What is budgeting?
You’ve probably heard the word a million times–budgeting. But what does it really mean? Budgeting is the process of tracking and managing money. It also involves figuring out how much money you need to earn or save, as well as planning how to spend it. Not everyone creates a budget for themselves, and that can sometimes lead to financial trouble. Fortunately, creating a financial budget is an easy process, and we’ll walk you through it in this article.
Why is budgeting important?
Budgeting helps people ensure they have enough money every month to cover expenses, and it also prevents people from spending beyond their financial means. Let’s look at a few reasons budgeting is so important.
It helps fix bad financial habits
If you find yourself worrying each month about paying your essential bills–rent or mortgage, car payments, loans, groceries, utilities, gas, and other items and services you need–you might need to improve your financial habits. Think about some of the things you pay for during the course of a week…lunch at work every day, a couple nights out for dinner each week, or a $7 cup of fancy coffee every morning, for example. Maybe you also pay for four different movie streaming services, or perhaps you bought a car that was a bit out of your price range.
There are just a few examples of spending habits that may need to be addressed if you’re having a hard time affording the things you need. The best way to fix these habits? Establishing a budget and sticking to it. When you create your budget, you’re going to give your spending a hard look because you’ll need to know how much you spend on just about everything during an average month. At that point, you’ll be able to figure out which purchases you can do without. Instead of that $7 coffee, brew your own at home–that alone can save you hundreds every month. You may be surprised how much money you can set aside on a budget and how little you’ll miss the unnecessary things you used to spend on.
Reduce financial stress
Money is one of the biggest, if not the biggest, sources of stress in anyone’s life. The financial stress of living paycheck to paycheck and having to worry about whether there’s enough money to pay for rent or food causes stress and anxiety and takes a toll on your mental health. When you create a budget, you can eliminate a lot of that stress because you know you’re not overspending and that you have the money to pay for what you need. Sticking to a budget may even help you save money.
Save money for the future
Speaking of saving, staying within a budget gives you the opportunity to put some money aside for many important things–retirement, a vacation, a much-needed house or car repair, and even an emergency. When you cut out unnecessary expenses and start spending smartly, you’ll find yourself with extra money each month, which can be set aside and saved for the future.
How to make a budget
Making a budget may seem like a scary task, but it’s actually simple. There is some math involved, so make sure you have a calculator nearby. You’ll also need your most recent bills, bank statements, and transaction history available because those numbers will help you determine what your budget will be. Here’s how to make a budget in five steps.
Step 1: Determine your income
Your income is the money that you earn in a given amount of time. Since most bills are paid monthly, you’ll need to calculate your monthly income. Gather your paycheck stubs and be sure to add in any other money that you earn each month–whether it’s from a part-time job, contract or freelance work, items you might sell online, and other similar examples. If you’re married or living with a partner, and they contribute to the monthly bills, be sure to add their income as well. Once you have all this information, add up all the money you earned for the month (after taxes), and that is your monthly income.
Step 2: Track your expenses
Now it’s time to figure out how much you spend in a month. This includes all of your bills that you regularly pay each month–housing, utilities, loans, credit card balances, phone/internet, food, gas, childcare, those daily coffees, transportation, and anything else you can think of. You may need to reference your bank account and credit card statements to be sure you’re listing everything. Once you have all of that information, add it up…that’s your average monthly expenses. Remember, your most important monthly expenses are your STUF–Shelter, Transportation, Utilities, and Food.
Step 3: Do the math
You’ve added up your income and your monthly expenses, so it’s time to see what your finances look like. Let’s use a couple of examples. For this practice budget, we’ll use a monthly income of $5,000, which includes all the money made in a month. For expenses, let’s say $4,800. That means, each month, there is $200 left over after all bills and monthly expenses have been paid. That may not seem like much, but it is! Having an extra $200 each month, even with bad spending habits, is a good place to be. But just because some money is left over each month doesn’t mean it needs to be spent. Starting a savings account or an emergency fund is a good use of that extra money, because they help you stay on budget and allow you to have some breathing room in case an emergency expense comes up or you simply want to save toward a goal.
What happens if you do the math and it turns out you spend the same or even more than you earn each month? That’s not an ideal situation, but it can be fixed easily by cutting some expenses. We hate to keep picking on that expensive coffee, but cutting that from your morning routine will save you a lot of money. Or only buying lunch twice a week instead of five days a week. You’ll be amazed at how much money you have left by eliminating just a few small purchases a week. And that money can help put you into the positive column each month.
Step 4: Determine the budget number that works for you
Now it’s time to pick a dollar figure that you’re comfortable sticking with each month. That usually includes setting a financial goal within your budget. Using the examples from before–with a $5,000 monthly income, a goal could be to save $400 a month, with current monthly expenses at $4,800. That means we’re $200 short each month if the goal is to save $400.
This leaves a couple of possibilities. 1) The goal may be a bit unrealistic. You don’t want to strap yourself each month just to hit that goal, so the savings goal may need to be adjusted to around $200. 2) If you’re determined to reach that $400 savings goal, you’ll need to cut out $200 of expenses, which is possible when you say goodbye to those coffees, lunches, and maybe a few other non-essential expenses.
Step 5: Stick with it!
Once you’ve found your budget number, it’s time to stick with it so you can achieve your goals! It may require a little bit of sacrifice and restraint at first, but once you see how much money you’re saving each month, those homebrewed coffees and brown bag lunches will taste even more delicious!
What different types of budgets are there?
There are several types of personal budgets out there. You just need to choose one you’re most comfortable sticking with. Here are some popular options:
1. Traditional budget
This is one of the easier budgets to use and is used quite often. With a traditional budget, you’re subtracting your monthly expenses from your monthly income, which we covered previously. Any extra money is yours to save or use however you wish.
2. 50/30/20 budget
This is also a very popular budget because it’s straightforward and helps you divide your income in a more organized way. The 50/30/20 (which adds up to 100) splits your income by percentages, each of which go toward different expenses.
- 50% necessary expenses: Calculate half of your income (after taxes) to put aside for the most essential expenses, such as all household bills (rent/mortgage, utilities), food, and other necessities.
- 30% discretionary expenses: This category is for items you want to spend on but aren’t necessarily essential. This may include movie streaming services, hobby-related purchases, the occasional dinner and a movie, and other similar expenses.
- 20% savings and debt: This percentage of your income is dedicated to setting yourself up with some extra money down the road as well as getting yourself out of debt sooner. You might be asking whether debt is a necessary expense. Yes, it absolutely is–you should consider whatever you spend each month paying down debts and loans as part of your 50% necessary expenses. Anything you pay over and beyond the minimum debt payment or what you normally pay each month would be categorized in this 20%. That’s because you’re paying more than usual to get yourself out of debt faster. For savings, this can be anything you want to save for–retirement, emergencies, vacations, or a new home or vehicle.
3. Goal-based budget
If you have a good idea of where you want your money to go and are focused on getting yourself in a better financial situation, a goal-based budget may be right for you. These budgets generally consist of multiple goals, such as:
- Save $250 each month for retirement
- Pay off $100 more of my student loan debt each month
- Cut my discretionary spending by 10%
These are just some examples of financial goals you might set for yourself. Keep in mind, if you need to adjust these goals or come up with new ones, it’s easy to do so.
4. Zero-based budget
The idea behind a zero-based budget is to get your income to equal zero by subtracting all expenses from it. That may sound a bit scary, but keep in mind that you do not have to spend all of the money you earn. The goal of a zero-based budget is to direct every dollar you earn to a clear place–that could be your rent or your retirement fund. With this type of budget, you’ll need to break down all your expenses into separate categories; for example, monthly bills, food, retirement, credit card payments, etc. Then you can decide how much goes into each specific category until your income is zero. It may seem like you won’t have any money left over, but that’s not actually the case. Why? Because you’re breaking every expense into a category. With a “savings” category, you’re saving your money. With an “entertainment” category, you’re putting money toward streaming services, movie nights, concerts, and other entertainment. The difference between a zero-based budget and other budgets is you’re giving those categories a name rather than just using any leftover money on expenses such as these.
5. Spending ceiling budget
Also known as a spending cap budget, this type of budget puts a “ceiling” on the amount of money you should spend each month, including savings and discretionary expenses. The thought behind this type of budget is to stay disciplined with your finances and not overspend. Using our earlier example of a $5,000 monthly income, a good spending cap might be $4,600–that’s for every expense. That would leave you with $400, which you can either save or put toward something else. A spending ceiling budget often results in smart spending habits. Just because there is extra money to spend doesn’t mean you have to spend it. And before you know it, your savings will have grown by simply putting that extra money away.
Final notes
At Sun Loan, we’re here to help you with all your financial goals, whether that’s through securing a personal installment loan, assistance with your taxes, or general financial tips and advice. Visit us at one of our many convenient branches today!
