April is National Financial Literacy Month in the United States. In most cases, schools do not extensively teach financial skills. Teenagers, highly susceptible to messages from the media, often do not have guidance from teachers, who are not trained to teach financial skills, or from parents, many of whom do not model healthy financial behavior. This series of articles at Consumerism Commentary serves to help inspire discussion about basic financial concepts. Please feel free to forward this article to someone who might benefit from a basic financial overview.

Forming a budget is a key to taking control of your finances, and they are best begun when you are young. This is the fourth article in the Money Basics series; so far this series has covered checking accounts, savings accounts, and interest.

I will be the first to admit that I don’t like budgets. My personal approach is to review and adjust my spending rather than create spending limits in advance. However, there was a time in my life that budgeting was necessary, and there was a time that I should have focused on a budget but didn’t.

When I was a teenager, I spent some time visiting one of my friends. He had material desires, like many teenagers, but relied on his parents. Often, his requests were met with a common parental response: “I’d love to help you, but it’s not in our budget.” My impression was not that his parents actually kept a formal budget; this response was just an excuse to curtail the collection of useless things. Regardless of the truth behind the words, a budget came to mean a restriction or limitation designed to eliminate fun and the things we want.

It’s true that budgeting, assigning categories to your expenses and deciding how to focus your spending, is not a fun exercise. And I think those who try to make it artificially fun are missing the point. Like bathing and cleaning your house, it’s just something that needs to be done — at least, at first.

Whether your income is from an allowance, a part-time job, or a full-time job, it’s smart to create your own budget. The point of the budget isn’t to curtail fun, it’s to ensure you have the money for fun when you want it. If chores entitle you to $75 a month, you have $75 to split into categories of spending and savings. If you have no required expenses like car insurance or gasoline, you may decide that $40 could be directed towards savings (a good idea) while the remaining $35 can be used for movies, concerts, or anything else you may enjoy. Savings should be the first part of your budget, and with no expenses you could put at least half your income into savings with the rest available for fun.

Budgeting gets more complicated when you have more responsibilities and therefore more expenses. For example, if you own a car you will need to factor in car insurance, gasoline, maintenance and repairs. Suddenly you are not having fun with the money you earn, or at least, not as much of the money you earn. Unfortunately that’s the stigma of budgeting.

Visualize your budgeting

In today’s world of electronic transactions, debit cards, and online access you your bank, it’s quaint to think about placing cash in envelopes with labels. This is a great way to visualize your budget, however. Start with a set of envelopes labeled “savings,” “car” (or “transportation”), “food,” “rent,” “utilities,” “charity” and “fun.” In each of these envelopes, you will place a portion of the income you receive. If you imagine you receive your income in cash at the beginning of each month, this envelope system makes sense. Start by putting 10% of your income directly in your savings envelope. This is a good habit to fall into early.

Rent and utilities are generally predictable expenses that are roughly the same very month. On day one, when you receive your income, place the exact amount of cash you know you will owe for rent and utilities into the appropriate envelopes. After these set expenses, you can decide how to divvy up your cash.

You know you will need to eat throughout the month, so that might be your next focus. It may be harder to imagine how much money you will need for food without tracking your spending for a time, but make a guess for now. Do the same for your transportation envelope. The remainder can be split between charity and fun, but consider beefing up your savings envelope, too.

Don’t seal the envelopes. You will need to remove the money once your expenses are due, but you are also allowed to transfer money from one envelope to another. Going on a road trip? Transfer some money this month from your savings envelope to the transportation envelope. (If you don’t have enough in the savings envelope, it may be a sign that you’re not ready to go on the road trip.) If you eat less this month, you can transfer some cash from the food envelope to another, such as savings or fun.

For your first budget, use a pencil and paper, even if you don’t use actual cash and envelopes. Look at the numbers and get used to working with them, doing simple calculations to make sure you’re spending less than you’re earning and saving at least 10% of your income. A pencil and paper system is great because it’s practically free and completely customizable. There are free online tools that help you budget, like Quicken Online and Mint, but their features can be overwhelming if all you want to do is set up initial flexible guidelines for your spending. Software designed specifically for budgeting, like Mvelopes, You Need a Budget, and PearBudget have thorough features, but you must buy the software or pay a monthly fee for its use. And unless you have room for a budget category called “software,” you may want to skip this in favor of the simpler but just as effective pencil and paper.

Suggestions for advanced budgeting

Here are a few tips I shared when I wrote about taking control of your finances.

Consider the 60% rule. I’m not a fan of rules, but sometimes a guideline can help get you started on the right path. As an individual, you can decide what’s right for you, but sometimes an example helps. The 60% rule suggests that the first 60% of your gross income (before income taxes are taken out) should be designated for your non-discretionary, essential expenses, like housing, food, clothing, and taxes. The rest of the income should be split with 10% going towards savings, 10% towards retirement, and the rest for “fun,” or your discretionary expenses.

Reward yourself for staying under budget. If your budget is realistic — not too difficult nor too easy to achieve — then you should reward yourself when you spend less than you plan. With your “fun” expenses, your spending may be variable month to month and difficult to predict. If you make a conscientious effort to spend less than you expected, perhaps by seeing fewer movies in the theater or cutting back on vacation plans, you have extra money left in your envelope (virtual or otherwise). First, move that excess money to savings. If you don’t perceive savings to be an intrinsic reward, treat yourself to something you’d like.

Use ING Direct’s subaccount feature. Since you can split money in ING Direct’s high-yield savings account into separate buckets, you can label these subaccounts to match your budgeting categories. this lets you earn a decent interest rate while keeping your money organized.

Pay yourself first. No matter what, make sure some of your excess income is diverted to your savings. If you set up direct deposit into your checking or savings account, this will require less work. Your savings envelope contains 100% of your income (minus income taxes) after you are paid, and from there you can distribute funds to your remaining envelopes.

(The following tip is new.)

Budgets are not set in stone. Once you have the process down to a science, don’t be afraid to loosen your grip and introduce flexibility. You can borrow from one category to pay for larger expenses in another, and you can borrow from one month to pay for the next. Just don’t get caught into the trap of borrowing from your future.

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