyle. Because fixed expenses are based on previous spending commitments, they probably cannot be adjusted. Take a look at variable expenses that might be reduced or
even eliminated with little or no pain. Remember that realistic budgeting means making wise choices, not enduring deprivation. Rather than taking drastic measures, such as selling your vehicle or canceling your annual vacation, consider cutting small amounts from several expense categories. For example, each month eat out less often and reduce your restaurant bills, and use e-mail instead of long-distance services to cut your phone bills. Before you know it, you will actually balance your budget and even find extra funds to increase savings for your spending goals.

And though your budget must always be realistic, financial advisers caution that it should also be flexible. Budgets often fail because they are too rigid; instead, make sure you include some breathing room for unplanned, but necessary, expenses. Readjust your budget regularly to fit your changing needs and circumstances. A budget that makes sense for you today will probably not work as well by next year.

TRACK EXPENSES
A budget has little value if you create it and put it aside. Knowledge is power, and keeping an accurate and updated account of what you spend is necessary to understand and manage finances.

When you match what you actually earn and spend to the income and expenses planned for in your budget, you will know — without a doubt — if you are on track or in trouble. The task is easy for conspicuous expenses such as housing, telephone or a loan payment. But accounting for cash spending — lunches, movies, sodas and anything else you pay out of your pocket — and less obvious expenses, such as bank fees — is a tougher assignment. If you cannot rely on your memory, you may need to record daily expenses in a notebook. Money management software such as Microsoft Money or Quicken can make the job even easier with electronic spreadsheets that show you, with just a few keystrokes, how much you are spending on everything from cappuccinos to credit card interest.

Whether you track expenses online or on paper, you will make the job easier if you save receipts from all purchases and use your checkbook and checkbook register to document where you spend money.

CREATE A SPENDING PLAN
A budget can keep you out of trouble, but a spending plan can make your dreams come true. Everyone has goals that require more money than they can possibly squeeze out of the monthly budget. A new vehicle, a plump savings account, the vacation of a lifetime, a wedding or a college education — whatever the goal is, it will require a financial plan of action to accomplish. A spending plan allows you to dream about your future and take concrete action month-by-month to turn your wishes into realities.

Look into the future. What do you see? Your spending plan begins with a written description of that vision of the future — your needs, wants and desires — expressed as short-term, intermediate- term and long-term goals. Breaking big dreams into manageable pieces and writing them down make achieving them more realistic and less overwhelming. Each goal represents something specific you want to do with your money within a certain period of time — a goal that will give you a purpose for the way you spend your money today and tomorrow.

Short-term goals can be accomplished quickly — in a few weeks or months, but no longer than a year. A short-term goal might be to begin an investment program or take a modest vacation.

Intermediate-term goals can be accomplished in one to five years. An intermediate- term goal might be to eliminate all credit card debt or buy a new vehicle.

Long-term goals can be accomplished in five years or longer. A longterm goal might be to buy a home or fund a retirement account.

You are most likely to achieve your goals if you make them:
Realistic. An aggressive, unreachable goal can frustrate you. If you cannot save $300 each month for next year’s vacation, for example, set a more realistic goal to save $150.

Specific. Clarify your goal with a precise and detailed description, and write it down. An example: “I will save $150 a month for the next 12 months, so I can buy a new computer.”

Flexible. Readjust your goals when life hands you a setback. If your income or expenses change, you may need to modify goals temporarily to accommodate to new circumstances, but avoid the temptation to give up or find a shortcut that puts you in debt.

Once you spell out your goals, keep them front-and-center. They will be your inspiration to stay on task and on track financially. Review them periodically to measure your progress and to ensure they still make sense for you.

CREATE AN EMERGENCY FUND
A plan for the unexpected, an emergency fund cushions you against the financial chaos that you might experience if an unexpected illness, disability or other crisis keeps you from earning income or puts an unusually large financial burden on your shoulders. Simply put, the fund is a protective measure against going into debt for basic living expenses if you suddenly lose income or add expenses.

Traditional wisdom suggests that the fund should be equal to at least four to six months of your fundamental living expenses, enough to cover necessities and pay ongoing monthly obligations. Make sure that these funds are located in a separate, safe and liquid account, such as an interest-bearing savings account or money market fund account.