Budgeting for a Major Purchase

(2 of 6)

Budgeting for a Major Purchase

The first step in (responsibly) financing a major purchase is to establish a household budget. That way, you can see how and where the planned purchase can be fit into your overall financial picture. In a nutshell, budgeting is simply the process of balancing monthly cash inflows with expenses.

Inflows and expenses can be looked at several ways

For most of us, cash inflows are predictable—typically, a paycheck. Expenses may be fixed (e.g., house payment or rent) or variable (e.g., entertainment or "pocket money"). These examples of expenses may also be characterized as discretionary or non-discretionary: You can choose to spend on a night at the movies, but have no choice about paying your mortgage.

A major purchase, by its nature, is a variable expense—we don’t need a new roof every month. But it is important to recognize whether a big purchase is discretionary or not. When the refrigerator dies, we need a new one immediately, but the 48-inch TV can wait.

Try this exercise

For a month, carefully record your cash inflows and expenses (especially the latter). This overview will help to project future cash-flow needs and suggest which expenses can be targeted for cutback, if need be.

The point of this exercise, as most financial advisors agree, is to "find" dollars that you can "pay yourself first." Paying yourself first means setting aside and saving a certain amount of money from your gross income on a regular basis.

Paying cash for everything we buy is clearly a good way to avoid becoming burdened by debt. Unfortunately, however, the dead refrigerator or a hole in the roof demands immediate attention, whether or not funds are available out of pocket. So you will also need to examine the use of borrowed funds for financing a major purchase.