WHY AND HOW TO BUDGET
WHY BUDGET?
Creating and maintaining a budget is one of the most critical steps to understanding where one stands financially. A budget promotes better spending and saving habits. A common reason for not having a budget is that it takes too much time and effort. Avoidance is another issue because it highlights what we may not want to see; our overspending. While it does take time and effort, creating and adhering to a budget helps realize and attain short and long-term financial goals. It often prevents one from acquiring too much debt and facilitates timely bill payment (avoiding extra fees and interest penalties). Most importantly, a budget aids in obtaining financial stability and peace of mind.
A budget shows where and how money is being spent. When built correctly, a budget will show whether you have money left after subtracting your expenses from your net income, also known as “cash flow.” If a budget shows “positive cash flow”, this is an opportunity to fund a person’s short and long-term goals, setting them up for future financial success. It is possible to have “negative cash flow”, meaning that more money was spent than was incoming. When one has negative cash flow, it detracts from one’s financial goals and burdens them financially. If there is negative cash flow, a person will have to withdraw from their savings to pay their expenses or increase credit card debt. This has been a significant issue in recent years: the Federal Reserve calculated a 15% increase in credit card debt from 2021 to 2022, the most significant jump in 20 years.
SHORT AND LONG-TERM FINANCIAL GOALS
A budget will help you stay on track to realize your short and long-term financial goals. Your financial goals may include; saving for an emergency fund, paying off debt, improving your credit score, buying a first or second home, education, traveling, or saving for retirement. We all have personal financial goals and should identify them, and once identified; there is more motivation to save and not spend. If married, ensure you are both on the same page regarding your financial goals and saving.
HOW TO BUDGET
There are many different methods of budgeting. Following are three popular choices:
Zero Sum Budgeting
What is it?
Zero Sum Budgeting helps individuals or couples prioritize remaining cash, to spend wisely, and stay on track to meet future financial goals. The premise is never to have money sitting idle in a savings account that does not have a purpose. Every dollar has a set goal.
How does it work?
Say you have $3,000 of net income every month. You have $2,000 in non-discretionary expenses; these are expenses that have to be paid monthly. There is $1,000 left. Some of this will go toward discretionary expenses, which are non-essential expenses. (You have “discretion” on how much to spend on these items each month). For this example, $600 was spent on discretionary expenses. This leaves $400 left in the savings account that needs to be assigned a purpose. You may have decided that $200 will go toward an emergency fund, $150 will go toward credit card debt, and $50 will be designated for future travel.
Alignment with Personal Goals:
This budgeting method is an excellent motivator for people who want every dollar of income to work for them. Every dollar has a purpose, a designation, or a job if you will.
Here is a site that explains Zero Sum Budgeting in detail:
https://www.nerdwallet.com/article/finance/zero-based-budgeting-explained
Line Item Budgeting
What is it?
This budgeting method is to have a list of categories, and expenses are designated in those categories to get a better understanding of where money is going. These categories may be; Auto, Home Maintenance, Home Improvement, Home Insurance, Mortgage, Groceries, Gifts, Life Insurance, and School Loans, to name a few.
How does it work?
A simple approach is to list non-discretionary expenses first, then discretionary. Constructing a Line Item Budget in this manner lets one see the month-to-month cash flow for discretionary spending, which can be adjusted accordingly. Beware of credit card debt. This can give a false sense of security. You may be paying the monthly minimum payment, but credit card companies charge anywhere from 18 to 22% for the privilege for you to keep a balance on that card. Think of it this way: if a credit card charges 20% annually on a $10,000 balance, that amounts to $2,000 every year just in interest!
Alignment with Personal Goals:
Line Item Budgeting is best for those who like detail. It is an excellent method to track purchases and help spend appropriately.
Here is a site that explains Line Item Budgeting in detail:
https://wsecu.org/resources/how-to-line-item-budget
50/30/20 Rule
What is it?
It is important to note that the method of 50/30/20 is more of a rule than a budget, but it does help to simplify the process and prioritize personal finances.
How does it work?
This Rule states you should expect to spend 50% of your after-tax earned income on non-discretionary expenses. Examples of non-discretionary costs are mortgages, utilities, loans, taxes, and insurance, to name a few. 20% should be split between debt repayment and savings. 30% on discretionary items such as groceries, dining out, clothing, entertainment, and other items that you can reduce spending if necessary. If you are overspending, discretionary spending is where you have the most control to reduce costs. To help reign in spending, ask yourself, “Is this a want or a need?” Most often, it is a want. Purchasing the item may feel good at that moment but doesn’t necessarily carry into the future.
Alignment with Personal Goals:
The 50/30/20 Rule is best for those who want to budget but are not concerned with too much detail. It simplifies the process overall and helps give direction for one’s finances.
Here is a site that explains the 50/30/20 Rule:
https://www.thebalancemoney.com/the-50-30-20-rule-of-thumb-453922
Note: These are three of the most common methods used in budgeting, but not the only ones. The following link explains a few others:
https://logicaldollar.com/budgeting-methods/
HOW TO GET STARTED
Budgeting takes commitment and time. To properly budget:
1. Think about your personal and family financial goals.
2. Choose what budgeting method to use (with your financial goals in mind).
3. Gather information such as monthly net income and all expected monthly, quarterly, bi-annual, and annual expenses.
4. List them as non-discretionary and discretionary.
5. You are now ready to create your budget.
Starting a budget can feel overwhelming, which is why so many refrain from initiating one. Some begin to build a budget with good intentions but do not keep up with it. Here are a few tips to consider when getting started:
· First, commit to planning and keeping a budget.
· It is helpful to break the process into small, manageable steps.
· Choose the day and time that works best for you.
· Make sure all necessary information is organized before you begin.
Be wary of the “I’ll do it tomorrow” excuse because, too often, tomorrow never happens. Be proactive, not reactive. Your future self will thank your past self for putting in the effort now and making financial sacrifices earlier in life to have financial stability and peace of mind as you age.