Regardless of whether you’re just starting out in the world on your own or want to get your finances on track or start saving for a certain occasion, one thing is for certain: you need to start by budgeting. The first step is to track your spending for a month or two. You can use Quicken, you can use Excel, you can use a notepad and a pen, but you need to keep track of every single penny that you spend for that period of time.

You will be shocked when you discover what you really spend.

Once you’ve gotten your monthly spending habits nailed down, it’s time to organize! Categorize your monthly spending and assign percentage points to everything. Keep your categories broad, such as in the example below:

• Income: $2000
• Rent: $700 - 35%
• Groceries: $250 - 12.5%
• Utilities/Cable/Internet/Phone: $200 - 10%
• Gas: $100 - 5%
• Beer: $50 - 2.5%
• Entertainment: $200 - 10%
• Personal Care: $20 - 1%
• Clothing: $200 - 10%
• Other: $180 - 9%
• Debt: $100 - 5%

Once you’ve got these numbers, you can see where the majority of your funds are being spent, and where you want to change in order to achieve your financial goals. While the majority of people assume that reducing spending in certain areas is less pleasurable than spending time in Guantanamo Bay, once you’ve taken a look at where your spending really comes from, you’re more likely to want to remove some items from your monthly budget. If you’re spending $5 per day at Starbucks, try reducing it to being a once-per-week treat, and you’ll save $30 per week, or $120 per month.

The next part is determining where you want to be with your finances. We’re going to keep using the above example, but assume that the person in question (lets call them X) has around 5k of credit card debt, to which those $100 per month had been going. X wants to get out of debt and start saving as soon as possible. Assuming these credit cards are at 20% interest, this means that X is paying $83 per month in interest charges. Right now, X is paying $100 per month towards those cards, lets see what X can do by reducing other parts of the budget:

• Income: $2000
• Rent: $700 - 35% - while X could move, it’s easier for now to just stay put as moving is expensive. Things aren’t so desperate for X that a downgrade is necessary.
• Groceries: $225 - 11.25% - Buying a few no-name items instead of brand names saves a few bucks here and there. There’s no need to exclusively buy no-name brands, but saving a few bucks here and there makes a little bit more available for the debt.
• Utilities/Cable/Internet/Phone: $150 - 7.5% - Getting rid of the premium channels on TV and going to a more basic phone service can really drive down the costs here.
• Gas: $100 - 5% - Lets assume that X drives to work and so this one is unchangeable, save without purchasing a bus pass.
• Beer: $20 - 1% - Reducing spending on beer, while tough, is necessary. Right now X is paying $83/month in interest, which is essentially throwing away money. There will be lots of money to be spent on beer when X is out of debt.
• Entertainment: $100 - 5% - While X can’t go out every Friday and Saturday night anymore, there’s still enough money there to allow X to go out every two weeks or so for a night out with friends.
• Personal Care: $20 - 1% - A person needs to take care of themself!
• Clothing: $50 - 2.5% - While X enjoys spending money on clothes, budgeting accordingly is important.
• Other:$150 - 7.5% - Reducing those other costs (a new DVD for example) by a small amount also helps keep the budget in order.

After all of these calculations, the total remaining to pay off the debt: $485 per month! In just under one year at this rate the credit card will be paid off. Without reducing the budget and increasing the amount of cash X has to pay off the card, at $100 per month it would have taken X over 6 years to pay off that card.

This small lifestyle change in X’s budget resulted in a large increase in available capital, and in less than a year X is debt-free and ready to save for the future.

The next step is to make sure you can stick to it. Try your new budget out for a month. If you’re in more dire straights than X and need to strictly reduce your budget, you need to ensure you’re still spending money on yourself. You won’t be able to stick to your budget if you’re only eating Ramen noodles and have no TV, cell phone or internet. Make your budget strict, but realistic and track your spending to ensure you’re sticking to it. If you cut your spending by 10% and you found it nearly impossible, try reducing it to 7%. If you found it to be simple, try further reducing your spending by an additional 5% until you find a place where you’re living happily but still saving as much as possible to put towards your debt or your future.

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It’s said that one should always keep at least three months of savings, some say even six months worth, in a high interest savings account. I completely agree, and definitely recommend at least three month’s worth. Keep this money in a high-interest savings account, preferably an online one like ING Direct or HSBC. If you keep it in an account with the bank with whom you have your main chequing account, you’re going to be seeing that money consistently and if you see the money there there is a good chance you will spend it.

There’s a mental aspect to this as well: if you keep your savings account with your regular bank, you’re going to be constantly seeing that money and being aware that it’s there, making you more likely to spend it. When your savings are entirely separated from your chequing account and bank, you can’t see that money and you’re less aware that it’s there.

If you’ve got international connections, you can be extra sneaky by taking advantage of higher interest rates in foreign countries. For example, my fiancee in Australia has a savings account which offers him 7.0%, which is much higher than the 3.65% offered to me by ING Direct Canada. Of course you need to be able to fully trust anyone to whom you send money, but in the case of it being a trustworthy family member or spouse, this is a great way to take advantage of savings accounts.

Now for recommendations. Always make sure your bank is insured (in the USA this is with the FDIC).

ING Direct is one of the most popular ones. If you have a friend or family member who already uses ING, ask them for a referral. If you deposit $250 or more initially and keep it in ING for 30 days or more, you get an extra $25 and the person who referred you gets $10. Not being American, I don’t have a referral link to offer you, so you’ll have to find your own referral.

In Canada, the referral is only $13, but still an extra little wad of cash. If you’re interested, e-mail me and I’ll send you my referral link. If you’ve been thinking of opening an ING Direct account, take the referral route as it’s free cash. What could be better?

HSBC Direct is another popular option, which usually offers the same, or similar rates to ING Direct. In Canada the HSBC Direct rate was 4.75% until May 2nd, which was a full 1.10% higher than the ING rate. Given our half percentage interest rate cut, this is likely to go down, but ING’s rate is likely to drop as well. However, HSBC does not have a referral program in place.

These are the two banks I would personally recommend. If you want to be particularly smart, use your ING Direct account for a referral, keep the money in the account for 32 days and then take it out and move it to your newly opened HSBC account. You’ll likely lose a few days worth of interest, but it will get you the $25 (or $13) bonus as well as the best rate.

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The idea of paying yourself first is one of the most basic rules of finance, and one which is covered extensively in the book The Richest Man in Babylon, which I highly recommend. Saving 10% of your net income every payday is the key to staying on budget and maintaining good control of your finances. Regardless of how much debt you’re in, you need to save a little bit and spend it on yourself.

This follows the same reasoning that doctors use when recommending that dieting patients eat the occasional sweet and indulge a little bit. Without feeling some sort of pleasure, you will relapse and go on a spending spree which can so often destroy the hard work you’ve put into getting your finances into order. Being able to spend a little bit to get something nice, be it a clothing item, some pizza at the end of the month, a book or nice jewelery, buying a little something for yourself will not only make you feel good but will help your long-term budgeting abilities.

As the book also mentions, keeping 10% of your income for yourself BEFORE all of your expenses forces you to reduce your overall monthly expenses. You may have to learn to live without unlimited text messaging or lowering the thermostat by 2 or 3 degrees but you’ll learn to reduce your monthly spending on top of having a little bit of extra cash to play around with.

Keep a little something for yourself. It will keep you sane and help you learn to reduce your monthly expenses so you have more to spend on yourself.

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