The One Personal Finance Skill You Must Master Before All the Others

By Dr Penny Pincher on 2 November 2016 0 comments

Recently, I detailed 12 personal finance skills to master to improve your happiness and quality of life.

Mastering this set of skills will put you on the road to financial independence, but it's hard to master 12 things all at once. If you are looking to get your finances on track quickly, what is the first personal finance skill you should master?

Start with budgeting.

What a Budget Can Do for You

A detailed budget holds the answer to one of the most important questions about your personal finances: "Where is all the money going?" When you understand where your money is going, you can find opportunities to better utilize your money to meet your goals instead of letting it slip away on things that are not important to you.

And a budget can be a great motivational tool. For example, if you learn from your budget that you are coming up $100 short each month, you can be motivated to solve the problem. Having a specific goal and measurement of progress toward the goal helps you take effective action. Without a budget, you may have a general feeling that you don't have enough money, but this can be hard to turn into tangible results.

"Can I afford this?" is another question that a budget will answer. With detailed knowledge of how much money is coming in and how much you need to cover bills and expenses, your budget will show whether you can handle taking on a new expense.

Looking at the bigger picture, your budget tells you if you are heading in the right direction, or if your financial situation is a sinking ship and you need to make some changes. Without a budget, it may not be clear whether you are moving up, down, or sideways. But most people don't have a budget...

Why Most People Don't Budget

Clearly there are significant benefits from having a detailed budget, but Gallup's annual Economy and Personal Finance survey shows that only 32% of American households have a written or computerized budget for monthly expenses. If having a budget is so useful, why do so few people actually do it?

  • Some people have no idea how to prepare a budget.
     
  • It takes too much work to quantify expenses and keep the budget up-to-date.
     
  • Some people are afraid to know much they are spending. They don't want to change their spending habits, so they avoid facing the numbers.

All of these reasons contributed to me not having a budget for years. I had plenty of other tasks on my list of things to do, and putting together a budget never made its way to the top of my list. Plus, I liked buying whatever I felt like buying and didn't want a budget to get in the way of being able to spend money however I wanted.

I finally realized that I didn't really know where my money was going, and this was preventing me from reaching financial independence. Preparing a budget was my first effective step to getting my finances on track.

How to Start an Effective Budget Today

Getting started budgeting is easier than you think — the hardest part is deciding to do it.

Step 1. Where Is All Your Money Going?

The first step in budgeting effectively is to assess your current cash flow situation, figuring out exactly how much income you have and breaking down your spending by cost category. This may seem like a lot of work, but this will give you insight into where all of your money is really going. You may be shocked. (See also: Start Saving More With a Spending Book)

First, total up all of your income during the month. Look at your pay stubs, or check your direct deposits from your bank account statement.

Then, figure out your expenses. You will need to keep track of the cash that you spend as well as bill payments from your checking account and spending with credit cards. When I started my budget, I used colored highlighters to mark credit card statements and bank statements to sort the spending into categories such as food, clothing, pets, entertainment, transportation, housing, utilities, etc. I put these numbers into a spreadsheet along with my income, and I had my first budget. Or, you can try budgeting tools like Mint or You Need a Budget.

Step 2. Where Do You Want Your Money to Go?

After you know the good, the bad, and the ugly about where all your money is going, you might want to make some adjustments. I found that overall spending was too high, especially spending on food, car payments, and fuel.

We started using a money envelope to pay for all food to help control this expense category. On payday, I put cash for food in an envelope. When the envelope is empty, we know we have spent all we have available, so we wait for the next envelope to spend more on food. We also sold our most expensive vehicle and replaced it with a less expensive one that uses less gas, saving hundreds of dollars each month. Without a budget, I would not have been motivated to make these changes and get my finances on a better track. (See also: Build a Better Budget in 5 Minutes Flat)

For your budget to be effective, you need to monitor expenses and make updates to your budget as they change each month. In other words, making a budget is not a one-time exercise. Keep track of the budgeted amount for expense categories and how much you are actually spending every month. As you understand your spending and work to control your expenses, you will be able to create budget items such as "emergency fund" and "retirement fund" and consistently have money to fund your future.

Wherever your life takes you on the road to personal finance mastery, it won't take you there if you don't master this skill first.

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Guest's picture
Melissa o

YNAB is amazing for budgeting easy!!