May 16th, 2017

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Today, the average American owes 11 percent more in household debt than a decade ago, Federal Reserve data shows. If that statistic isn’t shocking, perhaps these next two will make you gasp: The average household has accumulated massive credit card debt to the tune of more than $16,000. Meanwhile, the number of Americans who could pass a basic financial literacy quiz fell from 42 percent in 2009 to 37 percent in 2015, according to the FINRA Foundation.

Indeed, these disturbing numbers reflect poor financial management skills, underpinned by individuals’ and couples’ inability to distinguish wants from needs. Here are some guidelines you can follow to achieve more effective budget management skills.

Handsome man comparing two receipts and talking on a mobile

Budgeting Principles

One simple budgeting guideline many financial experts recommend is the 50/20/30 rule. Under this rule, you’ll need to budget 50 percent of your monthly income toward any fixed expenses, including rent and utility bills. Another 20 percent of your income should go toward variable expenses, such as family entertainment and eating out. Finally, the remaining 30 percent of your income should be set aside for savings and repaying any outstanding debt.

Fixed Expenses

However, the key to making the 50/20/30 rule work is your ability to identify which of your expenses should be counted as fixed expenses. You and your family’s health and well-being is second to none, and if you’ve racked up bills at your dentist or physician’s office, paying off these sums should be one of your top priorities.

Understanding you have to put a roof over yourself and your family, budgeting to pay your monthly mortgage or rent should also be a top priority. Additionally, setting aside enough money for monthly utilities is also essential; after all, who wants to freeze during winter and sweat it out in the summer?

Finally, if you drive to work, you’ll need a vehicle to get there and back, so car payments and gas expenses should also be considered a necessity. The same rule applies when budgeting for grocery expenses. These are costs that should remain fairly stable from month to month.

Variable Expenses

While eating is a necessity, dining out surely is not. Last year’s U.S. Census Bureau data revealed that, for the first time in history, Americans now spend more on eating out than they do on groceries. If you find you’re running a tight budget each month — and eat out a lot — then this is probably one of the first areas in which you can make cutbacks. Going forward, make sure your restaurant budget is part of your variable expenses — and not your fixed expenses.

This same rule applies for other non-essential spending, including going to the movies. However, not all variable expenses are created equal. For instance, no one needs to buy new tires every month. But, when you get a flat or your tread is worn, you hope you’ve saved enough money to buy some replacements. Remember to factor occasional necessary items — such as new tires — into your variable expenses, so you’re not scrounging for money when an emergency pops up.

Debt Repayment and Savings

When it comes to managing the remainder of your budget, repaying debt should normally take priority over savings. As you’ve learned by now, monthly interest is compounded to your debt, so your best option is to pay off any outstanding sums in a timely manner. Prioritize paying off student loans and credit card balances before you start investing your savings in the stock market.

There are, however, some exceptions to these general rules. First, you should save at least $1,000 for emergencies before pursuing other debt repayment obligations, according to personal financial expert Dave Ramsey. Additionally, while mortgage debt should be handled under fixed expenses, you shouldn’t ever attempt to pay off more than your minimum balance until you’ve:

  • Paid off smaller debts, like credit card bills
  • Saved up enough emergency funds to live on for at least a year
  • Started building your retirement savings

Finally, if your employer has a matching 401(k) fund, you should normally take advantage of putting part of your monthly income into this retirement savings plan, even if you have not yet fully paid off any credit card or student loan debt.

Mistakes to Avoid

To apply these guidelines successfully, avoid making some common financial management mistakes that can run up your debt. To maintain a good credit rating, always pay your bills on time, and don’t let your credit balances run up beyond 10 percent to 20 percent of your limit. If you find you’ve exceeded these balance limits, increase the portion of your income that you budget toward repaying debt in order to bring your balances back down.

You should also remember to factor holiday and birthday gift costs into your variable spending. Most Americans spend more than $900 per year on Christmas gifts. If you don’t include these costs in your budget, your debt will certainly creep up each year. Avoiding these mistakes — and following the 50/20/30 rule — will help you keep down your debt. Put these financial literacy principles into practice and you should gradually see your debt shrink and your savings grow over time.

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