Budgeting can be a scary word for some people. Many times, having a budget is associated with belt-tightening, going without extras, and hard times. Is that how you think of it?
A budget is a spending plan. It helps you direct your expenditures each month, quarter, and year. Following a plan can help you make wiser choices and achieve your financial goals.
Let’s look at why and how to put together a budget for the new year.
Why Make a Budget?
You may think that as long as you can pay your bills, you are good financially. Maybe, but maybe not. There are several reasons it is important to have a budget in place.
It gives a clear picture of your finances. When you put everything down on paper (or an Excel spreadsheet), you will see the numbers of what money is coming in and what is going out. Patterns will emerge and you will identify where the holes are in your spending.
It helps to identify and establish financial goals. By pinpointing a goal, like saving for the down payment on a home or for your child’s college education, you will work towards that goal in bite-size pieces.
It provides a spending roadmap. You are in the driver’s seat and you know where you are heading when you have a spending plan and stick to it. Without a budget, you are driving blindly.
It prepares you for emergencies. You are less likely to be financially surprised by whatever life brings your way. And you won’t be as apt to pay for those emergencies by charging them on a credit card.
It helps you say “no” or “not right now.” When you know you are working towards a goal and have a set plan, it becomes easier to walk away from the “good deals” that pop up in marketing emails and online retailers.
It prioritizes retirement planning and investments. Establishing a budget line item for your retirement accounts means you have made it a priority and are putting it into action. For many people, their well-intentioned thoughts of “someday” setting aside funds for retirement never materialize.
Now that we have some reasons budgeting is important, let’s look at how to do it effectively.
Getting Started on a Budget
First, there are a couple of budgets that you will want to think about: yearly and monthly. A yearly budget is an overall budgeting framework of how you plan to spend your money annually and includes short and long-term financial goals. A monthly budget has more nitty-gritty details and can be adjusted from month to month.
Before starting, you will want to decide on a budget framework. There are several ways to formulate your budget. The three most common are the envelope system, percentage-based budgeting, and zero-based budgeting.
Envelope System. This type of budgeting is sometimes called the cash envelope system. With this method, you divide your cash into assigned envelopes (such as groceries, housing, gas, etc.). As you spend, you see what you have left for the month in each of the envelopes. Since many people no longer use cash, there are virtual envelope systems that you can use that follow the same principle.
Percentage-based Budgeting. There are several percentage breakdowns but one of the most common is the 50/30/20 rule. In this method, 50% of your budget is spent on needs, 30% on wants, and 20% on debt repayment and savings. Another option is the 70/20/10 rule where 70% is spent, 20% is saved, and 10% is given away.
Zero-based Budgeting. In this type of budgeting, every month your income minus your expenses will equal zero. Sound scary? It’s not really. It just means that every dollar that comes in has an assigned place that it goes to in your budget, whether that is for necessities, extras, savings, or retirement accounts.
Steps to Budgeting
These are the basic steps to planning out a yearly or monthly budget.
Add up all after-tax income. This includes your salary, tips, bonuses, dividends, royalties, child support, government benefits, and side hustle income. It is basically any money that you have coming to you.
Add up all expenses. The biggies include food, housing, transportation, and utilities. Other expenses can include childcare, debt, dining out, entertainment, insurance, and medical.
Subtract expenses from income. After you have added up your income and expenses, subtract the figure for expenses from the total income. Was it a positive number? You can do a happy dance, then put that leftover money to work to help you reach a financial goal. What if you got a negative number? That means you will need to cut some expenses.
Steps to Sticking to Your Budget
You’ve made the effort to put together a budget. Now the next step is seeing it through. How can you stick to your budget?
Automate your payments. Certain expenses like rent, mortgage, and insurance are the same each month and can be automated. You can also schedule your payments to your retirement and investment accounts to be automated, too.
Plan ahead. Look at your week and your month. Plan your grocery shopping and other purchases. Take note of the birthdays, holidays, and special occasions coming up and plan expenditures accordingly.
Leave some wiggle room. Be realistic and leave a little extra money for the occasional dinner out or coffee with a friend. Not doing so will set you up to fail.
Final Thoughts
Hopefully, the thought of planning a budget no longer intimidates you. It can be done step-by-step and with some forethought. Planning a budget and putting it into action will help get you on track to achieve your financial goals this year.
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