There comes the point where we all must settle down, create a budget, and follow it. Whether this time comes in your 20s or 70s, it SHOULD happen.
But why has budgeting become such a bad word? How have credit cards become a staple of middle-class families?
It’s no accident that credit cards have become so prevalent, and budgets have disappeared. No matter the case, we all have the ability to follow a budget—we only need the reason.
Net Worth vs. Passive Income
Why is budgeting important? Budgeting is the only way to become wealthy. Wealth is the difference between income and expenses.
Therefore, a budget helps you determine what income you have coming in and what expenses you have going out.
Together, you can control your cash flow, eliminate useless expenses, and begin to save (and invest) the difference.
Budgeting vs. fixed income. I wrote an article titled “Budget vs. Fixed Income” that explains the difference between the two mindsets.
5 Steps to (Financially) Running a Household
Most middle-class families live on a fixed income—their employment income determines their spending level. Let’s look at a typical American household.
The Jacksons earn a combined $12,000/month from their two jobs. With their level of income, they buy a house with a mortgage of $6,000/month.
Everything goes downhill rather quickly from there. They added two car payments totaling $1,500/month and other expenses totaling $3,000/month—this leaves them $1,500/month to save & invest.
However, that $1,500/month first must pay down credit card debt, student loans, and personal lines of credit. In this case, they have $30,000 left across all their debt. With this tight fixed-income lifestyle, they find themselves turning to credit cards by the end of the month.
Investing for Interest 102: Super Safe Savers
Why is living on a fixed income wrong? Your income should not determine your living standards. You must set your living standard outside your current income level—we call this living below your means.
As you set your living standard, you begin living on a budget. The intent of a budget is to create additional cash flow that you use to build an emergency fund, save for assets, and invest for the future.
Let’s take the Jacksons again, but this time with a budget. They still earn $12,000/month but buy a house for $3,000/month.
Their goal is to live on $5,000/month out of the remaining $9,000/month. It may take effort, but they can live comfortably in the price range.
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They pay off and keep their cars for another five years. They reduce miscellaneous entertainment spending and keep tabs on their food allowances.
With the remaining $4,000/month, they tackle their $30,000 in debt. They complete their debt payoff journey in two years using the snowball method.
They then focus on saving a Tier 2 emergency fund of $10,000. After that is complete, they work on investing in savings bonds, treasuries, and dividends.
Finding your budget. But how do you find your budget? Do you just make it up from thin air? Your budget needs to be aggressive because you want a high savings rate.
Your Income Should Increase Every Year
A great starting point is the 50/30/20 budget from the book “All Your Worth.” The 50/30/20 budget says that 50% of your income goes to expenses (including housing), 30% to wants (entertainment), and 20% to saving and investing.
The Jacksons’ 50/30/20 would look like $6000 for expenses, $3,600 for wants, and $2,400 for saving and investing. I already know what you are thinking—housing is too expensive.
Budgeting around housing. Yes, housing is super expensive today, and it may take up 50% of your budget before food, utilities, and gas.
Single Ladies, What Are Your Retirement Plans?
But desperate times call for extreme measures. To increase your chances for success, you must make a change. Do you want to get ahead financially? Do you want to give your children a massive head start?
Nothing I say can make you change. However, the 50/30/20 will show you that your budget, and therefore your life, is out of whack.
Some recommendations to reduce your housing expenses are to move to an apartment, relocate to a small town while working remotely, or get roommates (family or friends).
My budget. I love my budget because I already bake in savings and investing. I wrote about my step-by-step budgeting plan in “Build a $1,000 Emergency Fund in 10 Steps.”
The Dividend Debit Card
Regarding my personal spending for food, gas, and entertainment, I give my $1,500/month or $50/day. I live in San Diego, so my personal budget ensures I can meet my overall household obligations.
Creating and living under a budget is about your motivation to achieve financial freedom. Saving even $400/month is beyond what most people can reach.
Throughout this series, I will show you how to increase your income through investing. My wife and I received $1,700 in dividends last month.
Even if we never invested another penny, that $1,700 is enough to set us free. Every month, we can reinvest that cash flow into more dividend-paying stocks. This will increase our cash flow every month.
How to Use Credit Cards
Finding the right budget. First, you must write down all of your income and all of your expenses. It may take a couple of months to see all the hidden charges you racked up over time.
There is no need to rush—you want to get it right. Do you have to budget down to the penny? Yes, every penny, dime, quarter, and dollar is vital to your mission for financial freedom.
Eventually, you can round your numbers, but not from the start. You want to document every expenditure and all the interest from your savings accounts.
What is Fixed Income?
Conclusion. It is through this extreme budgeting behavior that you start to become wealthy. But you don’t need to be cheap and miserable.
Don’t become a scrooge. You can still give to charities and buy McDonald’s for your kids—just need to write it down. Don’t mistake being frugal with being a cheapskate that everyone hates.
Budgeting helped us pay down $77,000 in debt and build a six-figure dividend portfolio in three years.
Overcome Financial Adversity
The best part is using positive cash flow to live our lives—no more living on credit cards. Having a $25,000 credit card limit with a zero balance is incredible. I remember when that same card had a $24,000 (out of $25,000) balance. Those were dark times.
Creating a budget is the first step to building wealth. As you make more money, you can slowly increase your budget for nicer things. After three years, I added some video services and Nintendo games back to my lifestyle.
Don’t let your credit card balance scare you away from budgeting. Face your fears, open your statements, and determine your net worth. If it is negative, work on making it positive—it’s that simple. Good Luck!
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