A budget refers to a strategic plan for managing your finances every month. Why are budgets significant? Budgets are crucial in controlling spending and ensuring your extra money is used effectively. They contribute to financial stability and offer several advantages, including:
- Developing healthy financial habits.
- Preparing for unforeseen circumstances.
- Building a favorable credit score.
- Saving for significant purchases
- Establishing a comfortable retirement plan.
Budgets are instrumental in maximizing both your present and future well-being. However, it's essential to identify your goals before you begin, as they will guide the budgeting process to suit your specific needs.
How to start budgeting
Focus on your long-term goals. Reflect and ask essential questions about your future, ensuring your thoughts are specific and honest. You can explore Financial goal-setting resources for additional tips on clarifying your long-term financial objectives.
Once you have your primary goal, break it down into smaller, more achievable goals. Setting unrealistic expectations can lead to demotivation and discouragement.
Once you have determined your goal, consider sharing it with friends, writing it down, or creating a vision board if that suits your style. Employ whatever methods are necessary to remind yourself of the bigger picture consistently. With a clear intention, developing a budget that aligns with your needs becomes more accessible, and you can start by applying the 50/30/20 budget rule.
How to begin a customized and realistic budget
A well-crafted monthly budget is a financial planning tool allowing you to effectively manage your regular expenses and savings. Additionally, it enables you to monitor your spending patterns, which is highly beneficial.
Creating a budget is crucial for maintaining financial stability. Budgets require a certain degree of balance to function effectively, as saving less in one area allows for more spending in another. Your budget will only succeed if you are honest about your net income and expenses. Ultimately, it will reveal your net income sources, available amounts, and where your extra money goes each month.
When constructing your budget, consider three types of expenses:
- Fixed expenses: Regular amounts that do not frequently change (e.g., rent, mortgage, or car payments).
- Variable costs: Likely to fluctuate based on purchases or usage (e.g., food, gas, and personal care).
- Non-monthly expenses: Unexpected expenses that may arise (e.g., emergencies, gifts, or travel).
Income - Fixed expenses - Variable expenses - Non-monthly expenses = Money for goals
Including non-monthly expenses and establishing an emergency fund is essential for wise budgeting. Both require intentional effort and planning. An emergency fund helps you avoid relying on credit cards and prevents the need to deplete other savings when unexpected events occur. It provides a financial buffer to cover deductibles or minor incidents. Aim to save money into an emergency fund to cover essential expenses—an health insurance policy for your budget.
To get started, envision your budget as having two main components:
- Income received.
- Expenses incurred.
If your expenses outweigh your net income, look for areas where you can make slight adjustments. However, avoid making drastic changes to your budget regularly or spending habits simultaneously. You are more likely to succeed by taking small steps toward change. To develop a budget, it's essential to clearly understand your current spending habits, comfortable spending limits, and goals.
Gather your financial records
Collect all relevant financial statements, including:
- Bank statements
- Investment account statements
- Recent utility bills
- Credit card bills
- Receipts from the past three months
- Mortgage or auto loan statements
A comprehensive view of your income and expenses is crucial. Monthly averages are particularly useful for budgeting purposes.
Calculate your income
Determine your average monthly income, considering factors such as net income from a regular paycheck (accounting for tax deductions) and any additional sources of income like self-employment earnings, child support, or social security. Sum up all these income sources every month.
List your monthly bills
Make a list of expenses you anticipate incurring within a month and keep it readily accessible. Reviewing bank records, receipts, and credit card statements from the past three months can help track your spending accurately.
Differentiate fixed and variable costs
Categorize your expenses. Fixed expenses are regular payments, such as mortgage or rent, car payments, internet subscriptions with fixed charges, recurring daycare fees, etc. Variable expenses encompass items like groceries, gifts, and other flexible costs.
Assign values to each category
Begin with the fixed expenses and assign a specific amount to each category. Calculate your monthly variable expenses by multiplying your income by the months you plan to budget for.
Total your monthly income and expenses
If you have surplus money, you can allocate it towards retirement savings or debt repayment. Overspending occurs when expenses exceed income, indicating the need for adjustments.
Allocate 10-20% of Income for Savings.
It is essential to prioritize your expenses to meet your financial goals. Start by setting aside money for savings, emergency funds, and investments. "Aim to save at least 10-20% of your monthly income. Determine what expenses are essential and which can be cut back or eliminated. Ensure you are consistently setting aside money for your financial goals", said Ranee Zhang, VP of Growth, Airgram
Adjust your expenses
If your expenses exceed your income, explore ways to reduce your variable costs. Identify areas where you can cut back. Aim for equal income and expenses columns, ensuring your money is allocated towards particular spending or savings goals.
The money you need for savings, emergency funds, and investments depends on your financial situation, goals, and risk tolerance. Aim for at least 20% of your income for savings and investments.
To prioritize your expenses, creating a budget and tracking your spending are essential to see where your money is going. Start by identifying your expenses, such as housing, food, utilities, and transportation. Then allocate funds towards your financial goals, such as savings, emergency funds, and investments.
By creating a budget, you can gain insight into your spending patterns, distinguishing between positive and negative habits. This process allows you to identify expenses that can be eliminated, giving you a clear understanding of the flow of your income and expenditures. Such knowledge will equip you to handle unforeseen costs or financial challenges.
Feel free to explore various budgeting methods until you discover the one or a combination of methods that suits you best. Remember, your budget doesn't need to be flawless—it simply needs to be tailored to your specific needs and preferences.
With proper help you can
- Lower your monthly payments
- Reduce credit card interest rates
- Waive late fees
- Reduce collection calls
- Avoid bankruptcy
- Have only one monthly payment