“A budget is telling your money where to go instead of wondering where it went.” John C. Maxwell
Spending within your means may sound like a simple rule to follow, but many Americans spend more than they save, which can result in debt. The good news is that it’s completely avoidable, and it’s reversible over time. With a little budgeting, planning, tracking and adjusting your spending, you can live happily within your means.
Keeping your personal finances in tip-top state does takes some planning, effort and time. Yet, many people live above their means and don’t even realize it. More than three-quarters of American workers (78 percent) are living paycheck-to-paycheck to make ends meet, according to survey conducted by Harris Poll on behalf of CareerBuilder in 2017. Thirty-eight percent said they sometimes live paycheck-to-paycheck, 17 percent said they usually do and 23 percent said they always do.
To improve your financial health and money management awareness, the one piece of advice you hear most often from financial experts is to create a budget.
“Budgeting helps you better understand how you spend your money and shows you ways to manage your money, pay off debts and save for future financial goals.”
Budgeting is one of the single most effective tools for money management. Making a budget simply means examining your income and expenditures in order to determine exactly how much money you have coming in and where you’re spending it. Once you’ve got a clear understanding of your current budget – what income you’re receiving and what expenses you’re responsible for – take a closer look and find places where you can spend less.
A budget will help give you a clearer picture of how much money you have coming in (income) and how much is going out (expenses). It’ll set guidelines for your expenses that will help you understand how much you can set aside for those bigger ticket items like a house and long term goals, like saving for retirement or an emergency fund. A budget is a personal cash flow roadmap. It can span a week, month, quarter—three months—or any set length of time. They are created by individuals and businesses.
Begin planning your monthly budget by figuring out how much you have coming in versus how much is going out every month. Ultimately, you want to end up with a blueprint that specifically breaks down your cash flow (income minus expenses), so you know how much you can spend and how much you can save each month. Building a budget starts with a few simple steps.
Budgeting is Important
“When making a budget, the idea is to make sure your expenses don’t exceed your income.”
A budget is a foundational piece of a financial plan. If you’re serious about reaching your financial goals, making a budget and sticking to it can help you achieve them. Here are some of the benefits of making and following a budget:
- Live within your means: If you haven’t been budgeting up to this point, you may often wonder at the end of the month where all your money went. It’s even possible that you’re running a deficit and taking on credit card debt to cover the difference. A budget can help you live within your means when you use it to set clear boundaries for your spending.
- Pay off debt: Making a budget is about taking control of your finances. If you’re working to get out of debt, decide how to allocate your spending to prioritize paying more toward debt payments. For example, if you notice that you spend a lot on entertainment, you can set a budget to only allow yourself to spend up to a certain amount on that category. Then use the savings to pay down debt.
- Save money: Long-term savings goals are also an important part of a personal budget. Think about setting aside money each month to save for retirement, a vacation or a home down payment. In the short term, make sure to save enough for an emergency fund. A budget can give you better control over how you spend your money, allowing you to cut back on spending and save more.
- Reach financial goals: You likely have financial goals you’re working toward. But if you don’t have a budget, it can be tough to know where to focus your efforts and make meaningful progress. A budget can help you decide how much money to allocate for each goal to keep yourself accountable.
While these are general benefits of budgeting, take a moment to think about why you want to budget. Whether it’s due to a short-term need, long-term goals or simply to understand where your money goes, knowing your reasons for budgeting can motivate you to keep up with it.
Step 1: Look at your paycheck.
To create a budget, you first need to know your net monthly income, or after-tax income. This is your monthly take-home pay, not your total salary — an important distinction when figuring out how much you can spend on a monthly basis. Knowing this number is the first step to creating a spending strategy.
To start, make a list of all your sources of income coming in the door every month. Every paycheck you get. Maybe a regular side hustle. Do you get alimony or child support? What about income from investments? Everything.
Step 2: Distinguish your essential needs from your wants and discretionary spending.
Start listing your expenses. Start with the big stuff: rent, car payments or transportation, utilities, groceries, any debt payments you need to make — things like that. Now it’s time to make a list of your essential expenses. This involves separating your “wants” from the “needs.” Needs usually include things like:
- Housing costs (monthly rent or mortgage payment)
- Transportation costs (car payment, fuel, public transportation)
- Utilities
- Food
- Insurance
- Internet, cable, and phone bills
Once you’ve tallied those costs, add them up and deduct your needs total from your after-tax income. Make note of that number. What about everything you spend money on that you like, but maybe don’t need? Eating out, entertainment, that new pair of shoes. Add those as a list to your expenses. Treating yourself is great! But you want to do it within your budget.
Step 3: Calculate how much your wants cost you.
Next, outline all the things you spent money on that don’t fall into the “needs” bucket, and tally up the total. The easiest way to do this is to look at your credit card statements from the last month or two. If you use cash to pay for things, keep a log for several days (or better yet, a couple weeks) of all your expenses.
Once it’s all written down, use a critical eye and note where you’re being your own worst enemy by overspending or wasting money on things you don’t need (or even want). Strategize on how you can modify your behavior to reduce these unnecessary expenses.
While it’s a-okay to splurge on occasion, it’s important to do so in moderation.
Step 4: Add up all your costs.
Jot down the total amounts of your “needs” and “wants” and see how they stack up against a common rule of thumb: the 50/30/20 budget. This popular money management plan says you should spend 50 percent of your take-home pay on needs, 30 percent on wants, and put the remaining 20 percent toward savings, investments, and any debts you may have, like school loans or revolving credit card debt.
Don’t panic if your current financial picture doesn’t align with this ideal ratio. It can be difficult to stick to this plan, especially if you’re new to the workforce and possibly paying down student loan debt.
But that’s exactly why a budget can be so useful. Matching up how much you spend to established guidelines can be a helpful way to identify where everything’s lining up — and where you can put in a little more effort and reduce your spending.
Step 5: Keep it up.
Now that you have your budget created, here comes the harder part: sticking to it.
The primary part of your budget should always cover your needs. What’s left over is split between the things you want and your savings. When it comes to minding your numbers, try out some of these tips:
- Be a stickler and set aside some savings for an emergency fund. It’s smart to have it an intrinsic part of your budget.
- While putting 20 percent of your take-home pay toward savings and debt isn’t technically considered a “need,” you should treat it as one. Avoid dipping into that bucket to pay for “wants,” so you can pay down debts and afford future unknowns, should something arise. In fact, you could remove temptation by setting up monthly automatic savings transfers.
- Break it down. If a budget isn’t as manageable, try chopping it up into monthly or weekly segments. A shorter time frame can make it easier to stay on track. That way, you won’t discover that you’re already pushing the limit of your budget.
- Review regularly. Along those same lines, keep track of your purchases as they happen instead of totaling them up at the end of the month. Checking your balance online or reviewing your recent credit card charges is a great reality check for daily expenditures.
- Get everyone on board. If other people, like your spouse, are supposed to follow your budget, make sure they’re on board with the financial goals you’re trying to meet. To help create a comprehensive budget, most financial advisers recommend following the 50/30/20 model for budgeting. This model suggests you use 50% of your take-home pay for essential needs, 30% for wants or discretionary spending, and 20% for savings.
Trim your expenses if your budget proves your expenses outweigh your income. One of the easiest ways to trim your expenses is to evaluate how much money you’re spending on the things you want but don’t necessarily need. For example, a night out with friends costs an average of $81, which really adds up if you go out multiple nights a week. This doesn’t mean you can’t go out and have fun, but you may need to limit your spending to make your budget work.
Another way to cut your expenses and get control of your finances is to see if you can lower the cost of certain services. Contact cellphone, internet and cable television providers to see if a competitor offers a better deal or if you can save money by bundling. Consider dropping premium cable television channels and opt for an economical basic package.
Setting goals
Successful budgeting starts with aligning your spending with your priorities. Creating goals and rewards is a fantastic way to increase your chance of budgeting successfully. For example, set a goal to save a specific amount to pay off debts by spending less on unnecessary expenses like dining out, buying lattes or shopping. Put this money into a savings account to earn interest. When you meet your savings goal, reward yourself with a reasonable splurge on something fun. Typical goals and priorities include:
- Planning and paying for college and post graduate educational expenses
- Saving a down payment to buy a home or paying off the mortgage early
- Paying off high-interest student loans and credit card bills
- Saving and investing for early retirement
Budgeting doesn’t have to be the complicated or intimidating task that it’s often made out to be. Follow this simple process, and your monthly budget will help keep your finances in check.
Now you have the beginnings of your monthly budget! It’s most efficient to build this your budget in a spreadsheet or budgeting software. Then add new expenses as you spend.
Keep it Simple: The 50/30/20 rule
Tracking your finances doesn’t have to be complicated. A budget starts with a list of your income and your expenses, and following a simple strategy as the 50/30/20 rule.
The 50/30/20 rule is a popular budgeting method that splits your monthly income between three main categories. It’s pretty straightforward: You split your money between your needs, wants and savings, according to those ratios.
Here’s how it breaks down, according to NerdWallet:
Monthly after-tax income. This figure is your income after taxes have been deducted and the cost of payroll deductions for health insurance, 401(k) contributions or other automatic savings have been added back in.
50% of your income: needs. Necessities are the expenses you can’t avoid. This portion of your budget should cover costs such as:
- Housing.
- Food.
- Transportation.
- Basic utilities.
- Insurance.
- Minimum loan payments. Anything beyond the minimum goes into the savings and debt repayment bucket.
- Child care or other expenses that need to be covered so you can work.
30% of your income: wants. Distinguishing between needs and wants isn’t always easy and can vary from one budget to another. Generally, though, wants are the extras that aren’t essential to living and working. They’re often for fun and may include:
- Monthly subscriptions.
- Travel.
- Entertainment.
- Meals out.
20% of your income: savings and debt. Savings is the amount you sock away to prepare for the future. Devote this chunk of your income to paying down existing debt and creating a comfortable financial cushion to avoid taking on future debt.
How, exactly, to use this part of your budget depends on your situation, but it will likely include:
- Starting and growing an emergency fund.
- Saving for retirement through a 401(k) and perhaps an individual retirement account.
- Paying off debt, beginning with the toxic, high-interest type.
Making a budget can be an important step in the right direction for you. But budgeting for the sake of budgeting isn’t fun. As you work with your budget each month, remind yourself of the reasons why and purpose you’re doing it. Also, evaluate your progress periodically to make sure you’re on track to meeting your financial goals.
References:
- http://press.careerbuilder.com/2017-08-24-Living-Paycheck-to-Paycheck-is-a-Way-of-Life-for-Majority-of-U-S-Workers-According-to-New-CareerBuilder-Survey
- https://www.thebalance.com/benefits-to-budgeting-453688
- https://www.ally.com/do-it-right/money/how-to-build-a-budget/?CP=135969424;274374394
- https://www.marketwatch.com/story/the-beginners-guide-to-building-a-budget-2019-08-09?mod=article_inline
- https://www.nerdwallet.com/article/finance/nerdwallet-budget-calculator
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