Many people will admit that managing their personal finances is no easy task, especially if you’re busy with other things. However, budgeting is essential because it helps you be in charge of the money rather than the other way around.
If you have ever struggled to save money, you probably need to create a better budget and stick to it. We will go over a few simple aspects of budgeting to get you started, including:
- What is a budget, and why should you have one?
- Steps to create a budget
- Advantages and disadvantages of a budget
- Types of budgets
- Importance of a budget
What Is A Budget And Why You Should Have One?
So, the book definition of a budget is:
“A budget is a formal statement of estimated income and expenses based on plans and objectives.”
Budgets are explained a little differently by everyone but it is not as complicated as people make it seem. Although the definition is dry and boring, the purpose of a budget is to tell what you can afford to buy based on your income.
Whether we like to admit it or not, a lot of us go over budget, which is when you buy more stuff than you can afford. Furthermore, a budget helps you keep track of your expenses and this helps you spend your money more wisely.
By following a budget, you will have more room for savings, which you can use for investments, an emergency fund, or just some fun. Budgeting is no easy task when you are first starting off. It requires perseverance and persistence but will pay off in the end by increasing your net worth.
As months go by, and you make budgeting a natural habit, you will control your expenses and eventually become the “Budgeting Master.”
Looking for an easier way? Check out Personal Capital for a great app to help automate your budgeting.
Steps To Create A Budget
Think you have a basic understanding of what a budget is? If yes, we can start talking about the very foundations that make up a budget.
After going through these steps thoroughly, you should be able to make your own budget from scratch.
1. Write Down All Your Expenses
The first part of budgeting is to determine where your money is being spent. I always break down expenses into two parts: fixed and variable cost. This is a good starting point to start making a budget as it helps to allocate your spending into large categories.
Fixed costs are those expenses that remain the same every month, like rent, insurance, or phone bills.
On the other hand, variable costs vary or change according to usages, like eating out, groceries, or entertainment.
To calculate the exact amount for your expenses, you can refer to your previous month’s bank or credit card statements to get a rough idea. If you buy everything with your credit card, it should be pretty easy to track what you spent your money on.
Don’t forget to include things that you spent cash on. Even if it is only a few dollars, it can add up in your overall budget. Make a quick note every time you pay for something in cash or withdraw cash from an ATM.
This way, you may not forget to add a certain expense saving you the trouble. I would recommend you jot down these expenses either daily or weekly. This will make your life easier, and it will help you to stay up to date.
2. Write Down Your Income
The other half of the budget equation is the amount of money that goes into your bank account. Income is money you receive, like for a job, rental income, or monthly interest, for that matter. Include anything that pays you, both a regular job, side gigs, and passive income.
When you do this exercise, you should list down the income you received after-tax. This is the actual amount you receive in your bank account and is able to be spent.
Again, with the case of income, I recommend breaking it down into either weekly or monthly, as it is easier to track your budget.
3. Track Your Spending And Make Adjustments
Now that you have all your expenses and income in one place, you should again recheck if you have not missed anything important.
Hate spreadsheets? There’s an easier way to manage your budget by using a free app to automate it for you.
The last step is to subtract your expenses from your income. This will show you how much money you have leftover at the end of the period. I would recommend you do it monthly if you are doing it for the first time.
If your total income is greater than your expenses – bravo! This means you have extra cash, which you can save or pay off your debt.
However, if your total income is less than your expenses, then you may be in trouble. It means that you are spending more than you earn and is not sustainable.
If you are spending more than you are earning, you must reduce your fixed and variable expenses as much as possible by looking for cheaper alternatives for the things you buy. Another option is to increase your income by adding a new revenue stream.
The above steps are some basic steps towards budgeting, which should be followed. Below, I have listed three widely used methods around the world.
Types Of Budgets
Spoiler alert! There are way more than the 3 types of budgets I have mentioned below and it would take forever to go through all of them. So, I shortlisted them into three types that would be the most effective types of budgets for most people.
50-30-20 Budget
I feel that this method or rule can be applied to most people as it has a degree of leniency and, at the same time, helps you be a bit more conservative.
This method’s fundamentals are simple since it splits up your disposable income into three buckets.
- 50% should go towards your fixed expenses such as rent, utilities, food, and insurance.
- 30% can go towards your variable costs or “wants.” This pertains to things that make your life more wholesome, like entertainment, cinema, or concerts, for that matter.
- 20% should be allocated to savings, to pay off your debt, or contribute to investments.
This budget type is very flexible as it gives you more control over your money and spending. Now rather than spending more than your total income, you could save a lot and maybe go away for a mini-vacation.
The 60% Budget
This method’s basics are straightforward as you can spend 60% of your disposable income on essential expenses like rent, utilities, food, or insurance.
The remaining 40% is allocated into 4 categories: retirement, long-term saving, short-term savings, and vacation savings.
This helps to give you some structure while also enough freedom to allocate your money to the areas you need. It also provides some flexibility in times when you want to save for short-term goals more heavily.
Zero-Based Budget
The Zero-Based Budget is when your total income equals your expenses. This helps provide every single dollar a purpose or a job and this keeps you from spending money.
I believe that this method helps you stay closer to your financial goals and payout your debt. The best part about this method is that every dollar is accounted for to reach your goal faster.
This is the most challenging of the three types of budgets as it requires much more perseverance not to spend excessively. I would recommend writing down your main financial goals and try following them whenever you have excess money. Say no more to impulse spending.
Budget Advantages and Disadvantages
Still not sure if creating a budget is worth your time and effort? I hope this changes your mind
Not Having a Budget
- You have no idea if you are living within your means.
- Saying no to something you really want is not easy.
- Lower flexibility to spend on “wants”.
- Unable to address unplanned financial emergency like hospital bills or car repairs.
Having a Budget
- You become in charge of the money, not the other way around.
- Your life becomes more stable.
- You reach your financial goals.
- Your stress levels decrease as your debt decreases.
- You have enough savings to help you in time of emergencies.
Conclusion
All being said, it is often not easy to implement a budget into your life. Although making a budget can be one of the most rewarding things in your life since it helps you become more responsible and makes you feel more in control.
The world is moving extremely fast, and budgeting helps the world to slow down a bit. Budgeting has and will always help you out in times of emergencies, like COVID-19. You can also use mobile apps to reduce your spending and keep track of where your money is.
Start off with a goal to track your budget monthly because, believe it or not, a solid budget can change your life.
