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Budgeting by Expense to Income Ratio

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When you don’t know where your money is going, you’re in the dark about the best ways you can save money. While anytime is a good time to start a budget, many of us are more successful following through when we start the new year with a fresh budget and spending plan.

Further, knowing what percentage, or "ratio" of your budget you should be spending on each major category will help you make changes.

A budget can help you save money for retirement, a vacation, to pay off credit card debt or to make a major purchase. If you have never set up a budget before, this guide will help you on your way.
 

Set up a Filing System

 To maintain an accurate budget, you need to organize your bills so you can sort through them more easily to find out what your expenses were in the past. Your filing system can be just an old shoebox, a filing cabinet, or a software program for a paperless filing system.

 Making a budget requires that you examine your current expenses, and then find ways to cut costs where appropriate. Go through all your bills for the past year and total your monthly costs for your living expenses, separated into the following categories:

  • Unsecured Debts
  • Housing
  • Food
  • Transportation Expenses
  •  Monthly Utilities
  • Clothing
  • Other Expenses
  • Savings
  • Personal Care
  • Healthcare
  • Insurance

Understand that housing should be the biggest budget item. You should include your monthly mortgage payment, home maintenance, taxes and insurance costs in this item.

Food includes the cost of eating out. You will probably be surprised to see how much you spend eating away from home. When trying to save money, eating out is often the first place you can cut expenses.

Transportation costs include anything you must pay in order to own and operate your car. This means any monthly payment, cost of fuel, car insurance, registration fees, vehicle inspections, maintenance and the likely cost of repairs. Repairs are a hard cost to predict. It is best to evaluate your past repair costs and average them over a few years. Add another ten percent since cars are more likely to break down the older they get.

Monthly utilities are those household expenses that recur from month to month in order to keep your home running. These include electricity, natural gas, heating oil, water, cable or satellite television, Internet connectivity, telephone, garbage pickup and similar services.

Personal care includes any expenses for your personal appearance like makeup, haircuts, manicures and similar expenses. Healthcare represents the cost of health insurance, copayments and medicine.

Budgeting Guidelines

 Financial planners recommend these guidelines for American families. Your particular situation is unique, so understand that being near these guidelines is close enough. 

To find your expense to income ratio, divide the monthly expense by your monthly income. For example, if your housing costs total $1,000 per month and your net (after tax) income is $3,500 per month, housing accounts for 28.5% of your total budget. 

If you find your expenses are too far outside the guidelines, find places to cut expenses. Be sure to check on your income to spending ratio in each category and adjust where necessary so that your percentages come out to 100%. Obviously, if you are over 100%, you are living beyond your means and headed for financial trouble.
 

Spending Category Expense to Income Ratio
Unsecured debts 10-20%
Housing 20-35%
Food 15-30%
Transportation Expenses 6-20%
Monthly Utilities 4-7%
Clothing 3-10%
Other Expenses 1-4%
Savings 5-9%
Personal care 2-4%
Healthcare 2-8%
Insurance 4-6%

The first glaring omission you may notice in these guidelines is the absence of a category for daycare expenses. Daycare is one of those expenses you have very little control over. Either you need someone to watch your kids while you are at work or you don’t. If you have daycare costs, simply subtract them from your income before examining your expense to income ration in these categories.

How to Cut Costs

Now that you know what you are spending, you will have to make some difficult decisions. For instance, if housing is accounting for 40% of your budget, you need to find a way to increase your income, find more affordable housing, or reduce your other expenses as much as possible until you can get into an affordable home. Trying to sustain housing costs over 35% of your income will sabotage your efforts to save money. 

Decide which expenses are optional and which are not. You may consider dropping premium cable channels or the Internet if you have the service on your cell phone and have access through your employer. Go through your budget line by line cutting wherever possible. 

The effort you put into setting up and maintaining your budget will pay off in money savings and the realization of your long-term desires. When it seems like too much work, remember your goals and use them to motivate you to stick to your budget and keep cutting expenses wherever you can.

Jessica Bosari is an Internet copywriter and blogger for various publications and her own blog. You can read more of Jessica's work here.

 

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