The following process breaks down budgeting in simple steps:
- Analyze how and where you're currently spending.
- Calculate how much more you want to save each month.
- Determine where to make cuts in your spending.
When you contribute money to a tax-deductible retirement account, you generally reduce your federal and state income taxes. If you're a moderate-income earner paying approximately 30 percent in federal and state taxes on your marginal income, you actually need to reduce your spending by only 7 percent to save 10 percent. The other 3 percent of the savings comes from the lowering of your taxes. (The higher your tax bracket, the less you need to cut your spending to reach a particular savings goal.)
So to boost your savings rate to 10 percent, you simply need to go through your current spending, category by category, until you come up with enough proposed cuts to reduce your spending by 7 percent. Make your cuts in areas that are the least painful and in areas where you're getting the least value from your current level of spending.
If you don't have access to a tax-deductible retirement account or you're saving for other goals in nonretirement accounts, budgeting still involves the same process of assessment and making cuts in various spending categories.