Your cost of living has a massive impact on your financial health; keeping it in control keeps you out of debt and building independence. The most effective way to keep your spending under control is by make and sticking to a budget. Most people are paid biweekly and calculate their monthly income as two paychecks, or four weeks. There are templates for this in Microsoft Excel or can easily be done by hand with a calculator.

Making a budget is straightforward if you start at the top with your long-term savings and work your way down through rent and needs to your wants before stepping back and examining the whole picture.

Save before you Spend

The first thing you should do - and you may have already done this - is set aside savings from your budget. This will be revisited again last to ensure your future self is being fair to your present self, but you should prioritize your savings first. While this may be painful in the short term, the more you save now, the sooner you can retire and the more secure your retirement can be. And there are other reasons to save; maybe you are planning to have a kid soon or put down a down payment on a house, and saving additional money for that now will help you prepare for it. If you anticipate future expenses and are able to, it is never a bad idea to start saving money for them now.

A basic, effective savings strategy is as follows:

  1. Save through your employer to meet their match - likely around 6%.

  2. Pay at least the minimum amount on your loans and always at least cover the interest.

  3. If you are young and these two things combined are less than 15% of your salary, set aside a full 15% of your income. If you are closer to retirement, start saving more than that. If you expect to make a lot of money for a short time, start saving much more than that.

  4. When you get a raise, visit Getting a Raise for advice on how to adjust the amount you save.

Second, Determine your Rent or Mortgage

Once you are paying your rent, you can’t adjust it until the next year - and you have to move to do so. You should budget your rent second after setting aside money for your future self.

The common suggestion is to put 30% of your income towards your rent.

Some places, like San Francisco, have high rents and mean that you may be forced to put more than 30% into your rent. If you are putting, say, 35% of your income into rent, then you should be committing 5% from your needs and indulgences for the next year and not 5% of your savings. Rent is not savings and a mortgage is not as secure as the entire stock market. (2008 called, and they want financial security back) If you are able to spend less than 30% on your rent or mortgage, then that is a great way to put more money in savings - better for you in the long term - without sacrificing your budgeted wants and needs.

Between your savings and rent, you will probably have about 55% of your after-tax income to spend on your needs and then your wants.

Third, Calculate Your Needs

The third thing you need to determine is how much you spend per month on things like groceries, utilities, internet access, cell phone bills. In most of the country, your needs also include car payments (or repairs) and gas. This also may include things like prescription glasses, contacts, or medication. With 15% saved for retirement and 30% put into your housing, you should have 55% of your income left at this point. To determine how much you are spending on your needs, look back several months at these bills to determine what you spend each month. Being honest about this number will prevent you from cutting into wants that you had planned for and promised to yourself. If you are looking to minimize the cost of your needs:

  • If you are shopping for a car, look for a used car.

    • Cars that are cheaper also tend to be more fuel efficient. (sports cars, muscle cars, and SUVs are more expensive both to buy and to drive)

  • It is a lot cheaper to buy last year’s cell phone and carry it for as long as possible than to replace it every two years.

  • If clothes aren’t a main focus for you, consider buying your clothes from a secondhand store.

  • Make your lunch at home and take it to work.

  • If you don’t like cooking, buy frozen foods instead of eating out; it combines convenience with thriftiness.

Fourth, Calculate your Wants

This is the fun part! Once you figure out how much you are saving and how much you are spending on your various needs, you can work with what is left to determine what you can indulge in. When picking your indulgences, you should remember that each bears an opportunity cost - that is, by spending $15 on a movie, you now have $15 less to spend on a new jacket or a pedicure. In order to optimize the income you have left, you can try:

  • If you eat out for lunch, you can eliminate this cost by taking an hour every Sunday to make your lunches for the week while watching Netflix ($12.99/month)

  • Look for activities that don’t necessarily cost a lot, like hiking or going to the zoo.

  • Package your indulgences - a month of Netflix is cheaper than going to the movies every week

    • Every couple of months, check your bills and statements for subscriptions you no longer use and cancel them

  • Think ahead with your purchases by leveraging end-of-season sales.

  • Host your friends for drinks instead of going out to a bar

Fifth, Save for Larger Indulgences

If you are able to keep the cost of your indulgences down, you might also have room in your budget for an annual vacation. The money you have left after saving, paying rent, buying your necessities, and keeping yourself sane can be put into a fund for a somewhat larger annual treat. You can take the amount you have left in your monthly budget and multiply it by 12 - depending on how much you are saving for this, it could be things like an extra-nice dinner for your birthday, an upgrade in your car when you have to replace it, or a vacation with your family.

Sixth, Revisit Your Savings

We started by assuming 15% of your income was savings, which would allow you to retire approximately 30 years after you start working. Now, we have to face the fact that:

your future self wants more savings today but your present self wants to treat yo’self

If you have reached the end of your needs and do not have enough to cover all of your needs or for any indulgences, you may need to decrease your savings for retirement. It is not realistic for everyone to save a full 15% (or more) for retirement. For those who are able, it is important to know that saving 10% or even just 1% for retirement is literally infinitely better than saving 0%. If you need to decrease your savings from the recommended amount, then, we recommend you do so in the reverse order of the initial recommendation:

  1. If you saved extra beyond your employer match and paying off debts to reach 15% savings, this is the first place that your savings can be decreased, but doing so means you will save more later to catch up or retire later.

  2. You may be able to refinance from, say, 10-year loans to 15-, 20- or 30-year loans in order to lower your monthly payment; in making this trade-off, remember that the longer you are paying for your loans, the more you will ultimately pay.

  3. If you have already refinanced your loans, you can decrease the amount your employer is matching into your retirement fund - but remember that this is like giving yourself a pay cut.

Finally, Stick To Your Budget!

Now that you have made your budget, the most important thing is to stick to it every month. Your finances will be under control and you will be more and more secure every month! When you spend money, keep track of it in Microsoft Excel or Google Sheets. If you want to buy yourself an expensive jacket or TV, then put a little bit of the money aside each month until you have enough instead of putting it on your credit card and paying it back with interest - it is cheaper this way.

Good Luck!