Planning for a Major Purchase > Budget for the Good Life
Budget for the Good Life
by Chris Warren
There's a common assumption among Americans that having more money leads to a happier life. A few years ago, financial journalist and author Jean Chatzky decided to test that hypothesis and found some surprising results.
With the help of a polling firm, Chatzky surveyed 1,500 Americans and learned that having enough money to cover housing, transportation, groceries and an occasional vacation was vital to happiness. According to the data, all these items could be acquired with $50,000 in annual income on average.
Chatzky also found that people who earned $100,000 per year were no happier with their standard of living than those who made half as much. She concluded that when it comes to happiness, how you manage your money is far more important than how much you make.
Indeed, smart money management comes down to budgeting, which is the best way for people to reach such short- and long-term financial goals as saving for retirement, buying a new home or getting out of debt. For you to be successful, experts say, the cash that leaves your wallet must go toward the real priorities in your life. When people start to budget, they often find that their current income actually provides them with enough money to live comfortably.
Judy Lawrence, a personal finance author who helps people improve their money-management skills, says her biggest hurdle is getting people to view budgets in a positive way. "Budgeting is not deprivation," says Lawrence. "It is one of the tools in life's toolbox."
Crafting a budget requires that you see how you're spending your money. There are a couple of ways to do this. Some financial experts suggest carrying around a notebook and jotting down everything you spend (even on something as small as a pack of gum) over a one-to-three-month period. Others suggest keeping receipts and then entering the information into a home accounting program that automatically separates outgoing cash into broad categories, such as entertainment, groceries and transportation.
No matter what method people use to chronicle how they spend their money, once it's done and the details are closely examined, the results are almost always surprising. Comparing overall monthly expenditures with income, for instance, reveals that someone's credit-card balance is ballooning.
Says Ken Downer, a financial planner in Burnsville, Minnesota: "I'll sit down with somebody and go through the budgeting process and find out that they're spending $200 or $300 a month on eating out. When I ask them if it's worth the money, they usually say no way."
A clear picture of where their money is going can often open people's eyes in a way that yields positive changes. For some, simply knowing that they're spending $150 per month on, say, DVDs or manicures is enough to make them drastically cut back.
Janet Bodnar, a personal finance author and deputy editor of Kiplinger's Personal Finance magazine, suggests guidelines for how household income should be divided. According to her calculations, people should ideally spend 30% of their take-home pay on housing, 10% on utilities and household expenses, 15% on food, 10% on transportation, 5% on clothing, 10% toward saving, 10% on debt repayment, 5% on entertainment, and 5% on car insurance and miscellaneous personal expenses.
Tracking and categorizing expenditures helps people determine whether they are spending too much in one particular category and need to set limits. It is important to note, however, that these are general guidelines and won't apply to everyone. For example, residents of San Francisco, Seattle and New York City generally pay higher real estate prices than do people in the Midwest, so they have no choice but to allocate more of their income to housing.
In addition, people have unique priorities, circumstances and financial goals; their budgets need to be specifically geared to their objectives. Families typically have many more factors to consider than do individuals without children because parents have more areas in which to spend their money.
Even so, single people can't adopt a one-size-fits-all approach. Just ask David Heymann, a 63-year-old retired social worker who lives in Mountain View, California. Heymann's passion is music. He hosts a local radio show featuring Brazilian music, often makes CDs for friends and frequently travels to multiday music conferences. But Heymann's love of music was expensive.
Worried about being able to make ends meet on a fixed income, Heymann sought help from Judy Lawrence, a budget coach. Heymann was initially cautious about seeking Lawrence's guidance, concerned that it meant losing control of his money. But Lawrence persuaded Heymann, who has never balanced his checkbook, to write down everything he spent. Together they reviewed his cash flow and discovered that the one thing he really needed to cut down on, not surprisingly, was CD purchases. They settled on a CD allowance of $100 a week.
The spending cap was actually liberating for Heymann. Before he established a budget, buying CDs was a stressful, guilt-ridden experience. "Now I can buy that $35 CD and not feel guilty," he says. "I feel free to spend money."
Pinpointing priorities, such as saving for a child's education, traveling or even buying CDs, is essential. So too is proactive planning. When Lawrence works with clients, she has them map out ahead of time exactly which expenses they know they'll face -- not just the obvious payments such as a mortgage, but the intermittent items such as vehicle registration renewal or the annual fees for credit cards. "It's all about anticipating and planning vs. reacting," she says.
Sasha Holder learned how to plan ahead after accumulating almost $8,000 in debt shortly after graduating from college. Holder says she was an "impulsive shopper." Today, the 25-year-old administrative assistant has her debt and spending habits under control. She has developed a solid budget and become more aware of her purchasing decisions. In addition, she now keeps careful track of her spending and plans ahead for upcoming expenses so that she has money on hand to cover them.
When Holder sees a product that appeals to her these days, she asks herself whether buying it will bring her closer to her goal of moving into her own apartment. If it doesn't contribute to her "apartment fund," she says, "I turn around and walk away. I would be living paycheck to paycheck if I didn't follow this way of thinking. It allows me to feel comfortable: that I have all my bills paid, I'm putting money in the bank and I still have a little left over for a movie or a nice pair of shoes."
David Scott, an author and a professor of accounting at Georgia's Valdosta State University, says budgeting is empowering. "Too many people don't connect their current spending with achieving many of the goals they've set for themselves," Scott says. It is important for people to become aware of the money flowing in and out of their hands. "A budget can lead to a much happier life because it helps individuals spend their money more wisely," Scott adds. "This in turn allows them to achieve their most important goals."
Today's Focus, Winter, 2006.
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