- Why You Need a Budget ➞
- Your Budget Must Have a Goal ➞
- Eliminate Debt FIRST! ➞
- Save Up an Emergency Fund ➞
- Zero-Sum Budgeting ➞
- Budgeting with the ‘Envelope System’ ➞
- Aim for 2 ‘No Spend’ Days a Week ➞
- Tracking Your Spending ➞
- Trimming Your Expenses ➞
- The 50-30-20 Rule ➞
- Change Your Money Script ➞
- In Conclusion ➞
(Photo by NORTHFOLK/Unsplash)
No discussion on financial planning would be complete without mentioning budgeting. It’s one of the fundamental principles of good personal finance and will save you from a ton of financial stress. Even multi-million dollar companies and government organizations have budgets they need to follow. As an individual, it’s just as important for you to have a budget.
Why You Need a Budget
For starters, it will keep your finances organized. For example, if your monthly take-home pay (after taxes) is $3000, but you spend $3200 a month and put the extra on your credit card, you’ll now be in debt.
While you could get away with this practice for a while by paying the minimums on your outstanding balance, over time, your debts will catch up with you.
This is how millions of people end up in debt without realizing it… and by the time the bills become overwhelming, it’s a Herculean task to eliminate the debt.
Having a budget will help you to save for emergencies, plan for retirement, squirrel money away to be invested, and so on. There are a multitude of benefits that can be accrued with good budgeting.
It will also teach you how to spend responsibly, and your budget will set boundaries for you. Contrary to popular belief, a budget doesn’t restrict you. Instead it gives you freedom from financial stress and worry.
You may not be able to spend as you please, but that’s not necessarily a bad thing. Delayed gratification in this area will reap rewards many times over in your future.
Your Budget Must Have a Goal
When creating a budget for yourself, ask yourself what your financial goals are. If you’re in debt, you may wish to eliminate it. At times like these, your focus will be on trimming expenses considerably and paying off your debts first.
However, if you have no debt, then you’ll need to decide how you wish to save and/or invest your money. If you already have an emergency fund set aside, you may wish to invest the money in stocks or bonds.
Alternatively, you may wish to buy a rental property and earn rental income which tends to be better than what you’d get from investing in other financial instruments.
If you’re planning for retirement, your budget may include contributions to your 401(k), IRAs, etc.
Your goals will determine how you allocate the funds in your budget.
Eliminate Debt FIRST!
If you’re in debt and have personal loans and outstanding amounts on your credit cards, your first step will be to eliminate these debts. While you should save about $50-$100 a month (while paying off your debts), the moment you’ve saved up $1,000, you have enough to cover any small emergencies.
From here on, pause your savings and focus on clearing your debts first. Ideally, you should adopt the debt avalanche method and pay off the debt with the highest interest rate first, while paying the minimums on the rest.
Once that debt is cleared, start paying the minimum on the next highest interest rate debt + the amount you were paying for the first debt.
When this is done, move on to the next debt and so on. You’ll discover that you gain momentum with each debt you clear, and it’ll take you a shorter and shorter time to eliminate each subsequent debt.
Save Up an Emergency Fund
Even when you’re in debt, you should strive to save a small amount monthly. Many people make the mistake of paying off their bills with every last dollar and keep nothing for themselves.
As a result, they feel broke and stressed out. Even if you saved $50 a month, after 4 months you’d have $200 in the bank and feel better knowing that you have some money there for you. This feeling of ‘abundance’ is priceless and you’ll be less financially stressed out.
Your goal should be to save up about 3-6 months of your income. Some personal finance books will ask you to save up 3-6 months of expenses, but it’s safer to aim for income just so you have more money.
Ideally, you should aim for 12 months. This will truly create a buffer for you, just in case you lose your job or face some unforeseen emergency that requires money.
So, create a budget that allows you to save some money monthly.
Zero-Sum Budgeting
Zero-sum budgeting is a method where you give every dollar a ‘home’. That basically means that every dollar is accounted for. Nothing is left to chance.
Your money is allocated to specific categories like debt management, expenses, savings, investment, and so on. When you practice zero-sum budgeting, you’re forced to know exactly where your money is going.
Too often, people just charge bills on their cards or withdraw money as and when they please without really knowing where the money is going to go. As a result, their expenses and savings are not following any real plan.
When you adopt zero-sum budgeting, if you’ve allocated $200 to entertainment and you spend $200 on the weekend clubbing, you’ll know that you’ve used up your entertainment budget for the month.
You’ll not carry on spending without control. Zero-sum budgeting is very effective for debt management and getting your finances in order.
Budgeting with the ‘Envelope System’
If you find it difficult to stick to your budget, the ‘envelope system’ has your name written all over it. The method itself is simple, but will be difficult to follow if you’re used to spending excessively.
What you’ll do is get 14-30 envelopes, depending on whether you’re paid monthly or bi-weekly. Once you’ve created a budget and decided how much money will go towards your daily expenses, you’ll divide that sum by 14 or 30.
You’ll then place your daily allowance in each envelope. Remember to write down a number on each envelope from 1-14 or 1-30.
Each day, you’ll take out the money from the corresponding date’s envelope and that’s all the money you’ll be allowed to spend. In this way, there will be a very low chance of you overspending.
Ideally, you should not be carrying your debit/credit cards with you so that you’re not tempted to buy anything on credit. The envelope system will ensure that you never overspend.
But you can still do better. Which brings us to the next point…
Aim for 2 ‘No Spend’ Days a Week
This is a tough challenge, but it can be done. It’s especially useful if you’re deep in debt and trying to come out of it.
A ‘no spend’ day is a day where you don’t spend any money. If you’re going to work, that may mean packing your lunch at home and bringing it with you.
Or if it’s the weekend, you stay at home and not spend a cent. Very often, you’ll find that if you do your grocery shopping once a week, you’ll have enough supplies to last you through the ‘no spend’ days.
If you can successfully pull off 2 ‘no spend’ days a week, you’ll have about 4 untouched envelopes a month (if you’re using the envelope method). You can either save this money or use it to pay off debt.
Tracking Your Spending
Besides using the envelope method and/or no spend days, there’s another excellent way to monitor your expenses – you must track your spending.
With everyone owning a mobile phone these days, it’s very easy to do this. Make a note in your phone every time you spend money on something. If you do this for 30 days, you’ll start to see patterns in your spending.
You’ll see where you’re spending money unnecessarily. For example, you may be spending $8 on 2 coffees ($4 each) every day. Over a month, that amounts to about $240. You may not even realize it because you’re paying just $4 each time.
But when you track your spending, it’ll all become clear. Eliminating this one expense alone might allow you to pay off some of your outstanding debt much faster.
This is why it’s imperative to track your spending.
Trimming Your Expenses
Making your own coffee will be much cheaper. Frugality is vital when you’re trimming your expenses.
Just because you’re following the budget and saving and paying off debt doesn’t necessarily mean you’re doing the best you can.
Eliminating unnecessary expenses will help to ‘free up’ more money. For example, if you’re paying for cable channels but mostly watch Netflix, you’re wasting your money. Cancel your cable and stick to Netflix.
Another example would be your cell phone plan. If it’s expensive, switch to a cheaper plan instead of paying for perks you don’t need or use.
Constantly find ways to trim wasteful spending. You don’t need to be a miser, but you should only be paying for what you use.
The 50-30-20 Rule
The ’50-30-20’ rule is often mentioned in financial planning articles, books, etc. The idea is that you’ll allocate 50% of your income to your essentials.
20% of it will go towards savings. The remaining 30% will be used for everything else.
This method sounds good on paper, but it’s not entirely reliable because it doesn’t take into account your current financial situation.
If you’re up to your eyeballs in debt and barely have enough left to save, you might not be able to save 20% of your income.
Following this plan in your budget will be very difficult. So what you should do is take a hard look at your current financial situation.
Write down how much will need to go for your bills, debts, and so on. If you’re using the debt avalanche method, decide how much above the minimum you’ll be paying.
Then add up all your expenses until you have a number. Now you know exactly how much you’ll be spending.
After that look at your disposable income – the money you take home after taxes. From there, create a budget based on your expenses and see how much you can save. Even if all you can save is $25, that will have to do for now.
As you clear your debts, you’ll have more money to save in future. Think long term. Trying to do too much too soon will only stress you out.
The point to note here is that your budget must be tailor-made to fit your current financial situation. Some arbitrary distribution ratio like ’50-30-20’ may not be practical for you.
Do what’s right for you.
Change Your Money Script
Research conducted showed that people generally fall into 4 categories when it comes to money:
- Money Avoidance
The most common category is money avoidance and people often have this ‘money script’ installed in them since young. Parents may say, “Money doesn’t grow on trees” or “Money is the root of all evil”.
As a result, the children grow up avoiding money because they feel that they don’t deserve it, or it’s too difficult to get, or it’s not right to have.
People in this category will usually spend off any money they have. It may look like their spending is uncontrollable, but they’re just following their internal script. They often find that they live from paycheck to paycheck.
- Money Vigilance
People with money vigilance are the polar opposite. They watch their money very closely and fear losing it. They’re also tight-lipped about their finances and may live very frugally to hold on to every cent they have.
While they may have savings and be debt-free, they might still experience financial anxiety, stress, and worry that they may not have enough money – or lose it all.
- Money Status
Money status refers to people who feel that being wealthy makes them ‘better people’. They associate money with status. They long for big mansions, fast cars, ostentatious goods, and the usual trappings of success.
Looking wealthy is very important to them… and it can lead to overspending and massive debt.
- Money Worship
People who worship money believe that winning the lottery will end all their problems. These are the people who gamble often and expect windfalls to elevate their lives.
Money is the be-all and end-all of success and a good life to people with the money worship script. They may incur lots of debt and struggle to manage their finances.
Whatever category or money script you believe you have, always know that you can change it. You can find balance in life and learn how to break through your money patterns and establish good beliefs about money that serve you well instead of sabotaging you.
Be aware of your money script when creating your budget and watch your actions closely when you handle your money. Any time you catch yourself about to slip up, refocus your thoughts and correct yourself.
In Conclusion…
Budgeting is all about managing your money in a way that allows you to live comfortably while staying debt-free.
It’s about increasing your net worth without being overly tight-fisted.
It’s all about finding balance between your spending, saving, and investing. A budget is a roadmap that will keep you on the right track so that you avoid the pitfalls of debt and financial stress.
Create a sensible and detailed budget for yourself and follow the pointers given here.
Last but not least, if despite your best efforts at budgeting and following through with the plan, and you’re still short of money – that means you must increase your income.
Improve your skills so that you can get a better job, or take on a second job if possible. The more money you make, the more options you’ll have.
It’ll also be easier to budget when you have more room to maneuver in.
And that’s budgeting in a nutshell.