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6 Steps to a New Year Budget

A budget is the first step to fiscal fitness

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According to a recent survey, the second most common New Year’s resolution was to improve finances. Now is the perfect time take control of your 2024 finances by building a relatively simple budget. Why budget? If you don’t measure what you are making and spending, it’s virtually impossible to change and take charge of your financial future.

Admittedly, budgeting is a about as much fun as losing weight. And aside from the new prescription weight-loss drugs, the only way to lose weight that has stood the test of time is to burn more calories than you take in. The same goes for achieving financial independence: You must take in more income than you spend.

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Step 1: Calculate last year’s income and expenses

Income is pretty easy. It’s all the cash that was paid to you, such as Social Security; your paycheck (after taxes and other withholding); investment income, such as dividends and interest; and any other material amounts of cash, such as a large gift from a relative.

Expenses are a bit harder. Look at what you spent last year, and categorize it according to type of expenditure, such as mortgage payments, other debt, utilities, food, insurance, medical, taxes, travel and miscellaneous. This may seem daunting, but many credit card companies provide a summary of your expenditures for the year. A combination of those credit card expenditures plus items paid from your bank accounts typically amounts to nearly all your expenditures. Unless you spend an enormous amount of cash, you can categorize your cash withdrawals from the ATM as miscellaneous.

Next, a bit of a sanity check: Your income less your expenses should be close to what you saved (or didn’t save). If your calculation shows you took in $10,000 more than you spent but you fell further into debt, something is wrong.

Step 2: Take a stroll down memory lane

Now that you have a summary of the past with a lot of supporting detail from your credit card categorizations, think about those expenditures. Note which expenditures were fixed, meaning you can do nothing about them, like property taxes. Many fixed expenditures can, however, be reduced. For example, you could shop around for the right insurance at the right price.

When it comes to expenditures that are more discretionary, concentrate on the largest ones. Consider the following when evaluating each expenditure:

Did it bring you pleasure? In other words, did you get more benefits from it than it cost you?

Did you get it at the best price?

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Step 3: Take a first stab at building a budget

Now that you have a good understanding of the past, it’s time to think about the future. What will change in both your income and expenses? Social Security payouts will increase by 3.2% in 2024. That’s about the long-term average inflation rate, so all things being equal, your expenses will increase too.

Luckily, it’s never been easier to build and track a budget, thanks to the web and smartphone apps. AARP has an online budgeting tool, and there are many apps, such as those listed here, to assist you. One of these, Honeydue, helps couples stay on top of their money.

Once you are done, you’ll have a rough first stab at a budget. Take a quick look at how this compares to what you took in and spent last year.

Step 4: Refine your budget

Now comes the analysis. I bet there were some expenses last year that you didn’t expect. Those particular surprises may not come up again this year, but others will — things like major dental work or a dead water heater, for example. You can prepare for the likelihood that something costly will go wrong by putting a reasonable amount in a category called “contingency.” This should be at least a few hundred dollars.

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Next, budget for what I call “lumpy expenses.” You shouldn’t need to purchase a car every year, but you’ll have to buy one eventually, so budget a reserve for the purpose of purchasing a car every so many years. I’ve found the single easiest way to cut expenditures is to buy a modest car (especially one a few years old) and keep it for a decade or longer. It will get you from A to B just as quickly as a brand-new luxury car.

Finally, split each line item into two additional categories: “must have” and “nice to have.” For the most part, you must have utilities and pay taxes, so those line items are easy to categorize. But some items, like travel, can be a combination of “nice to have” and “must have.”

For instance, you could budget $5,000 for travel, with $2,000 being a “must have” to visit the kids and grandkids. The remaining $3,000 for a winter vacation might be “nice to have,” so you could reduce it or cut it out completely if things aren’t going well with your finances. By pre-identifying areas you can cut, you’ll be more prepared to quickly make changes if necessary.

Step 5: Measure your performance

Don’t wait until the end of the year to see how you did. At that point, it will too late to take any corrective action for that year. Instead, periodically look at actual expenditures compared to your budget. How are you doing? If you are on track, pat yourself on the back for having the discipline to develop and follow a plan. If not, you may need to make some of the cuts you identified in the previous steps.

Step 6: Celebrate

Clearly, if you are coming in at or better than budget, you deserve to celebrate. You are making strides toward financial independence and have more of a cushion in case a large emergency expenditure comes up.

But even if you fell short of the planned budget, you should still celebrate, knowing that this process likely resulted in an improvement. It’s pretty much like weight loss: Even if you don’t reach a specific goal, you should be pleased with any progress you do make.

Budgeting is to your financial wealth what weight loss is to your physical health. And feeling good about your finances reduces stress, so it has a positive effect on your physical health as well.

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