Spending more than their monthly income is the reason many people are falling into debt. To reverse this bad habit, creating a personal budget should be your priority.
Budgeting is the process of creating a plan on how to spend your money. There are two main reasons why you should create a budget:
- To help you manage how much you earn
- To help you figure your spending habits.
An effective budget requires an honest evaluation of your financial capacities. Besides helping you avoid piling on debt, budgeting also helps you allocate funds for essential things like insurance, emergency fund, and retirement.
Why Budgeting Is Important
Aside from helping you get out of debt, budgeting your monthly finances provides many important benefits in your life, such as the following:
1) Gives You An Opportunity To Work On Your Long-term Goals
Drifting aimlessly through life is not beneficial for everyone. For sure, you’re working because you want to achieve something in the future.
Are you planning to get a car or a house in the next few years? Are you planning on going on an extended vacation abroad? These things require a significant amount of money. Budgeting will help motivate you to save and achieve these goals.
2) Helps You Avoid Spending Money You Don’t Have
Many people use their credit cards to make purchases thinking they’ll gradually pay it off when they receive their salaries. But having a credit card tempts people to spend more than the money they have on hand. Spending money you don’t have is one of the reasons you’ll fall into debt.
Sticking on a budget will help you avoid these kinds of situations. Your budget will tell you how much you earn. Your spending should always be based on how much you earn so you won’t be tempted to borrow money or use credit cards to purchase items.
3) Helps You Prepare For The Future
Spending within your means is not enough to secure your future. Besides helping you spend your money wisely, budgeting enables you to allocate savings you need for the future.
In your budget plan, make sure you include a portion of your savings each month to contribute to your retirement fund. The little sacrifices you make now will give you plenty of benefits in the future.
4) Helps Build An Emergency Fund
You’ll never know what challenges will come to your life. Preparing for it financially mitigates any negative effects it may have on your financial capacity. Many things can lead to financial turmoil, like an unexpected illness, loss of income source, injuries, or death in the family.
Besides preparing for your future, you should also allocate funds to build your emergency fund, enabling you to prepare when something unfortunate happens. A good emergency fund helps cover all of your essential needs for six months to one year, in case you lose your source of income.
The Elements Of A Good Budget Plan
A good budget plan considers a few basic elements. Your budget plan should always have the following:
Keeping track of the money coming in your account is critical because you should only spend how much money you have to avoid piling up on debt. It’s also important to understand the terms involving your salary:
- Gross income is the total amount of income you expect from your work before any deductions are removed.
- Net income is the total payments you receive after all the deductions have been made. The deductions include the negotiated benefits that are deducted to your pay and income tax.
2) Fixed Expenses
Fixed expenses are the bills or payments you have limited control over. The amount of fixed expenses is fixed every month, like your mortgage or car loan payments.
A good budget plan will account for all your fixed expenses so you can have a better understanding of other things you need to pay for.
3) Variable Expenses
Variable expenses have two categories: necessary and discretionary.
Necessary variable expenses include utilities and essential items, like gas, the electric bill, and the monthly food budget. These are considered as variable expenses because the amount you spend on them every month is not consistent. Discretionary expenses consider all your ‘wants,’ like a new pair of shoes or the latest mobile phone model.
4) Emergency Expenses and Savings
A good budget plan lets you prepare for emergencies and your future. As stated earlier, you must allocate a portion of your income to the retirement fund and unplanned expenses.
To avoid the temptation of using your savings for emergency purposes, place your retirement fund and the emergency fund in two separate accounts.
A Definitive Guide For Personal Budgeting
Now that you’re already familiar with the basic elements included in a budget and the concept of budgeting, you can begin creating a budget plan from scratch.
To help budget your money, here are five easy steps you should follow:
1) Put Together All Your Financial Information
The first step in creating a budget is to gather all your financial information. Doing so allows you to have a picture of what you’ll include in your budget. How should you organize this information?
Here are some budgeting tips:
- Start with your salary. Check more than one pay stub and calculate the average salary you get in a month. Looking at several months of pay documents will give you an idea of your pay spectrum’s lower and higher ends. Base your budget on the lower end of your income spectrum.
- Gather all your fixed expenses or payments, like loans, mortgages, and credit card statements for the last few months.
- Account all the utilities you pay for the month, like the electric bill, food, subscriptions, etc.
- Don’t forget all other important payments, like insurance, retirement funds, savings, and other frequent payments, like vehicle registration.
2) Evaluate Your Spending Habits And Check Where You Can Reduce Costs
Tracking your spending is a great way to find out where your money goes. To know where your money is spent, you should gather all receipts of your bills, loan and mortgage payments, and food purchases. If you don’t have a copy of the receipts, you can check your credit card statement and find the last purchase transactions.
Don’t worry if you fail to secure a copy of the receipts of your past purchases. Just list all the purchases you made and an estimate on how much you spent on them. It would be best to have a definite idea of how much you spend on food, utilities, and other unnecessary items.
Once you have an idea of your spending habits, try to find ways to decrease them. Here are some tips to help you decrease your spending in a month:
- Create a category of all your expenses and evaluate if a particular expense is a need or a want. You’ll want to reduce your “want” purchases to save up money or use that money to pay off debts.
- Always make a list of essential items you need before heading to the store or supermarket. Making a list is a great way to avoid making unnecessary purchases that’ll hurt your budget.
- Resist sales and advertisements. Your favorite shoe brand may be offering a new sneaker model for a special introductory price, but do you need it? To not spend too much on things that only give temporary joy, avoid giving in to sales temptations.
- Check your subscriptions. You can share Netflix or Spotify subscriptions with other people. Do you have friends and family you can share the cost with? To help with your budget, find other people to share the cost.
- Reduce utility costs. Is your electric bill high? Evaluate your power usage at home. Don’t forget to plug off appliances that are not in use and turn off the lights when no one is in a room.
- If you can’t help but borrow money, there are instant loans online that give you reasonable payment terms and offer lower interest rates.
3) Choose A Budget Method
There are various budgeting methods you can find online. When it comes to personal finance, below are the three most useful:
- The 50/30/20 Method: This is a type of balanced formula budgeting method widely used by many today because it’s the easiest to work with. The rule for this method is to allocate 50% of your net income for your needs, like food, utilities, bills, mortgage payments, and insurance. The other 30% is allocated for your wants, and the last 20% is for your savings or debt repayments.
The benefit of working with this method is you know exactly where your money is spent, and you can easily see if you’re overspending on a specific category. If you want to make sure that you’re paying off your obligations while allocating money for savings and other goals, this is the method you want to start with.
- The 60% Solution Method: This is another type of balanced formula budgeting method where 60% of your net income is allocated towards all your needs and payment obligations like food, utilities, mortgages, loans, and insurance.
The remaining 40% of your income is divided into four categories, each allocating 10% of your net salary: Retirement fund, long-term savings, short-term savings, and ‘fun’ money.
- Zero-Based Method: If you want to start with a clean slate for every chosen period, you can use this budgeting method. The method helps you allocate a fixed amount of funds for all your expenses every month.
It takes a lot of discipline to do the Zero-Based method because you have to ensure that you’re only going to spend this amount for a particular expense. There’s no room for overspending or using your credit card for purchases.
4) Remember To Stick To Your Plan
For your budget plan to be effective, you should make sure to stick with it. Strictly following your budget plan helps you achieve your financial goals and paving the road to becoming debt-free.
Here are some ways to help you stick to your budget plan:
- Always pay in cash. The purpose of your budget is to allocate a fixed amount for every expense that you have in a month. Limiting the use of your credit cards will make a significant change in your spending habits, which won’t pile up to your debt as well.
- Limit your shopping trips. Go out to buy supplies only when necessary and avoid the temptation of doing window shopping.
- Log your expenses frequently. Always remember to save your receipts so you can check which part you’re overspending in a month. Logging your expenses also helps you evaluate how you can reduce your costs.
- Meal planning helps you stick to your food costs every month. Aside from saving money, preparing your meals is also healthier compared to buying take-outs.
5) Adjust Your Budget When Necessary
You must always adjust your budget every month. For example, the Christmas season is coming, and you need to allocate funds for presents or prepare for a celebration.
If you’re a regular employee, you could receive performance bonuses. Spending all of your extra money is not a very smart move. It’s best to allocate a part of your bonus to pay off debts and spend a part of it for recreation.
Always remember to reward yourself when you achieve a specific goal. Rewarding yourself will keep you motivated in sticking to your budget and working on your financial goals.
Creating a practical budget plan is critical in maintaining good financial health. It also helps you manage your finances to get you out of debt.
Now that you have a baseline in creating your budget plan keep it going as this is only the beginning. To ensure that it’s still working for you, take the time to go over your budget plan regularly.
There are tons of resources and tools you can use online to help you organize your cash flow. Don’t worry too much if you don’t get it right the first time. Budgeting is a skill you learn over time, especially if you religiously practice the concepts.