Budgeting is like giving your money a roadmap. Without it, you’ll spend when you want and never give your money a guide. It’s impossible to reach financial goals or even live within your means if you don’t budget your money.
Budgeting has a reputation of being overwhelming, too hard, or sacrificial. It’s none of those things and when you use it right, it can be the best tool in your financial life.
Here’s what you need to know.
What is a Budget and why Use One?
A budget is an estimate of your income and expenses. You make a budget to make sure your expenses fit within your income the way you want. It’s not meant to make you sacrifice or feel restricted. Instead, it should empower you because you’ll always know where you stand financially. If you have to cut back on something, consider it a smart move because you’ll be better able to handle expenses in other areas of your life.
Everyone should use a budget, whether you struggle financially or not. It’s a way to make sure you allocate your money where you want. Are you reaching your financial goals? Are you getting out of debt? Have you saved for retirement?
A budget tells you how you’re doing with your money and everyone needs this information.
What are the Different Types of Expenses?
Everyone has different expenses, but here are the most common categories to include in your budget.
- Living costs
- Motoring costs
- Medical costs
- Lifestyle and leisure costs
- Financial costs
- Investment costs
Once you break down your expenses into various categories, figure out what percentage of your income should go to each category.
It’s easiest if you split your costs into needs, wants, and debt/savings. Your needs are any expense that’s necessary for living. Housing, motoring, medical care, and food are essentials. But be careful, food costs don’t include dining out or entertainment. Only include food you buy to prepare at home.
Your ‘wants’ categories are any expense that doesn’t fall in the ‘needs’ but is something you’d like. Lifestyle and leisure costs, entertainment, dining out, and unnecessary shopping fall into this category. Everyone needs some disposable income to enjoy life.
Finally, you need a percentage of money for debt payoff and savings. If you have high-interest debt, focus there first – paying off your debt so you have more money to invest and save. Split your money in this category between paying off debt, saving for emergency funds/current needs, and retirement savings.
So what’s the right breakdown? The 50/30/20 budget is a great option. 50% of your income covers your ‘needs,’ 30% covers your ‘wants’, and 20% goes to savings and debt payoff. You can play with the numbers, but this budget works for millions of people.
How to Create a Budget
To create a budget, you first must gather the necessary paperwork. You need to know how much you spend and where.
Start with your bank statements. Pull the statements from the last 6 – 12 months and write down your regular expenses. Categorize them so you see how much you spend in each category.
Write down every expense including insurance you only pay once or twice a year, gifts you buy annually, holiday expenses, and any other expenses you regularly incur. Be honest with yourself as this is the only way to set up a successful budget.
Next, write down your income. Compare the two numbers. Are you within your means or should you make changes?
This is when you create a workable budget. Play with the numbers, and create a budget using an online budgeting tool, pen, and paper, or your favorite spreadsheet program. There’s no right or wrong way to budget – as long as you make a budget, you’re on the right path.
We have also created a handy Budget Calculator to help you which you can download here Budget_Calculator
The Goals of Budgeting
Everyone has different goals for budgeting, but overall, it’s to make sure you live within your means. It’s easy to get caught up in overspending, living on credit cards, and ignoring the important areas of our life, like retirement, because they seem so far away.
Some common goals for budgeting include:
- Pay off debt – Living in debt is like throwing away money. Interest accrues on your interest, leaving you more in debt than you were before. Create a debt payoff plan and include it in your budget to end it.
- Save for retirement – Even if retirement is 30+ years away, save for it now. The more money you put away now, the less money you have to contribute monthly, but the more money you’ll have when you retire thanks to compounded earnings.
- Save for other goals – Think about your other financial goals. Do you want to buy a house, take a special holiday, buy a car, or send your child to college? Figure out how much you’ll need and look at your timeline so you know how much to save.
It’s easy to get off course if you don’t track your income and spending. Budgeting helps you stay on track, shows you what costs you should cut, and where you can improve your finances so you have enough to meet your goals and don’t overspend in unnecessary areas.
Budgeting is for everyone, whether it’s a simple budget on a pad of paper or an elaborate budget using an online software program. The key is to know where your money goes, how you spend it, and where you can make changes that help you financially.
Getting out of debt, saving for emergencies, and planning for retirement should be everyone’s ‘large goals.’ Beyond that, you can set up individual goals that help you meet your needs and desires while ensuring that you can cover the necessary expenses in your life.