Optimize your budget

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Once you have assessed your current financial situation, it is time to ask yourself some important questions;  are you ending each month with positive surplus of money? If so, how much? Is the amount regular? Or are you ending each month with a deficit (raising your credit cards debt)? The best way to answer these questions is by optimize your budget

With this guide I will provide you with ideas on how to optimize your budget. The objective is to end each month with a reliable positive left-over.

Learn how to optimize your budget

This is part of the first steps on how to improve your finances.

Break down the proportions

Once you have a detailed view on where your money come from and go to, the first thing you should do is to check the proportions between income and expenses.

That means taking the various expenses groups and divide them by your net income.

The generally accepted benchmarks are the following:

  • Rent/mortgage: 25-30%;
  • Utilities: 5-10%;
  • Food: 10-15%;
  • Insurance 20-25%;
  • Transportation: 10%;
  • Quality of life (i.e. recreation, vacation, etc.): 5-10%;
  • Saving: 10%.

Of course, since your income is locked at 100%, every percentage point you spend more in a category, is a percentage point less you can spend in another.

Optimize your budget by paying off your debts

For this step you need the left-over money from the next steps, but it still the first as it is the most important.

If you have any debts (especially credit cards debt), you should try to pay it of as soon as possible; the reasoning is obvious: on top of the principal you owe, you are wasting a lot of money in interests.

If you have multiple debts, there are two schools of thoughts on the strategy to use:

  • smallest to biggest: some suggests to pay out the smallest debts first and then gradually move to the biggest; the reason is that the smallest debts are the quickest to pay off and gradually cross them off will give you a sense of progress and therefore motivation to keep going;
  • biggest to smallest: some other people suggest the opposite and pay off the biggest debts first; the reason here is that, by having the biggest principal, they are the one that cost the more in terms of interests and therefore you should keep them for as short time as possible.

We will talk about it better in a future article, but keep in mind that there are 2 kinds of debts:

  • Good debt: it is debt for assets that most probably increase in value over time – for example a house; this kind of debt is OK to have and pay off over time;
  • Bed debt: debt for anything that lose value over time, like electronics, a car, etc. If you want to improve your finances, you should avoid it as much as possible and if you already have it, you should pay it off as soon as possible.

Food expenses

On the food department, if you see that you are spending a lot on dinning out, try instead to buy more groceries and prepare your food at home. If even the groceries are a big chunk of your expenses, try to cut on junk food (chips, alcohol, etc.). If you always buy on the same supermarket, try another chain for few weeks to check if the average spending for the same things is cheaper.

I do not recommend to try to “game the system” by trying to map which specific grocery cost less in which specific store and divide your groceries in multiple stops: it will take a lot of time, you will lose part of the saving in more transportation costs, and since prices changes often you are not guaranteed to save money. Instead, if you find a store that is “overall” cheaper, focus your shopping there (and occasionally  try another chain for the full groceries).

Transportation expenses

For the transportation expenses there are few tricks. First, if you often find traffic on your regular path to work, try some different route; it may be longer in term of kilometres, but with less time in traffic you may save in gas. Another trick is to keep your vehicle regularly maintained: a car in good conditions will save gas and you may discover potential problem in advance (and therefore saving on repairs). If you regularly travel for long distances, you should switch to a more fuel-efficient car: it may cost more when you purchase it, but you will amortize it with less gas spent.

A last trick is to check the quality of public transportation on your area: you may have purchased a car out of habit, but maybe your city transportation may be good enough that you don’t need a car and you will save a lot of money (considering that for a car you have to pay not only for the vehicle itself, but also for maintenance, gas, insurance, and in some countries a vehicle registration tax).

Quality of life expenses

For quality  of life expenses, we are talking about expenses that make life enjoyable; going out to the movies with a love one, have a drink out with friends, a vacation, etc.

This category  is both the easiest and hardest to fix. On one side, quality of life expenses are not obligatory for your survival and therefore they are easier to cut; on the other end, you don’t want to make your life miserable in order to save some money.

Any optimization here is at your discretion.

Optimize your budget on utilities and insurances

Here the trick is simple: periodically check if there are utilities and/ot insurances providers that are cheaper. But I want to give you a word of caution: before switching, ask your family and friends for opinions on the new providers and check for reviews online; you don’t want to risk switching to a bad provider (for example a slow internet provider or an insurance that keep rejecting your reimbursement claims) just to save a couple of bucks a month.

Too much rent/mortgage?

The last category of expense to optimize is your rent/mortgage payment. As shown on the above list, you should not spend more than 25-3o% of your net income on your housing; if you are spending more, you are living in a home too “luxurious” for your means.

Of course the solution here is to check around for a cheaper place to live. But you have to be careful:

  • when you visit prospect houses, check the distance to your work and places you visit often; you don’t want to save in rent and end up spending more for gas each month and hours a day due to a longer commute;
  • compare the energy classes of your current house and the prospect one for the same reason as above; you don’t want to save on the rent itself if you will spend more on the utilities bills.

Optimize your budget by earning more

The point here is obvious. When you have optimized your expenses as much as you can, if you are still not saving enough you need to earn more. There is no way out from it.

The first step is obvious: check any job-seeking website for prospect new jobs that pay more and apply to them.

Another solution is to use the money that your saving now to improve your skills. There are plenty of schools (many online) that offer evening classes. There are also online services that offer training not bound to specific hours (you can access the materials at any time). The broadest skill-set you have, the more opportunities you have to get a high-paying job.

In conclusion

Of course the instructions I have provided in this article are just general ideas and not super-detailed steps. That is because your budget needs are different from anyone else and there is no detailed plan that work for everybody. But hopefully you can adapt these ideas to your situation and end up saving quite a few money every months.

Once you start having a positive cash flow every month, you will be ready to the investing opportunities that we will see in the next few articles.