I recently distilled my many years of teaching people how to get out of debt and stay out of debt into a five-step system called Dump That Debt! My system is simple, easy to use and highly effective. Best of all, anyone can use it to get out of credit-card debt, and, really, all debt. The techniques it teaches can be applied to anyone — regardless of income, assets or the amount owed.
Unlike debt consolidation, which typically has an 80 percent-plus recidivism rate (more than 80 percent of the people who use debt consolidation loans end up back in debt), my system teaches the user to think about spending money in a new way. Once the user has incorporated my techniques into his or her daily life, they are able to reduce and eventually completely eliminate their debts, and, most important, stay out of debt permanently.
In this week’s column, I will discuss the first step in my five-step system: The Budget. Creating a budget is the first phase in the debt-reduction process because, if you don’t know how much money you have coming in and going out each month, it is next to impossible to make any real progress with debt reduction.
Most people cannot do a lot to change their income, at least in the short and medium terms. Many people are on a fixed income, having a salaried or hourly job, which pays the same amount each pay period. Some of these individuals may have opportunities to work overtime, to work on additional projects for extra pay, or could get a second job to supplement their income. The upside to having a fixed income is that it makes the budgeting process a bit easier because you know exactly what you have coming in each pay period, each month and each year. The downside is that there is a fixed amount of money coming in to pay expenses and to pay down debt, which sometimes isn’t enough.
Some people are not on a fixed income. People who own businesses and commissioned sales people usually have fluctuating incomes, which makes the planning process considerably harder. Their upside is that they can sometimes increase their income dramatically, providing additional cash to pay down debts faster. The downside is that they never know for sure how much money they will have month to month, and can have a bad month, requiring borrowing more to pay bills, etc. We will return to this issue later.
When creating your budget, you first will need to write down all sources of income from all household members. If you are single, you are on your own, and only your income is available. If you’re a member of a couple or a family, you will typically have additional income sources, but you will also have more expenses. While my Dump That Debt! system comes with a spreadsheet program to help the user organize information, you can simply use a piece of paper to write down the information for your budget. If you are familiar with Excel or another spreadsheet program, you can create your budget with that software.
Write down all sources of income at the top of a page, or at the top of a spreadsheet. List each source individually. It is also a good idea to indicate when during each month that the money comes in. Total all income sources for the month so you know the total amount you will have coming in. If you have a fluctuating income, use your best guess. Most people have a reasonably good idea of what their income will be, at least a month or two out. Those with fluctuating incomes can also review the previous 12 months and take an average, or can estimate from that previous 12 months what they think the next 12 will look like. I recommend using after-tax incomes, since we are looking for cash available to pay bills and pay debts.
Once you have completed the income section, the next step is to write down each and every expense. If you keep accurate records, such as with a checkbook register, you can transfer those expenses into your budget. Otherwise, you can begin to write down each expense as it is incurred. I recommend keeping track of expenses for at least three months. This will usually provide you with a good idea of your normal monthly spending. You will then need to add one-time expenses and annual expenses, such as insurance payments, taxes, etc. You can estimate your monthly expenses — adding to that an amount that reflects your monthly average for your one-time, quarterly and annual expenses — to get a reasonable estimate for your monthly expenses, if you don’t want to wait the three months to track actual spending.
Once you have all of your income and expenses written down, you can take the total of your income from all sources, and your total expenses on a monthly basis, and subtract the total expenses from your total income to see how much, if any, cash you have left over. This extra cash is the key to getting out of debt.
Next week I will discuss the next step in the process, which is to go through your expenses one by one, and reduce or eliminate any that are not necessities.
— Craig Allen, CFA, CFP, CIMA, is president of Montecito Private Asset Management LLC and founder of Dump Your Debt. He has been managing assets for foundations, corporations and high-net worth individuals for more than 20 years and is a Chartered Financial Analyst (CFA charter holder), a Certified Financial Planner (CFP) and holds the Certified Investment Management Analyst (CIMA) certification. He blogs at Finance With Craig Allen and can be contacted at craig@craigdallen.com or 805.898.1400. Click here for previous Craig Allen columns. Follow Craig on Twitter: @MPAMCraig.
