Money comes in, money goes out. For many people this is about as deep as their understanding gets when it comes to personal finances. Rather than ignoring your finances and leaving them to chance, a bit of number crunching can help you evaluate your current financial health and determine how to reach your short- and long-term financial goals.
As a starting point, it is important to calculate your net worth—the difference between what you own and what you owe. To calculate your net worth, start by making a list of your assets (what you own) and your liabilities (what you owe). Then subtract the liabilities from the assets to arrive at your net-worth figure.
Your net worth represents where you are financially at that moment, and it is normal for the figure to fluctuate over time. Calculating your net worth one time can be helpful, but the real value comes from making this calculation on a regular basis (at least yearly). Tracking your net worth over time allows you to evaluate your progress, highlight your successes, and identify areas requiring improvement.
Equally important is developing a personal budget or spending plan. Created on a monthly or an annual basis, a personal budget is an important financial tool because it can help you:
Plan for expenses
Reduce or eliminate expenses
Save for future goals
Spend wisely
Plan for emergencies
Prioritize spending and saving
There are numerous approaches to creating a personal budget, but all involve making projections for income and expenses. The income and expense categories you include in your budget will depend on your situation and can change over time. Common income categories include:
Alimony
Bonuses
Child support
Disability benefits
Interest and dividends
Rents and royalties
Retirement income
Salaries/wages
Social security
Tips
General expense categories include:
Childcare/eldercare
Debt payments (car loan, student loan, credit card)
Education (tuition, daycare, books, supplies)
Entertainment and recreation (sports, hobbies, books, movies, DVDs, concerts, streaming services)
Food (groceries, dining out)
Giving (birthdays, holidays, charitable contributions)
Housing (mortgage or rent, maintenance)
Insurance (health, home/renters, auto, life)
Medical/Health Care (doctors, dentist, prescription medications, other known expenses)
Personal (clothing, hair care, gym, professional dues)
Savings (retirement, education, emergency fund, specific goals such as a vacation)
Special occasions (weddings, anniversaries, graduation, bar/bat mitzvah)
Transportation (gas, taxis, subway, tolls, parking)
Utilities (phone, electric, water, gas, cell, cable, internet)
Once you’ve made the appropriate projections, subtract your expenses from your income. If you have money left over, you have a surplus, and you can decide how to spend, save, or invest the money. If your expenses exceed your income, however, you will have to adjust your budget by increasing your income (adding more hours at work or picking up a second job) or by reducing your expenses.
To really understand where you are financially, and to figure out how to get where you want to be, do the math: Calculate both your net worth and a personal budget on a regular basis. This may seem abundantly obvious to some, but people’s failure to lay out and stick to a detailed budget is the root cause of excessive spending and overwhelming debt.
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