Personal Finance 101: How to Budget the "SMART" Way

By Markets Fool.com


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No two ways about it, America's saving habits stink.

According to data from the St. Louis Federal Reserve, the U.S. personal savings rate as of Sept. 2016 was just 5.7%. That's down nearly 50% from where we were 50 years ago, and it's a far cry from what the citizens of other developed countries are socking away.

It's not hard to understand why America's saving habits are so poor. Aside from the fact that consumption comprises around 70% of our GDP, and thus consumers tend to be freewheeling with their disposable income, a bigger factor could be that just a third of American households is keeping a detailed monthly budget, at least according to Gallup. Gallup's findings in 2013 showed that it really didn't matter all too much how much money you made, what political ideology you believed in, or how educated you were -- America gets a big fat "F" when it comes to budgeting.


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Why budgeting is so important

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The purpose of a budget is pretty simple: to understand your cash flow. If you have a good understanding of how much money you're bringing in and, more importantly, a solid comprehension of where that money is going, then you'll be in a much better position to succeed in setting money aside for an emergency savings account or for your retirement. Saving money for retirement is especially critical for today's workers given that Social Security could be facing benefit cuts of up to 21% within the next 18 years and life expectancies continue to lengthen, meaning your nest egg has to stretch even further.

There are a number of simple actions consumers can take to increase their odds of staying on track. For example, getting everyone in your household involved can be critical to sticking to your objective. This means kids and grandparents should also be abiding by the budgetary rules of the household. If you live alone, then meeting once or twice monthly with like-minded individuals who share similar goals could be the impetus that keeps you on track.

Along those same lines, something as simple as using cash for your purchases instead of credit can make a huge difference. Credit cards are exceptionally convenient, and the only true accountability we feel is when we receive the bill many weeks later. If you were to use cash, though, you'd have an immediate and tangible loss of value since you'd be handing over your cash in exchange for a good or service. Using cash could be a good way of reducing discretionary purchases.


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It's time to get "SMART"

But, no matter what steps you take to improve your odds of saving money, nothing is more important than your budgetary goals. Without well-defined goals and an action plan, your chances of success aren't good. The best way to increase your odds of formulating a successful budget is to get "S.M.A.R.T."

The acronym "SMART" stands for:

  • Specific
  • Measurable
  • Achievable
  • Realistic
  • Time-based

Be specific: One of the biggest problems with budgeting and trying to save money is that people are often far too vague. Simply saying that you'll "save money" simply isn't good enough. Instead, you need to set a specific end goal that you're aiming for, such as "I will save enough money to fully fund an emergency account and maximize my Roth IRA contribution." The more specific your end goal, the better shot you have of reaching it.

Make sure it's measurable: Second, you want your budget to be measurable. In other words, you should be able to answer the question "How will I know when I've accomplished my goal?" This is where it pays to take your specific idea of fully funding an emergency account and your Roth IRA and put measurable figures to it. Therefore, a successful measurable goal would look something like this: "I plan to save $5,000 a year for my emergency account and $5,500 annually for my Roth IRA." It's critical to have specific figures here since it makes it easy to tell how much progress you've made toward your goal, and it helps decipher whether spending habit changes should be made.


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Make your plan achievable: The next step is deciphering if your savings plan ($5,000 into an emergency fund and $5,500 into a Roth IRA annually) is achievable. While we'd all love to sock away $1 million annually, that sort of salary and savings probably isn't attainable for the vast majority of people. However, we do know that tens of millions of working-class Americans have been socking away money into an emergency fund, and have been annually adding money to a Roth IRA. If millions of other people are funding their retirement and saving money for emergencies, then it would certainly seem feasible for you to do as well.

Keep things realistic: Next, it's time to decide if your saving goals are realistic. For instance, if you're only making $25,000 annually, but you're trying to set aside $10,500 a year (as in our example above), that's probably not realistic, especially with other costs, like rent, involved. By a similar token, if you've recently purchased a home, had a baby, or dealt with some other major life-changing event, you may want to adjust your goals. The key to a realistic goal is finding a reachable percentage of your income that you could set aside and still live comfortably.

Set a time frame for your goals to be reached: Last, in order to keep your plan specific and measurable, you'll need to set time frames by which you want to reach saving milestones. For instance, saying that you'll max out your Roth IRA annually doesn't mean much if you don't have an actionable plan to sock away money each month. Having a specific time frame listed is another component to keeping your actions measurable so that corrective action can be taken if you're not on track to meet your goal(s).

One final note is that you should keep in mind that this is your budget, and as such, it can be changed whenever you decide. If $100,000 is your specific savings goal, but five years from now you get married and have a child, then it's perfectly fine to adjust your specific savings goal higher to, say, $150,000. Ultimately, you are the only one accountable for your finances, so it's in your best interest to be an active participant. It all starts with being "SMART."

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Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.

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