What's the very first thing you should do to save for retirement? Your first step should be to create a realistic budget book that reflects your current income and expenses.
A budget book is an essential building block for a healthy financial life. It doesn't mean you have to cut every bit of fun out of your life. Rather, it's a tool you can use to balance your expenses and your income to make decisions that reflect your priorities and goals. If you're in a situation where you need to either increase your income or decrease your expenses, a budget book lets you know that. Ultimately, it gives you a plan for your financial life, including savings and retirement.
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Keeping a budget journal can also help you avoid a major retirement planning pitfall: Withdrawing funds from a retirement account or else taking out a loan, as about 30% of Americans have done, according to the Transamerica Center for Retirement Studies. Sound retirement planning requires steady savings and principal growth over time; borrowing or withdrawing money early can severely impact the latter.
A budget book gives you a basis for calculating your retirement needs, and your expenses listed in it aren't static either; you can adjust your budget as you get closer to retirement. Are you ready to set up a household ledger? It's helpful to have your bank statements on hand for this, so view or print them on your computer and let's get started on creating your budget book.
1. Make a list of fixed expenses
Step one: make a list of fixed expenses, that is, anything that requires a fixed monthly payment. Look at what you've paid in recent months, and make sure to include housing (mortgage or rent), car payments, student loans, insurance (auto, health, liability, homeowner's), utilities (water, internet, cable), and monthly subscription costs for things like the gym.
2. Create a list of variable expenses
Variable expenses can occur every month, but the amount isn't always the same. Electricity and gas bills are variable expenses because their use changes seasonally based on temperature and climate. The cost of maintaining your car can be in the thousands some months and zero in others. Other variable expenses include food (both groceries and eating out), clothing, travel expenses, credit card bills and other debt payments, hair salon visits, cell phone bills, cosmetics, gifts and medication prescriptions.
Also look at several months' bank statements to make a complete list of all variable expenses.
3. Make a list of one-time or infrequent expenses
You'll also need a category for one-time or infrequent expenses. Vacations, for example, occur only once or twice a year, as does the purchase of home furnishings or expenses for home repairs. Possible expenses in this category: taxes, charitable contributions, dental work – whatever shows up in a bank statement throughout the year.
4. Compare your expenses to your income
Now it's time to add up your expenses. Divide one-time or infrequent expenses by 12 to get an idea of what you need each month.
Next, look at your usual expenses each month relative to your income.
There are three possible scenarios. In the first case, your income far exceeds your expenses. Hooray! You can set aside 10% for savings and then create a retirement plan.
In the second case, there's a head-to-head race between spending and income. It's not ideal, because a healthy financial life should include both a 10% savings rate and retirement savings. In the third, you're in the red – your expenses exceed your income.
If you are in scenario two or three, don't worry, just continue with step 5 below.
5. Lower expenses and increase income when needed
If you need to close the gap between your income and your expenses, there are two ways to do it, and you can use both methods individually or in combination.
The first is to lower your expenses. Start with the easy categories.
Can you reduce your housing costs by taking in a roommate, offering the occasional room on Airbnb, or downsizing your home? Consider lowering your mortgage payments through refinancing. Consider moving to a less expensive area with a lower cost of living. Can you sell your car and get around on public transportation? Could you spend 10% less on groceries and eating out each month? The more you think about it, the more possibilities you will discover. Check out this list for more ideas on saving money.
The second method is to increase your income. There are several ways to do this. One option is to ask for a pay raise. Another option is to look for a job that pays better, perhaps in a more lucrative sector. You could also try to get a promotion, or start a side hustle. Part-time jobs have helped many people afford a more comfortable retirement than they would have managed based on their other savings options.
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