Crunching the numbers
The first step is to list the various claims on your income. A typical budget breaks down as follows.
A place to live. Whether you rent or own, there are unavoidable housing costs such as rent/mortgage, utilities, telephone, and property taxes. But when the going gets tough, everyone can live without premium cable, the weekly cleaning service, flowers at the Saturday market, or new wine glasses. The historical maxim was that housing costs should not exceed one-fourth of take-home pay, although housing markets in some regions (New York City, for example) make it difficult to follow this rule of thumb. If rent or mortgage is significantly higher, though, it could be time to consider a roommate, refinance, move back home, or do something else to plug this drain on resources.
Transportation. Car payments, maintenance, gas, insurance, license and car registration, toll payments, parking fees, and tickets are legitimate expenses in any budget. For those without a car, costs of public transportation and taxis count.
Healthcare. Even great employee benefits have additional monthly costs for premiums, copays, medication, dental fees, contact lenses, and more. Those paying directly for health insurance might do some price comparisons to ensure they're not paying too much.
Taxes. When listing what you pay for, include all taxes deducted from your paycheck: federal, state, social security, occupational privilege etc. (But don't deduct them twice. Start with gross salary at the top of the list, not take-home pay.)
Debt service. For people who habitually spend more than they earn, this category can get ugly. List everything on which you owe money - car, student loans, credit cards, overdraft. Personal loans from friends and family are still debts and have to be planned for. Include principal and interest payments. "If more than 36 percent of your income is going out on monthly payments, look for ways to cut them," said Keith Fortier, Director of Compensation with Salary.com.
Entertainment. Few people can estimate accurately how much they spend on fun. Think restaurants (even fast food), drinks at the bar, cover charges to nightclubs, upscale coffee drinks, movies, concerts, poker night, art exhibitions, golf, bowling, salsa lessons, video rentals, magazines, CDs. This category is the king of discretionary expenses, meaning the world won't end if you have to forego the pleasure. When it's time to cut back, start here.
Personal. Food, clothing, shoes, jewelry, health club fees, fitness expenses, hair stylists, manicures, makeup, toiletries, and candy all count. There's room to maneuver in this category. How much did you spend on dry cleaning last month? Wash-n-wear means earn-n-save.
Children. Most parents know that in addition to being bundles of joy, children are also bundles of costs: day care, diapers, clothes, shoes, toys, babysitters. Expenses related to raising a family are much easier to manage if you plan for them.
Giving. Many people have strong financial commitments to nonprofit organizations such as religious organizations, schools, arts organizations, and social service agencies. In addition, most people give gifts at birthdays, weddings, baby showers, office celebrations, and Christmas or other holidays. When creating a budget, allocate money for giving every month because you know you're going to need it. When the time to fork out for birthday or Christmas presents actually arrives, it won't be such a budget-buster. Consider picking up presents during sales year round in order not to leave it to the last minute, when retailers can charge top dollar.
Vacations/recreation. The best way to afford vacations once or twice a year may be to budget for it on a monthly basis. This is a variable, discretionary expense. If you're broke, consider a local camping trip or some quality time with your relatives. Include vacations in your budget anyway, because sooner or later everyone needs a break - you might as well plan for it.
Savings. Experts encourage people to save 8 percent of their gross income. Most people with money worries have nothing left over to save. Developing new habits of cost-cutting in discretionary categories can enable long-term savings and planning to begin.
Emergency money. This is a crucial category, because it can make or break your faith in budgets over the long term. All of the expenses detailed above are routine, involving spending that's obvious and ongoing. But nonroutine expenses occur; they're just unforeseen. Examples include major car damage, losing teeth in a hockey game, a last-minute bachelor's party weekend in Vegas, or even getting laid off. The reality is, unforeseen things happen all the time, and you need a safety net so that when they do occur, they don't put you into major debt. "One way to estimate a monthly figure is to add up any nonroutine expenses that cropped up last year, then divide the number by 12," said Fortier. It's not foolproof, but it's a start.
Where to start
Because individual cases are unique, you might want to start with consulting an agency such as the National Foundation for Credit Counseling, a nonprofit organization with a network of qualified financial counselors. They can help you to record your expenses to help you design a budget that will keep you debt-free.
Visit Money.com's Instant Budget Maker to find out more on how to allocate your money. By inputting a few details about yourself and your household, you can find out how your spending measures up to other American households with matching demographics. You can also analyze your budget plan by supplying additional information on your spending.