A budget is an estimation of revenue and expenses over a period of time and is usually re-evaluated when that time period ends. Budgets provide a method for organizing and optimizing cash flow for people and businesses. A budget can be very simple or complex depending on your finances.
We must consult our means rather than our wishes.George Washington
Why is budgeting important?
Budgeting is important as it allows you to create a spending plan for your money. This ensures that you will always have enough money for everything you need, even things that are important to you but not necessarily a direct need.
If done properly and adhered to, a budget will keep you out of debt. A budget can also help you get out of debt and start working towards more financial freedom.
A few key benefits to creating and maintaining a budget:
- It gives you complete control over your money.
- It helps you reach your financial goals.
- It keeps you focused on where your money is going.
- I keeps you aware of your savings and debts so you’re always working towards improving your financials.
- It can help you save for unexpected costs.
- Helps you identify habits that are impacting your financial success.
- It can help you when you want to buy a car or buy a house.
How to Create a Budget
Why do so many of these budgets fail?
- The rules set are too strict.
- There are too many “exceptions” to the budget.
- Forgetting about one-time expenses (ex: License Renewal).
- Estimating too much, or too little, income or expenses.
- Failure to create a new budget when your financial situation changes (ex: increase to income).
Steps to Create a Budget
- Calculate Income – You’ll want to calculate all of your income after taxes are taken out in a single month. This is also known as a you “take home pay” and you’ll want to include every source of income. If your income fluctuates we suggest using your lowest income month as a baseline.
- Calculate Expenses – You’ll want to calculate all of your monthly expenses. These expenses should include recurring and variable expenses whenever possible.
- Review Spending Habits – In this step you will want to review and identify any spending habits you are noticing so far. You’ll want to look for patterns like using your credit card more than debit or buying fast food every day for lunch.
- Researching Budget Plans – There are tons of budget rules and methods (we outline below) that you can choose from that can help you along the way. You’ll want to start researching the best ways or tools you can use to help you stay on track.
- Set a Financial Goal – This is probably the most important part and the reasoning behind why you’re setting up a budget. For most people they budget to help themselves get out of debt while others do it to help build a savings. This goal should be custom to you and should help you reach financial goals you have set for yourself.
- Create a Budget Plan – At this point you should have identified a methodology you want to follow or be creating your own custom plan. Based on your financial goal you should be allotting your money where it needs to be for each month. Keep in mind – you should always have an emergency fund and you should always be adding to your savings.
- Monitor Progress & Adapt – You should be monitoring your budget and making adjustments to it as you go. If your budget isn’t working for you then you should figure out a new methodology or tool that can help and start using that. The key to a good budget and financial habits is persistence.
Keep in mind – any change to your financial situation is cause for you to refresh your budget. If you’ve increased your income, added another expenses or paid off an expense, you should be creating a new budget.
Budgeting Reminders & Tips
These are just a few things you should keep in mind when you’re setting your financial goal and creating a budget:
- You will want to always budget in advance as proactive planning is the only way for a budget to truly work.
- If you have variable income you will want to be aggressive with your savings and debts in month’s where you have more income.
- Try and avoid using credit cards whenever possible and if you do use them pay them off immediately.
- Set aside money as early as you can for infrequent purchases like insurance or a driver’s license renewal.
- If possible, you should automate as much of your budget as possible with automatic payments and splitting up direct deposits.
- Make sure you have an emergency fund built up beforehand or are actively building one while you budget.
- The easiest way to improve your financial standing is to lower your expenses.
Budgeting Methods & Rules
There is no such thing as a “one size fits all” method to budgeting. There are some frameworks that many use to try and budget as its easier than creating a custom budget plan each time. You’ll often find that these are “trendy” or heavily promoted by influencers on social media – that doesn’t mean they will be right for you.
Your best option is to review the most common budgeting methods below and make the decision for yourself. You should try as many as you need to find the right budgeting plan techniques that fit your lifestyle and goals.
A zero-based (or zero-sum) budget method is where you expect to use every dollar or cent you make in your budget and you leave nothing to rollover. In this budget plan your total income will equal your total expenses for the month. The thing to keep in mind is that this budgeting technique puts a purpose to each penny you earn and that includes adding to savings or investing. The goal is to have $0 rollover at the end of the month and all of your income, fixed or variable, is used for something.
In most cases, people that don’t budget and just pay their bills and throw the rest in savings are loosely following a zero-based budgeting system and they just don’t realize it.
Perks: This budgeting technique is perfect for people who want full control over their income.
Disadvantages: This budgeting technique is very time consuming as you constantly have to track your spending and basically have to generate new plans each month.
50/30/20 Budgeting Rule
A 50/30/20 budget method is where you divide your income into three categories that serve different purposes.
This budget method breaks down to using 50% of your income to cover your needs, 30% of your income to cover wants, and 20% of your income to go into your savings or retirement.
The numbers above are treated as guidelines and this budget method gives you the freedom to adjust the percentages as you see fit to accommodate income. For example, if you can use only 30% of your monthly income to cover needs that extra 20% can float into the other categories. This is where this budget method can be counterproductive as many will simply push that 20% into the wants and now their wants category exceeds savings and needs.
Perks: This budgeting technique is perfect for people who are a bit more experienced at budgeting and simply just don’t have time to budget or redo their budget each month and their expenses or income does not change often.
Disadvantages: This budgeting technique is considered to be “too flexible” in that it allows the person to spend a large portion of their income however they want to as long as they stay within that percentage for that category. It can harm users who aren’t as disciplined as usually there isn’t much money “left over” at the end of the month.
80/20 Budgeting Rule
The 80/20 budget method is simpler than the previous 50/30/20 method but still follows the same methodology.
This budget method breaks down to using 80% of your income to cover your expenses and 20% of your income to go into your savings or retirement.
This style of budgeting is very customizable and is often the entry point for how someone budgets. They put forth a certain percentage towards bills, and expenses, and the rest just sits in their account or gets moved to a savings account. This budget plan benefits users who tend to make well more than their expenses in income each month and provides more benefit to users who can put more than 20% of their income away into savings or retirement.
Perks: This budgeting technique is perfect for people who have more discipline with their income and spending habits. They also generally have more income than expenses each month.
Disadvantages: This budgeting technique can sometimes bite people who aren’t paying too much attention to what falls into their “expenses” category of their budget plan and continue to spend. Typically people who have more income than expenses fall under this category as they tend to not monitor their spending habits “as long as the money is there and the bills are paid”.
Envelope Budgeting Method
The “envelope method” dates back to when people weren’t using banks or not everyone had a checking account or savings account. Your thinking is probably spot on with this method by just reading the name.
This budget method breaks down to someone assigning an exact dollar amount to each expense or savings account each month or budget cycle.
Did you guess it right based off the name alone? You’re one smart cookie. This is by far the most effective method to budgeting and forces you to look at every expenditure in your account and keep track of exactly where your money goes. If you’re paid in cash – you should be using this method almost always. If you’re not paid in cash – you should opt for one of the other methods as banks and credit unions have several other added benefits in this digital age.
Perks: This budgeting technique is perfect for people who want complete control over their finances and where their money is going.
Disadvantages: This budgeting technique is the most time intensive and intense out of this list. You will have to consistently monitor your budget and keep track of all of your finances as often as you’re paying an expense or gaining income. The easiest thing to compare this to is someone “balancing their checkbook”.
60% Budgeting Method
The 60% budget method is a lot more aggressive than the other percentage based budget techniques but if you’re financially in a good spot it can be one of the more lucrative ones that allows you to still have your wants.
This budget method breaks down to using 60% of your income to cover your expenses and the remaining 40% of your income to go into 4 different categories (Retirement, Long-Term Savings, Short-Term Savings and Wants) with each getting 10% of that left over income.
Perks: This budgeting technique is perfect for people who want to put more away for retirement and savings but still have a little fun on the side. This budgeting rule tends to help you build wealth a lot faster than the others.
Disadvantages: This budgeting technique is fairly aggressive towards saving and building long-term wealth. This is not the best budget method if you’re trying to pay off debts or have a large amount of debts you’re trying to pay off (excluding a house or car).
|Weliver, D. (2019, April 12). Why Most Budgets Fail (But Yours Doesn’t Have To). Money Under 30. https://www.moneyunder30.com/why-most-budgets-fail|