1. Balanced Budget, Balanced Life: Setting Your Financial Priorities

Many people don’t plan their spending. It just sort of happens.

But what we spend on the basics—where we live, how we get around, what we wear, what we eat—can have a profound effect on the quality of our life. So can the amount of debt we’ve taken on. If basic expenses or debt eat up too much of our income, we won’t have enough left over for the fun stuff—vacations, entertainment, and other experiences that make life worth living. And if we spend too much today, we won’t have a cushion to protect ourselves from an emergency tomorrow or to sustain us in our old age.

A budget can be empowering. We’re wresting control of our spending away from advertisers, lenders, and mere impulse. Instead, we’re directing our money toward what’s truly important to us. A good budget also helps balance our competing priorities so that we’re enjoying the present while building security for the future.

Read on for strategies and techniques that can help you build a budget that works.

A: Wouldn’t you like to stop thinking about money? Or at least, when you do think about it, to feel calm and in control, confident that you have enough, that you’re making progress toward your goals, and that you can handle any setbacks likely to come your way?

Managing your money well gives you the power to achieve what you really want in life while dialing back the anxiety that plagues people who live paycheck to paycheck.

Budgets tend to fail when people view them as an awful exercise in deprivation instead of as a tool to help them stop wasting money on things they don’t really want so that they can get the things they do. When you view your spending plan in this light, it’s easier to skip those sales and invitations.

You might want some inspirational reading. Your Money or Your Life, by Joe Dominguez, Vicki Robin, and Monique; Tildord, MoiqueTilford (Penguin Books, 2008) would be an excellent beginning. This book, which is the bible for the voluntary simplicity movement, can help you understand the connection between the choices you make every single day and the bigger financial picture that makes up your life. (Savings tip: Check it out at your local library or buy it used online.)

Most importantly, let go of ideas about where you “should be” at this stage. You are where you are. Regrets about not having more, or not being able to spend more, can lead you to chuck the whole idea of a budget. Many people overspend by trying to buy the lifestyle they think they should achieve instead of being realistic about what they can actually afford.

You also may find it helpful to seek out a support group of people who are trying to get their finances under control. You might join an online forum, such as http://simplelivingforum.net, for inspiration and tips.

You can do this. Good luck!

I think the problem is that I spend a lot of money on wasteful things, such as eating out. I try to track my spending but don’t do it consistently. I would like to stop wasting money and buy a bigger, better home than my current townhouse. I spend $845 on my mortgage, including taxes and insurance. I have two car payments, totaling $700, plus $200 a month for insurance; utilities of $200; a home equity line of credit payment of $200; and a student loan payment of $200. I also have $4,000 in credit card debt. I contribute 6% to my company 401(k), which has a 3% match, but I don’t have an emergency fund. I know I should be paying myself first, but I don’t know how much. I’m just at a loss. Can you help?

A: First, give yourself credit for what you’re doing right. You’ve bought an affordable home, you’re keeping up with the payments, and you’re saving for retirement.

Your big problem is your debt. Your car costs alone are high, given your income and other expenses. That $200 payment on an interest-only home equity line of credit indicates that you’re carrying substantial debt there as well. And the proper amount of credit card debt is zero. All these indicate that you’re living above your means, despite how you might feel.

If you want a budget that works, get your “must have” expenses down to 50% of your take-home pay. That includes your housing, transportation (including gas), utilities, food, insurance, and minimum loan payments. Then you can devote 30% to “wants,” such as clothing, vacations, entertainment, and dining out. The remaining 20% of your pay goes to savings and debt repayment, starting with that credit card debt. (Harvard bankruptcy expert Elizabeth Warren and her daughter, Amelia Warren Tyagi, explain this budgeting system in their excellent book All Your Worth [Free Press, 2005].)

A “must have” is any expense that you can’t skip for several months without serious, immediate consequences. Failing to pay the minimums on your loans, for example, would result in trashed credit, at the very least, and you could face lawsuits, wage garnishment, and foreclosure. Not paying your insurance premiums would result in a lapse in coverage that would leave you vulnerable to catastrophic costs in case of an accident or illness.

A “want,” by contrast, is any expense you can do without, at least for awhile. You may think you “need” new shoes, for example, but you likely have enough in your closet that you won’t have to go barefoot in the snow if you don’t go shopping for awhile.

The last category, for savings and debt, underscores how important it is to pay off our past (our debt) while simultaneously saving for our future. Exactly how you divvy up this 20% is up to you, but at least some money should continue to go into your retirement accoun.

Getting debt, especially auto debt, under control can be difficult. Ideally, you’d sell the two cars and buy one less expensive replacement (your college student can take the bus). But often people with high car payments are “upside down,” owing more than their cars are worth. If they tried to sell their cars to buy cheaper ones, they would need to come up with the cash to pay off their loans, in addition to the money they’d need for down payments on the replacement vehicles. If that’s your situation, it may be best to “drive out of the loans” by continuing to make the payments until you have some equity in the cars. Your college student could get a job and help contribute to the cost of her car. If that’s not possible, you could sell hers as soon as you have some equity in the vehicle and keep the other for several more years until you’ve saved up cash for a replacement.

Consistently tracking your expenses will help you identify areas of overspending and stay within your budget. If your current method isn’t working, consider using an online site such as Mint.com, which automatically gathers and tallies your bank and credit card transactions.

A: You can find averages in the U.S. Census Bureau’s annual Consumer Expenditure Survey, which you’ll find at www.census.gov. The categories are fairly broad—you won’t find a line item for diapers, for example—but the bureau provides averages for housing, food, transportation, clothing, and insurance, among other categories. The bureau also slices the data various ways: by income, by metropolitan area, and by child, for example.

You may find the information more interesting than helpful, however, because every family’s situation is different. A couple with little debt and no children, for example, can comfortably afford a bigger mortgage payment than a family that has both kids and debt.

A better way to manage your spending is to use the 50/30/20 plan, which limits your “must haves” of shelter, food, transportation, utilities, child care, insurance, and minimum loan payments to 50% of your after-tax pay.

That leaves 30% for wants, including clothing, entertainment, gifts, and vacations, and 20% for savings and debt payments.

Many families in high-cost areas find it extremely tough to keep must-haves to 50% of their after-tax pay. Some spend that much or more on their housing. But the 50/30/20 plan underscores how important it is to contain your basic overhead if you want to have money left over to pay down debt from the past, save for the future, and enjoy your life in the present.

A: If you live in a high-cost area but don’t have a high income, you’ll need to get creative if you want to keep your “must have” expenses—shelter, food, transportation, child care, minimum loan payments, and insurance—to less than 50% of your after-tax income.

Many people in high-cost areas devote 40% or more of their incomes to shelter costs, which makes it all but impossible to have enough money left over for their “wants” (clothes, vacations, gifts, and other non-necessities that should consume 30% of their after-tax income savings, according to the 50/30/20 plan) or savings and debt repayment (which should consume 20% of your after-tax income under the plan). The result is a perpetually unbalanced budget, which often leads to more debt and lots of anxiety.

But people have come up with various solutions to better balance their budgets. Blogger Donna Freedman was an apartment manager for several years, which helped lower her shelter costs. Fred Ecks, who retired in his 40s, lived on a boat to reduce his rent in notoriously high-cost San Francisco. Janine and Brad Bolon chose to raise their four kids in a 1,500-square-foot townhome in Southern California instead of springing for the McMansions their peers were buying. Other people have exchanged their services for free or reduced rent by babysitting or serving as a companion to an elderly person.

If you can’t find a solution that lowers your housing costs, you have two options: continue to live with a lopsided budget, and accept that you may never be able to achieve a balanced financial life, or move to a place where you can make the math work.

Q: The 50/30/20 budgeting plan you advocate just doesn’t work on a low income. I currently rent because I can’t afford the purchase of a house, and the lowest I can go and still be in a safe neighborhood is $600. That’s much more than 40% of my salary, and you say all your “must have” expenses, including shelter, food, and transportation, should be 50% or less of after-tax income. With rising prices, saving and eliminating debt seems like an unreachable reality. What concrete advice do you have for someone who doesn’t have a credit card and is trying to get out of $7,000 of debt, to get to stability to purchase a home?

A: Saving and debt elimination are tough on a low income. But that doesn’t mean basic math doesn’t apply in your situation. If you spend too much on your “must have” expenses, you simply won’t have enough left over to live your life, pay off your debt, and save for your future.

People on lower incomes manage to stay out of debt and save money. To do so, though, they have to limit what they spend on their overhead. They find roommates or rent a room in someone else’s house, or move in with a family or an elderly person and offer to help out in exchange for part or all of their rent. Some decide that they simply can’t live cheaply enough where they are and opt to move elsewhere. Books and Web sites devoted to the voluntary simplicity movement can give you other concrete ideas about how to live on a shoestring.

If you can’t bear to trim your expenses, your only other option is to make more money. That’s not always an easy prospect, but a second job or a side business could help you get out of debt and save for a down payment.

Q: I’m a mother of two children, and I work part-time. On top of that, I go to school full-time. Even though I receive financial aid, I have trouble saving money on a tight budget. How can I do it?

A: Saving money in your situation is hard, but it’s not impossible. The most important piece of advice is to make it a priority. In other words, don’t wait until you’ve paid your bills and otherwise spent your paycheck to figure how much is left over that you can save. Instead, pay yourself first by setting up an automatic transfer that moves some amount of money, however small, from your checking account to your savings account. The transfer should occur the day your paycheck is deposited, if possible. Even small contributions build up over time, and you’re unlikely to miss the money if you make the process automatic.

If you’ve found yourself raiding your savings for nonemergencies in the past, decide now under what circumstances you’ll tap your funds. A car repair may be a good reason. Dinner out, even if you’re bushed from all that working, mothering, and studying, probably is not. If you really can’t keep your hands off your savings, you may need to move the money somewhere that’s harder to access. You could set up an account at an online bank or at a bank or credit union that’s different from the one that holds your checking account.

Another issue that prevents many people from saving is that they spend too much on their so-called fixed, or basic, expenses. If too much of your income goes to rent, food, utilities, and transportation, for example, you may have continual trouble making ends meet. Trimming those expenses can have a profound effect on your ability to save.

Following frugality-oriented Web sites can give you ideas for reducing your expenses, as well as offer encouragement that your sacrifices will be worthwhile. As one blogger put it, saving money isn’t about deprivation; it’s about gaining control. When you make the decision to save and follow through with action, you’re putting yourself back in control of your spending and your own life.

It won’t be easy, but remember that you won’t always have to work this hard. Your education should result in bigger paychecks that will enable you to save more easily—as long as you continue to pay yourself first.

A: You need to accept your new reality instead of papering it over with ill-advised loans or raids on your retirement accounts.

That means reducing your expenses dramatically to reflect your new, lower income. If your housing expenses eat up more than a third of your current pay, for example, you need to consider your alternatives. You have equity in your home, which should make a sale easier. If you want to hang on to the house, consider getting roommates or even renting out the house while you live elsewhere (if the rent will cover your home’s monthly expenses).

You may have loan payments or other debts that you took on when you had more income that you can no longer afford. If that’s the case, discuss your situation with both a legitimate credit counselor (one affiliated with the National Foundation for Credit Counseling, at www.nfcc.org) and a bankruptcy attorney (find referrals from the National Association of Consumer Bankruptcy Attorneys, at www.nacba.org).

Reserve your home equity for emergencies; don’t use it to finance a lifestyle you can no longer afford. And leave your retirement funds for retirement.

A: What you’re experiencing is frugal fatigue. You’ve cut and you’ve cut, but you still have a long way to go. It’s easy to look at the road ahead and feel discouraged.

But you have to give yourself credit for paying off $13,000 in debt. That’s a huge achievement. Give yourself another pat on the back for staying current with your bills.

The discipline you’re learning will help you enormously in the years to come. You’ll be able to build a substantial emergency fund after the debt is paid off simply by redirecting a portion of the money you’re now sending to creditors.

In the meantime, don’t sweat the fact that you don’t have a huge savings account. Work on setting aside just $500 or so, which should cover most small setbacks and keep you from having to use your credit cards. If you have to drain your savings for an emergency, that’s okay—the fund is serving its purpose. Just build it back up again.

Earning more money is usually the fastest way to dig yourself out of a hole. If you can’t find another job or a better job, create your own job. Perhaps your work skills lend themselves to moonlighting. If your job allows you to take on freelance clients, that’s a good way to bring in extra money. Otherwise, if you have a talent or skill you can teach, do that. If you don’t, consider providing services that others need: house cleaning, house sitting, dog walking, errand running.

You can look for some ways to give yourself more breathing room. If you’ve cut all the small expenses, it’s time to look at the big ones: your rent and your debt payment. You may be able to free up more money for saving, and for living, if you find a roommate. Also, ask your credit counseling agency about the possibility of reducing your payments a bit. It will take longer to pay off your debt, but it could make life more pleasant in the meantime.

Q: We’re a newly married couple with an 11-year-old and hope to have another baby soon. We have $20,000 in emergency savings, $40,000 in investments, $480,000 in retirement funds, $20,000 in low-interest student loans, and $43,000 in high-interest credit card debt. If we have another child, we’d like for my wife to be able to stay home. I am struggling with how to prioritize debt reduction, college savings, home improvements, and an emergency fund. I don’t want to tap our savings or investments, as life often holds surprises and I do not want to be caught short. The problem is that aggressively paying down the debt hurts our cash flow for our other goals.

A: It’s understandable that you don’t want to tap your savings or investments, since it’s difficult to build up those funds. But it really makes no sense to carry high-interest debt when the returns you’re getting on these other accounts are probably much lower.

Talk to your tax pro about the implications of selling some or all of your nonretirement investments. If your investments have gained substantially in value, you’ll want to factor in the tax bill or consider selling some of your money-losers instead.

After paying off the credit cards, you’ll free up some money that used to go to those payments and can use it for other goals.

Your priority needs to be saving for retirement. When you’re on track there, you probably should focus on rebuilding your emergency fund to equal at least three—and preferably six—months’ worth of expenses. You may not be able to accomplish that before your second child arrives, though, so consider opening a home equity line of credit as a proxy for a larger emergency fund. Leave the line of credit open and unused, however, because racking up a balance defeats the purpose.

Saving for college is a worthy goal, although it shouldn’t take priority over retirement, paying off toxic debt, or having an emergency fund. You may not be able to save enough to pay the whole bill, but you can shoot for saving a third or half of the expected cost, and your child can use federal student loans for the rest. SavingForCollege.com has a calculator to help fine-tune your plan. Even if you can’t save as much as you’d like, you should save something. Even $25 a month over time will help reduce the amount your child needs to borrow.

Home improvements should be last on your list of priorities, and you should try to pay for those with cash. Despite what the real estate and remodeling industries tell you, they are not an investment in your home. The right home improvements can increase the value of your property somewhat, but you’ll typically get back less than 70% of what you spend. An expenditure with a 30% or greater built-in loss is not an investment—it’s consumption and should be paid for in cash.

A: Cable and cell companies have competitors. Start by calling one of the satellite television providers and asking what specials it offers new subscribers. Then call your cable company and let it know you’re thinking of switching. Whatever the first offer is, hold off and see whether you can get a better deal. If not, switch or consider a life without pay television. Many popular shows are available free on the Internet, and others can be purchased as downloads. If you don’t watch much TV (and you’ve got lots of better things to do, right?), you can save a lot of money.

Cell service can be a little trickier, particularly if you’re in the midst of a long-term contract. Consider using BillShrink or Validas (www.myvalidas.com) to see whether you can get a better deal from your current carrier. If you’re not using all your minutes, texts, and data, your carrier typically will let you step down to a cheaper plan without extending your contract (check to make sure, of course).

If you’re not under contract, the world’s your oyster. Those two sites can help you search among the carriers to find the best fit for the way you use the phone. Or you can consider switching to a prepaid plan with no contract.

A: That must have been one massive mortgage you were carrying. You may feel positively giddy when those payments are gone, but don’t let it go to your head.

It would be easy to ratchet up your spending now that you have so much extra money in the bank, but resist the urge. Concentrate first on wiping out your credit card debt; then focus on building up your emergency savings. The discipline of paying off debt and building savings will help you learn to live within your means, something that you obviously weren’t doing when you took on that home loan and built up credit card debt.

You also should be saving aggressively for retirement, if you aren’t already. Take advantage of any workplace retirement plans: Contribute at least enough to get the full company match, and consider funding Roth IRAs for both of you. Roth contributions aren’t tax deductible, but the money is tax-free in retirement, and you can contribute up to $5,000 each as long as your modified adjusted gross income as a married couple filing jointly is under certain limits (in 2012, the ability to contribute phases out between $173,000 and $183,000 for married couples filing jointly; for singles, it phases out between $110,000 and $125,000).

You can learn more about the basics by reading Eric Tyson’s excellent primer Personal Finance For Dummies (Wiley, 2012).

A: Congratulations in advance on your entry into the great adventure of parenthood. The most important thing to know is that you can’t predict what’s ahead, financially or otherwise.

The U.S. Agriculture Department estimates that it will cost middle-income parents nearly $300,000 to raise a child to age 18. But your costs could be a lot less if you’re particularly frugal or a lot more—particularly if you have a high income, plan to pay for private school, or have a child with special needs.

You can get some idea of what to expect by using the Agriculture Department’s new calculator, at www.cnpp.usda.gov/calculatorintro.htm.

Your annual food, clothing, and health care bills typically rise $3,000 or more with each child. You also may opt for a bigger home or car, which can add to the bill. Child care and education are other considerable expenses.

Then there are the setup costs. Denise and Alan Fields, the authors of Baby Bargains (Windsor Peak Press, 2011), one of my favorite books about preparing for a child, say you easily can spend more than $6,000 just on equipment such as strollers, car seats, maternity clothes, and nursery care. If you’re smart, however, you’ll try to spend a lot less by buying or borrowing used furniture and selecting well-reviewed, midrange brands of strollers and car seats rather than status brands.

You’d be smart to start trimming other expenses now and saving the difference so that you have a fund to pay these startup costs and the added expenses of a child don’t push you into debt.

If one of you is planning to stay home with the baby for an extended time, consider starting to live on one income now and banking the other.

A: When you’re facing a layoff, you should be conserving cash. That means paying the minimums on any debt and looking for other ways to trim expenses as much as possible. Selling one of your vehicles might also be in order.

Try to avoid tapping any retirement savings, since you’re likely to incur penalties and taxes if you do so—plus, you’ll lose all future tax-deferred return that money could have earned. Dip into other savings sparingly, as you may be without a job for awhile.

You need to batten down the hatches because you may be without a job for months. The median length of unemployment in July was nearly 20 weeks, up from 10 weeks in July 2008. A whopping five million people have been without jobs for 27 weeks or more. Given the environment, you should consider any job that will provide income and help you conserve your cash.

Recently, I have had an overdraft experience that leaves me wondering about ethics and legalities. It was three days from payday, and I had about $45 in my account.

I made four purchases less than $10. Then a $54 automatic payment came through that I could not reschedule. One would think I would then be charged one overdraft fee, as all of the previous purchases made were within my available funds at the time.

I logged in today to find that the bank had cleared the largest transaction first, which threw all other small transactions into overdraft. I was charged five overdraft fees because of this rearrangement of clearance order. I talked to a customer service manager, who said that nothing could be done.

Essentially, it appears that the bank is manipulating transactions to capitalize on overdraft fees. This strikes me as unethical, and I wonder, do I have any rights in this situation? Aside from getting a better job and making more money, what can I do to protect myself?

A: Of course the bank is manipulating your transactions to increase its fees. Most banks do. Lawmakers and regulators have questioned the practice, but so far, it’s not illegal.

What you can do to protect yourself is to stop living paycheck to paycheck. That may sound like a flip answer when you’re on the financial edge, but you’ll never get ahead as long as a $54 overdraft can throw your finances into chaos.

Having just a $500 cushion in the bank can reduce not just bounced-check fees, but also worry, sleeplessness, and lost productivity at work, according to a savings review by Stephen Brobeck, executive director of the Consumer Federation of America.

How do you get a cushion? Try a “no spending” month. Limit your purchases to true essentials. Eat out of your cupboards instead of at restaurants. Entertain yourself at home or at the library. Most people can raise at least a couple hundred dollars this way, which you could supplement by having a yard sale and selling unneeded items online.

If you want more ideas, consult one of the many frugal-living Web sites; start with one of the oldest, the Dollar Stretcher, at www.stretcher.com.

You also need to limit the bank’s ability to swamp you with “gotcha” fees.

First, sign up for true overdraft protection. You may be enrolled in an inferior substitute, called “bounce protection” or “courtesy overdraft.” These programs allow the banks to approve overlimit transactions and charge you $30 or more for each one.

True overdraft, by contrast, links your checking account to another of your own accounts, typically a savings account, line of credit, or credit card. If your transaction exceeds your balance, the money is drawn from one of these accounts. You’ll pay an annual fee of around $50 and possibly a fee of $10 per transaction, but the costs for making a mistake will be substantially lower than under bounce protection.

If the bank won’t approve you for true overdraft, tell it to stop approving overlimit transactions.

A: Well, for one thing, you drained a retirement account to pay off debt. That’s extremely shortsighted because you incurred unnecessary taxes and perhaps penalties to tap money that should have been left alone to grow.

What’s probably happening is that you’re waiting to save until you’ve paid all your other expenses. That rarely works because expenses have a mysterious way of rising to meet your income.

You need to turn your priorities around and save first—take something out of every paycheck or other money that comes your way.

The best way to do that is to put your savings on automatic so that the money is swept out of your checking account into a high-yield savings account. If you have to make a decision each paycheck to save, you’ll typically find other things to do with that money.

If you try that and find yourself still falling short, your fixed expenses may be out of whack. Often when people aren’t extravagant but still have trouble saving, the reason is a home or a car that’s eating up too much of their incomes. If you’re spending much more than 25% of your gross income on housing or 10% on your car, you may find that you have trouble making ends meet.