Creating a Budget

Before you can begin making decisions about how much of your income you'll allocate to pay for the various expenses you have, you need to know the details of your current spending.


One approach is to examine your bank statements, receipts and credit card bills from the past year. Another is to keep a written record of everything you spend for a couple of months. Recording every purchase you make (either on a digital assistant or in a small notebook you carry around with you) may make it easier to keep track of where you are spending your money.

Once you have a thorough understanding of your current spending patterns, you'll be better equipped to make decisions about how you can alter them so that you're on track for meeting your future financial goals. You may find, for example, that you could save more by making coffee at home instead of buying a cup on the way to work or by finding a more economical cell phone or cable TV plan than the one you have now.

Using financial filters

Before you start making cuts in your budget, it's helpful to take your financial analysis further by categorizing your expenses. One way to do this is to run them through two filters. The first separates fixed from variable expenses, and the second separates needs from wants.

Fixed expenses are those that do not change from month to month, such as your mortgage payment or rent, insurance premiums and gym membership. Variable expenses, on the other hand, fluctuate from month to month. They include what you spend on food, transportation, medical bills and entertainment.

The second filter distinguishes essential from discretionary, or non-essential, expenses. More informally, it distinguishes needs from wants.

Essential expenses are those you literally could not do without, such as food, clothing and housing. While you can make choices to keep spending in these areas under control—for instance, not eating out regularly and choosing a smaller house or apartment than you'd like—you can't cut out these expenses entirely.

Discretionary expenses, on the other hand, are more often than not "nice to haves," such as a new cell phone or pair of shoes, but aren't necessary. While this category is probably the easiest place to make cuts in your budget, you don't need to do away with everything in this group to make a positive difference in your spending habits.

By categorizing your expenses, it will become clear where you spend the least and where you spend the most. You can also use your spending ratio as a guide to further clarify the areas that could use some trimming. A spending ratio identifies how much of your total income is going toward paying for a particular expense.

For example, if your income is $60,000 and you spent $20,000 on housing last year, divide what you spend on housing by your total income to find the spending ratio. In this example it would be 33%.

Since a standard guideline for housing expenses is 28% of income, you may want to reduce your housing costs and free up money to put toward other goals, such as your retirement. If this isn't possible, either because you aren't able or don't want to move, you'll have to find other areas in which to cut expenses.

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Learning Lessons

The financial downturn that began in December 2007 came as a surprise to many. If you lost a job or faced steep losses in your investment portfolio as a consequence of the recession, you weren't alone. Like many others, you may have found you needed to make significant sacrifices in order to get back on track toward meeting your goals. While sacrificing may be challenging, it can certainly help you move forward and make the future a bit easier.

Since the economy moves through continual periods of ups and downs, it's impossible to avoid economic downturns entirely. However, maintaining a positive cash flow, saving for emergencies and spending within a budget that will help you meet your financial goals can help ensure that the next downturn won't throw you off your financial track or lead you into debt.