This topic is more geared towards individuals that are finishing their school work and are entering the workforce. That being stated, this topic could be a refresher for the rest of us that are working...or have even retired.
A few months ago, I enjoyed a beer with my mentor's 25 year old son. My mentor, who will remain nameless so he can protect his reputation, was my first legitimate boss I've ever had. I've known him and his family since 1994. He's a great man, and you couldn't ask for a better family. Back in May, I dropped by his house in Mebane to shoot the breeze. During the conversation, they told me that their son had a lot on his mind. He just came out of college and had entered the workforce. .
After talking to these find folks, I contacted their son and invited him to a local watering hole for a beer. Their son was incredibly stressed. He had a job making around $32,000/year, but he also had $40,000 of student loan debt, credit card debt, a car payment, and had to make some additional miscellaneous monthly payments. In addition, he had to pay rent (he's renting a house with one of his friends). What does he do?
There are two main facets to developing a monthly budget: budgeting for money that is coming in and budgeting for money that is coming out. However, before you can start a budget, you have to create your own balance sheet. What is a balance sheet? It's merely listing your assets (cash, property, investments) and listing your debts (what you owe).
I'll give you an example of a balance sheet:
1st car: 10,000
2nd car: 8,000
Retirement savings: 75,000
Total assets: 303,000
Line of credit: 20,000
car debt: 4,000
credit cards: 2,000
student loans: 20,000
Total debt: 186,000
Net worth: 117,000 (net worth is merely subtracting total debt from total assets).
The following is an example of a monthly budget:
Your monthly take home pay: $3,500
Spouse's take home pay: $2,500
Total take home pay, per month: 6,000
Home mortgage (including escrow): $1,100
Line of credit: $200
Car payment: $300
Student Loans: $250
Cell phones: $100
Power bill: $150
Home maintenance: $200
Gas/Vehicle maintenance $300
Life Insurance: $100
Car Insurance: $100
Child care: $800
Other expenses: $700
Total expenses: $5,850
Please note that "Other expenses" entails many different things. It could be pet expenses, maintenance on your heat pump, etc. These expenses occur periodically, but maybe not each month.
Where do you start when you join the workforce? First off, have an emergency fund. A good initial emergency fund is one months take home pay. To get that money, you can try to work a second job, sell something that you own, or work some overtime. This is a sacrifice, but it's a sacrifice that will take away long-term stress.
Second, let's pay off what I call "bad debt". "Bad debt" would be anything you owe on credit cards that have lousy interest rates. Anything right now with double digit interest should be paid off immediately.
Third, I'd try and expand my emergency fund from one month to three months of take home pay. Some will balk at this idea, but this cash on hand isn't an investment, it's merely insurance.
Fourth, start paying off other debts such as car loans and student debt. Making accelerated payments will save you money in the long-term.
Fifth: start placing more money in retirement. Many companies offer 401(k), 403(, or other profit sharing plans. Many companies will make a match, too. Ideally, you want between 12-15% of your income going into these plans. This percentage includes your employer's match, so if your employer gives you 4%, you only need to put in 8-11% of your income in the plan. Some will ask whether to go traditional 401(k) or Roth 401(k). Personally, I have funds in both. There's different things to look at for tax implications, but you won't hurt yourself by investing money in a retirement plan.
Sixth: If you have kids, start saving money for their education. I place education behind retirement because you can always "catch up" with education, but once you are retired, you are pretty much on your own. Yes, that sounds cold, but your kids can help out later with the cost of their education.
Seventh: Expand your emergency fund from 3 to 6 months.
Eighth: Go ahead and pay off that house! Think about it: wouldn't it be nice not to have to make that huge mortgage payment each month? It's a novel, but very attainable deal.
Should I use credit cards or a debit card? Personally, I use a credit card which is opposite of what most pundits will tell you. However, I do things differently than most: I pay off our credit amounts on the 15th and 30th day of each month. I also have developed a system where I've budgeted money that will be used to pay off the credit cards. I use the credit card for two reasons: to help me keep good credit and because I'd rather deal with contacting the credit card company on a fraudulent transaction than I would having to find out after the fact that someone has depleted my bank account. For those of you with no discipline, try and use cash in lieu of a debit card. That's a good plan.
Finances are a burden for most of us. However, we need to accept this necessary evil so we don't share our financial burdens with friends or family members. For example, if a $1,000 bill comes your way, let's not try and borrow money from a family member. It can be very awkward.
The good news is that over time, you will see your salaries rise. Some will tell you that what you make, won't matter with budgeting, but I totally disagree. While money won't buy you happiness, it will allow you to buy some Advil if you have a headache. Having salary increases will help alleviate some of the financial stress in terms of budgeting. What hurts most people is that when they get a 4% salary increase, they increase their spending by 5%.
Just remember, this isn't a sprint, but this is a marathon. Show financial discipline by trying to avoid the urge to blow your money on something that won't give you happiness, but will later on give you stress.