Budgeting is part of personal finance management which is the process to ensure that an individual has enough money to fulfill the current and future needs and wants. It is important to manage your money properly. And, this is done through effective budgeting.
Budgeting is the process of creating a plan to spend your money. This spending plan is called a budget. Budgeting helps to
It is an itemized list of expected income and expenses that help you to plan for how your money will be spent or saved as well as track your actual spending habits.
Start by setting realistic goals for your money. Ask yourself: What do I want my finances to look like in one year. Decide what’s important to you in three horizons of time – short-term, medium-term and long-term, and start there.
When setting financial goals, think about how much you need to save and for how long. Then think about how you will accomplish those savings. For most people, this means putting a set amount aside each month, according to their pay schedule.
Next, you need to identify your income and expenses. It feels great to earn a paycheck. However, sometimes it seems that even when you have a job you still may find you don’t have enough money to buy all the things you want. Pay close attention to where your money comes from and where it goes.
List down all your income sources and amounts. Include everything: post-tax wages, commissions, self-employment income, child tax benefits, pensions, child maintenance, and spousal support and other regular income.
Write down your expenses: Now, this isn’t easy for most people. The best way to do this is to keep track of how much you spend in a month. If some of your expenses change significantly each month, estimate the monthly expense with a three-month average of that category’s total.
Expenses fall into two buckets:
Compare income and expenses to find out your cash flow. Once you’ve totaled up your monthly income and expenses, subtract the expense total from the income total to get the difference. It’s a simple step that can reveal a lot about your spending habits. If the result is a positive number, congratulations – you’re spending less than you earn. If it’s negative, your expenses are greater than your income, and you will need to trim them in order to begin living within your means.
Once you know these two things, you can look for ways to reduce your expenses or increase your income to allocate an amount of money that you can afford to save.
Understanding needs and wants
As you will track your spending, you will discover that some of your money gets used for things you really don’t need. Instead, you will realize you merely wanted them and most often would have bought them impulsively.
Impulse spending is unplanned spending; purchasing things that you may or may not need, or spending on an item more than you’d planned.
People who link their spending to their feelings are mostly spending impulsively. For example, you spend when you are in a good mood like in a holiday season; you go on a shopping trip to uplift your mood when you are feeling sad; use shopping as a stress-buster. All these things rob you of your ability to make wise choices between needs and wants. You ‘need’ a cup of coffee but you ‘want’ to have it from Starbucks. You ‘need’ a car to commute to work but you ‘want’ to buy an expensive SUV instead of an economical vehicle. So, everything that you buy requires a need versus want calculation to make a money-wise choice.
You should limit spending on your wants as much as possible or at least avoid impulsive spending on your wants and plan for it in advance.
Saving money
Everyone must put aside some part of their income. It could be to pay for something specific like a holiday, down payment for buying a home or to cover any emergencies that might crop up. To help you save money, you would want to start by opening a personal savings account at your local bank.
This is very helpful for meeting your long-term goals. You are less likely to spend on impulse this money that you will put aside in the bank, and you will also earn interest. This means that the amount you have saved grows slowly over time because the bank pays you a small amount for keeping your money with them.
You should also set up an emergency fund. The general rule is to have three months’ worth of living expenses saved up in an instant access savings account. This should include rent, food, school fees, and any other essential outgoings. Your emergency fund means you have some financial security if something goes wrong. After you’ve got an emergency fund, you should continue to save up at least 10% of your earnings each month or as much as you can afford. Set yourself savings goals and put away enough to buy what you want. You could also start to think about investing your money.
Design a budget
The first thing you need to ensure is that your expenses are not more than your income. If this is the case, you will need to re-look at your spending habits to separate your needs from wants. You might have to cut down a few expenses like entertainment, eating out, using taxis for commuting or subscriptions. Identify what expenses you can cut down to fund some other expenses in your budget. If there is a surplus, you need to make some choices about what to do with the extra money and may want to add it to your savings for now.
A better practice is “pay yourself first” – it is setting aside a fixed portion of your income as saving every month. Automatic transfers to savings account each time you are paid is a good way to ensure that this amount gets added to your savings even before you see it.
There is no fixed number that everyone should be saving each month. It entirely depends on each person’s income level, stage of life and financial goals etc.
Different types of budgets
1. Time-based budget: A time-based budget plan is any bills that need to be tracked within a specific time, such as weekly, monthly or yearly.
2. Cash-only budget: A cash-only budget means that you will use only cash for paying all of your bills and another discretionary spending. This is also known as an envelope method where you physically divide your money into different envelopes. This will definitely help you to stop overspending in grocery stores which usually happens when you swiping a card.
3. Survival budget: A survival budget is basically a plan for your most basic necessities in life, such as food, shelter, clothing, and transportation. In the event of job loss, medical emergency or death in the family, you may temporarily need to cut out all non-essential spending. The best way to find out if you can survive in an emergency situation like that is to have a back-up plan, with a survival budget.
4. Special events budget: A special events budget is a plan to meet the expenses related to special events in your life e.g. wedding, starting a side hustle, purchasing a new home, retirement, etc. This type of budget is for long-term goals.
5. Debt-free budget: This helps you assert more control over your finances. The focus is to get out of or avoid debt, by spending less than you make. It involves simply figuring out the 2-3 problem areas where the spending is discretionary but has a disproportionate effect on your finances. For example, eating out, buying clothes or taking expensive vacations. Budgeting means setting a maximum amount that you would want to spend in the month on each of those problem categories. Over time, you will be able to bring down that amount, spend less, and direct the extra money into paying down debt or building up savings.
6. Financial Freedom Budget: This is useful when planning for the longer term. “Paying yourself first” strategy is used in the financial freedom budget. In this, you set aside a certain proportion of your income, say 10% or 30%, and then spend the remaining sensibly. The easiest and most effective way to do this is to automate your finances. You need not focus on individual spending categories or tracking every bill. If you feel you have some left at the end of the month, then you might think about increasing the percentage of saving.
7. Zero-based budget: This is useful for beginners and habitual over-spenders. The simple rule is expense should never be more than your income i.e. income minus expenses (including savings/investments) should equal zero at the end of the month.
8. 50-20-30 budget: You may also follow this simple 50-30-20 Rule to build a budget by using three spending categories:
Quick tips to make budgeting easy
1. Establish goals that are detailed, clear and motivating.
2. Track your spending to the last cent.
3. Don’t confuse wants with needs. Eating healthy is a need but eating a five-course meal at a five-star hotel is a want.
4. Watch the smaller expenses that you do every now and then. You might be surprised that they total up to a big amount at the end of the month.
5. Control your urges to indulge. Just because you got a bonus or some extra money doesn’t mean you have to find a way to spend it. It’s better to save or invest a part of it.
6. Replace credit/debit cards with cash. Bring the credit card balance to zero. Work towards paying it off immediately.
7. Prioritize saving by automating the transfer with every paycheck.
8. Take the time to check on your budget each day. This will help you to stick to the budget.
9. Work on finding ways to save on your daily expenses. One good way is to find out the best deals in your locality.
10 Keep learning about budgeting.
