Tuesday, June 26, 2007

Making your money fit your priorities: budgeting advice for new (and not-so-new!) grads

A friend of mine just graduated from college, and asked some advice about budgeting.  I thought about it for a minute, and told him that there are no hard and fast rules... budgeting is about understanding your priorities and finding ways to make them work.  After reflection, I still think that soul-searching about your values is the most important part of budgeting-- money is and should be just a tool to help us shape our lives the way we want-- but it is also important that it be informed priority-setting, with a full understanding of what your constraints are and what options you have available. 
This guide is addressed to those new to the workforce, but I think most of the principles are good ones for anyone...
Understand your constraints:
  • Figure out your take-home pay. Remember that your gross pay and your net pay will look very different-- run your information through a calculator like this one to see what you'll actually be taking home.  You can do this even if you don't have a job yet-- in fact, it's a great way to understand what different salaries will mean for you. 
  • Figure out your fixed expenses.  Think as thoroughly as you can about your basic, unavoidable spending.  What is the cheapest rent you could reasonably get?  How much will basic utilities cost?  How much will you spend on groceries?  Will you have health insurance payments?  Car payments and/or auto insurance?  Student loan and/or credit card minimum payments?  Is there clothing you really have to buy for work?  Are there other expenses you consider truly non-negotiable, like trips home to visit family?  Even if they're not monthly recurring expenses, you'll have to pay for them somehow, so divide the cost up and plan to save a portion each month. Now, how much do those basic costs add up to and how does that compare to your take-home pay?

Understand your options and their consequences:

  • Read up about the smart moves you have available and make sure you know why they're smart.  No one will force you to take advantage of all of them, but it is wise to at least know what you're deciding on.  Make sure you really understand the benefits of compounding interest, the advantages of starting young .  Read up on the benefits of opening a Roth IRA at your age, especially if you're in a low tax bracket.  Learn about the 401(k) or 403(b) from your employer if you're offered one, and if there's a 100%, 50%, or even 20% match, keep in mind that it's the kind of return on investment you won't find anywhere else.  Find out if you're eligible for the  Saver's Tax Credit, and think hard about the benefits of saving for retirement and getting 10-50% back in your pocket.  If you have credit card debt,  take a serious look at how much you're throwing away in interest which you could keep if you accelerated your payments, and understand that paying only the minimum will keep you in debt for decades.  You don't have to make every smart move in the book, but you should at least make informed choices.
  • Have a plan for emergencies.  If your plan is asking for help from your parents (or other relatives), that's okay, if you're sure they are willing and able to back you up, and you're comfortable with asking them to.  If they're not or you're not, you need to save up an emergency fund.  Convential wisdom suggests you shoot for three to six months worth of expenses... figure out a monthly savings amount that works for you, but remember that until your emergency fund is bulked up you risk falling back on Plan B-- and if Plan B is credit-card spending, think long and hard what that means in terms of the interest payments you'd be handing over to the credit card company.

Understand your priorities:

  • Do some soul-searching about what matters to you.  What optional spending is most important to you?  Do you want an apartment in a better location, with more space, and/or without roommates?  Do you want to pay for cable and/or Netflix?  Do you want to spend on books or music?  Better food?  Clothes, shoes, accessories? Do you want to eat out, go to bars, movies, concerts, go on vacations?  Which can you find smart, creative ways to do more cheaply, and which are so important that you won't cut corners?  Do you want to make donations to charity and/or causes?  If you don't have a job yet, this is the time to think about how different job possibilities with different salaries (and benefits!) fit into your priority list-- what spending/saving are you willing to give up for a great job?  Then take a look at your available funds, and your list of priorities, and make a plan for what you can spend on each.  That's really all a budget is. 
  • Think about what sacrifices today are worth it for benefits tomorrow, and vice versa.   You can put money into retirement savings today and get way more bang for your buck than if you try to catch up later.  You can save up an emergency fund and help cushion the stress of an emergency later.  You can pay the minimums on your credit card or add credit card debt in order to have a better cashflow today but give yourself a huge interest burden for years to come-- or you can pay down (or avoid) debt now and have the freedom of no payments later.  It's silly to be completely focused on the future to the exclusion of the present-- none of us know what tomorrow will bring-- but you need to find where the balance lies for you.  (I struggled with this in Save for tomorrow or live for today?)
  • Be honest with yourself about your weaknesses.  If you find that your priorities don't match what you're spending in certain areas, you'll need to make a plan to cut back in order to achieve your goals.  Don't make a budget that rests on expecting dramatic changes, but do set goals and commit to making progress, and when you slip, remind yourself that you're doing this because you decided you wanted something else more.  And if you realize you don't actually want the other thing more, change your budget!  I love this quote from Gandhi:

"As long as you derive inner help and comfort from anything, you should keep it. If you were to give it up in a mood of self-sacrifice or out of a stern sense of duty, you would continue to want it back, and that unsatisfied want would make trouble for you. Only give up a thing when you want some other condition so much that the thing no longer has any attraction for you, or when it seems to interfere with that which is more greatly desired."



Michele said...

Great post - thank you!

MoneyChangesThings said...

I would Urge,Cajole, and Cheerlead for a young person to put some money away each year for retirement. It seems so far off, but if you look at the extra compounding you get from those early years, it is soooooooo worth it, even if it means going without something else. Also, if you get a retirement account going early, and the compounding is working for you, then if you have to cut back a bit later (though by then, it's a habit, so that's less likely) you ALREADY have a retirement nest-egg going for you. Pay yourself first, in other words.

Malachi Leopold said...

Very thought-provoking! I’d like to invite you to republish this entry as a posting on the SRI Open Forum. My firm, Marc J. Lane Investment Management, Inc., hosts the online community bulletin board called The SRI Open Forum (just Google the name to find it) which was built as the central location for the free exchange of ideas and experiences around everything related to socially responsible investing, corporate governance, environmental issues, social enterprise, etc. I invite you to visit the site, and feel free to republish this article as a posting. Hope to see you there!