Fitting a Major Purchase into Your Budget
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Fitting a Major Purchase into Your Budget
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.
Things To Know
- A major purchase is a variable expense.
- The purpose of recording your cash inflows and expenses is to "find" dollars that you can "pay yourself first."
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.
Automatic savings and investment plans for major purchases
The most painless way to "pay yourself first" is to set up an automatic savings program. Consider having regularly scheduled withdrawals made from an existing account (e.g., the checking account where your paycheck is deposited) and transferred into a dedicated savings or investment account. Generally, any financial services institution that offers savings or investment accounts will offer an automatic savings plan.
Experts recommend creating an emergency fund as a first savings priority; three to six months’ living expenses is a rule-of-thumb goal. Ideally, this is where you would turn for that new refrigerator tomorrow.
