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At some point in your life, you might find yourself trapped in a financial mess. This is when you’d realize the importance of learning how to budget.
A budget is a word that is often overlooked by people. In fact, only 47% of Canadians are said to budget. It’s important to keep your finance life well balanced and budgeting can help a great deal.
Where do you think big companies like Google or Amazon would be today without managing their money properly? Do you think Warren Buffett or Bill Gates could have achieved such success without proper budgeting? No! Budgeting won’t just help you get out of a hole — it can also help you acquire financial wealth. And yes, it can help you do that even if you have a modest salary or income.
What is a Budget?
In simple words, a budget is a strategy that helps a person or a family highlight the expenses and incomes. It’s designed to understand and decide how and where the money should go.
A budget can also help differentiate between luxuries and necessities. It is prepared in the form of a financial document with numbers.
Why Have a Budget?
Budgeting is all about devising a strategy to spend your income in the best way possible.
A lot can go wrong if you do not spend your life on a pre-planned budget.
Budgeting is important because it will help keep track of money. Without it, your hard-earned money would disappear in no time
Apart from that, it gives you control over your money and helps you focus on your financial goals in the long run.
So, without much ado, let’s have a look at how to make and stick to a budget.
How To Make a Budget
There’s a stepwise strategy plan that you can follow if you wish to create a killer budget.
Let’s dive in.
Have a Goal
The main purpose of creating a budget is to understand your financial feasibility. However, that’s not enough. You must have other goals as well.
Your budget gives you a clear picture of things to come. You can use the achieved data to create a goal, i.e:
- To save $10,000 in 12 months
- To visit Europe with the family next Summer
Having goals will help you decide how much you want to save and where you wish to spend.
Remember that your budget is not only about where you spend but also about where you want to spend.
Determine Your Income
Every budget starts by penning down the total net income you get to take home. Add up all possible sources of income you receive. This can be divided into two:
- Fixed Income: Your fixed income is the salary you receive at the end of the month for providing services. It can be your fixed share for an investment, monthly fixed salary, rent, and fixed profit from.
- Variable Income: This income varies and depends on factors such as your performance. It includes bonuses, returns from investments, profit from side hustles, interest income, tips, etc. Since you can’t be sure of how much you’ll make in bonus, this will go into the variable income column.
When you have noted down all the sources of income, add them up. This is the total net income that you need to create a killer budget.
Determine Your Expenses
Your budget sheet should have three columns:
- Fixed: The expenses that need to be paid no matter what are fixed expenses. These include mortgage, insurance, school fees, rent, etc. You do not control these bills and not paying these expenses can lead to trouble.
- Variable: These expenses involve items and expenses that you can control. Examples include grocery shopping, clothing, etc. There’s room to reduce these expenditures.
- Discretionary: These expenses are not necessary and can wait. These include luxury shopping, holidays, etc. It is best to save for these expenses and avoid them until you have enough in your account.
Creating these three categories will help you manage a budget properly. You will know where you have a bit of flexibility and which expenses you can drop if you are low on money.
Find Your Favorite Budgeting Method
There are several ways to create your budget. Here are some of the most popular techniques:
50/30/20 Budgeting Method
The 50/30/20 budgeting method was popularized by senator Elizabeth Warren. It emphasizes to divide up your after-tax income according to this rule:
- 50 percent to needs
- 30 percent to wants
- 20 percent to savings
Needs make up the largest share because you must pay these bills. Examples include your monthly rent and utility bills.
Wants are expenses you can avoid or reduce according to the changing scenario.
Savings are absolutely necessary to cover sudden expenses.
- The method is very simple to follow
- It can be effective in reducing fixed costs
- It is easy to stick to since you can make changes to the plan
- It can be difficult to differentiate between needs and wants
This method involves stuffing and marking envelopes for each category.
Let’s say your budget says to only spend $50 this week on dining out. The best way to stick to this budget is to put $50 in an envelope and take it when you dine out.
This way you will only spend $50 even if you’re itching to buy more. The technique is a bit difficult to follow but it will keep your expenses under control. However, it will work only if you spend cash. Hence, leave your credit card at home.
The best way to use this method is to pick categories that you have difficulties with. In addition to envelopes, you may also use small accordion folders.
- It is easy to stick to this technique
- It helps you stay loyal to your budget
- You’re guaranteed to not miss payments
- Reduces wastage and can help save money
- It can be difficult to get your entire family on board
- You will have to withdraw cash to stuff envelopes
- There will be no credit card rewards
Zero-Based Budgeting Method
Zero-based budgeting is a simple technique that involves wiping your previous budgets and starting from scratch at the beginning of each year.
The process starts from a ‘zero base’ and every function in the firm is analyzed for its costs and needs. Budgets are built around what’s needed for the next year, regardless of previous figures.
This technique is different from other strategies as it does not involve using last year’s budget. It allows you to have a new beginning by using real-life data and not guesswork.
You must justify each expense – including recurring and old expenses – before including it in your budget.
The idea was developed by Pete Pyhrr in the ’70s and is said to be more suitable for businesses. In fact, a large number of Fortune 500 firms have adapted it.
According to a study from Accenture Strategy, this budgeting technique grew at a rate of 57 percent per year between 2013 to 2017.
- Reduces wastage since you must justify all expenses
- Keeps a check on legacy expenses
- Gives you full control over costs
- Can be very time-consuming and costly to create and manage
Track Your Budget
For most people, it is easy to keep track of the money that they earn. They get a paycheck at the end of the month. However, it can be a bit difficult to track expenses. But, it’s important since your budget will not be of much value if it doesn’t include correct figures.
Merely making a budget at the start of the year or month is not enough. It needs to be updated from time to time and that may not be possible unless you track it.
You will not know when or how you overspent if you do not keep track of your expenses. Similarly, you will not know how much you can afford to spend if you do not keep track of your earnings.
Hence, tracking is one of the most important aspects of budgeting. Here’s how to handle it:
Use Pen and Pencil
The traditional way of creating and tracking your budget is to use a pen and pencil. It may sound tiring but a large number of people still use this method.
We suggest that you buy a notebook or diary to track the flow of cash. You can also include reference numbers in a column so that it is easy to refer to a specific expense.
The best way to manage this budget tracking technique is to keep the pen and notebook at a designated place so that you never miss out on noting expenses. Most people prefer to do it at the end of the day so that they do not miss anything.
Make sure to write carefully so that it is easy to read. This technique can be effective for people who do not deal with a lot of expenses.
- Is quite simple
- You do not have to depend on another device
- Less costly since you do not have to pay for an app or software
- Higher risk of errors
It may be a good idea to use a tool like Excel to get the job done. Microsoft Excel is easy to use and works on mobile devices as well. Plus, there are formulas you can use to quickly add figures and get results.
With Excel, you can keep all your information in a single file that can even be shared thanks to GoogleDrive, which supports spreadsheets.
You can customize spreadsheets according to your needs and review them from time to time. Plus, some even offer strong collaboration options. While Excel is the most popular choice, you can also opt for other platforms offering spreadsheets.
One look at the spreadsheet will tell you the current situation of your budget including expenses, revenue, etc. You can make columns and rows to add expenses as they occur.
- Very easy to learn and manage
- Work on both mobile devices and computers
- You can take out prints
- You will need to sit in front of a computer or mobile to make changes
Use Budgeting Apps
It is not uncommon to use a mobile app to track expenses. Since most of us always carry a mobile phone, it gets easier to track expenses just as they occur. There are a huge number of mobile apps designed for this purpose, including some paid and free options.
Some apps offer basic features but some may offer add-ons such as the ability to take pictures of receipts. Some of the best budgeting apps include PocketGuard, Mint, You Need a Budget, Wally, and GoodBudget.
Some of these apps may even send warnings or reminders when you’re close to overspending. Plus, some even offer the option to link to your bank account and ensure you never miss out on payments.
We suggest that you opt for an app that allows you to backup files so that you do not end up losing your data, which may include personal data.
- You can do more with some apps
- Some apps may offer benefits including access to special offers and discounts
- Very easy to keep an eye on income and expenses
- You will not have to perform manual calculations
- Some good apps can be very costly
- You may lose data if the app crashes or you lose your phone
How to Allocate Your Money?
We discussed different ways to create a budget earlier in this article and they all talked about allocating money based on your income.
The best way is to follow this formula:
Allocate 50% Income on Needs
Half of your budget should be allocated to your needs. A need is defined as an expense that you cannot do without. Some examples are:
- Mortgage Payments
- School Fee
- Utility Bills
Since they make up the largest chunk of your expenses, it’s best to devote about 50 percent of your income to needs. But, what if the 50 percent is not enough?
The best option is to take steps to reduce your needs. It may sound like a difficult task but it’s quite possible.
For example, you cannot go down to eating once a day but you can cut down on foods that are costly. Instead of beef, opt for vegetables that are more affordable. This change can help you save about $20 per week.
Similarly, instead of disconnecting power, be careful about the appliances that you use.
Budgeting is about living in your means. You should save money wherever you can. In fact, take steps to reduce expenses even if the 50 percent you set aside is enough to meet your needs.
Allocate 30% Income on Wants
This is the part that most people find difficult, especially since it can be hard to differentiate between wants and needs. In simple words, a want is something you can live without but you should still make some space for it as eradicating your wants can leave you sad and depressed.
Food is a need but eating out is a necessity. If your budget doesn’t allow then you can reduce trips to the restaurant or move to a more affordable restaurant.
Gifts for your friends, trips to the movie hall also fall into this category. About 30 percent is considered enough because you can control how much you spend on wants.
If your financial condition is poor then you can reduce this section even more.
Allocate 20% Income on Savings / Debt Reduction / Retirement
Despite the low share, this is a very important part of your budget. The remaining 20 percent can be used for a variety of purposes:
- To get rid of debt quickly. If you owe money then you can use this money to get rid of the loan if making early payments offer advantages.
- If you are low on savings then you can save this amount in your emergency fund to fall back on in case things go haywire in the future.
- You can invest this money to prepare for the future.
Consider reducing this section only if you have enough money in your savings account, no debt, and decent savings for your retirement.
Set Up Priorities for Your Budget
As mentioned earlier, a budget needs to be updated according to the changing scenario.
Here are a few factors you must keep in mind:
Your emergency should contain at least four months’ of expenditure or income. Period. This should be your first priority because you can never be sure of what the future holds.
The amount you save after paying your ‘necessary’ bills should go to your emergency fund. You can move to the next step once you have saved enough.
Pay Off Consumer Debt and Loans
Do not get us wrong here. Making monthly payments should be a priority. Never be late on your payments. But, if you have money left after making your payments and contributing to your emergency fund, then you can consider paying off consumer loans if that brings you benefits such as lower interest.
Contribute to your Retirement Plans (401k – USA / RRSP – Canada)
You should start your retirement planning as quickly as possible. You may have the option to choose from various programs including some for retirees.
If you do not want to invest in an IRA or RRSP then you can invest your money elsewhere with the intention to have enough by the time you retire.
You cannot make future plans, increase your wealth, and improve your living standards without saving. The best way to do so is to invest money for which you will decent savings.
If you struggle to save money then consider automating savings. This will make it easier to manage your money and reach your savings goal.
Most of us have a difficult time setting aside money for a retirement fund or savings account. Automating your savings will ensure a specific amount of money goes to your savings account every month.
However, you need to be careful about the amount you decide to save since saving too much may lead to a financial mess and not saving enough may cause losses.
Note: How much you save depends on how much you earn and spend. For some people, 5% is enough, for others 20%.
How To Stick To a Budget?
Creating a budget is one thing but sticking to it is a completely different ballgame. You will face numerous problems in the beginning. You may fail to keep track of income and expenses or forget to record important expenses.
Do not let such issues fail you. Follow these tips on how to stick to a budget.
Tag in a Partner
You can do with a helping hand. It can be your spouse, child or family member. Work with someone who understands budgeting and is willing to help.
You should ideally choose a partner who is interested in saving. If the other person is a spender then you may end up having issues with each other.
Try To Keep It Entertaining or Rewarding
Budgeting does not have to be a boring job. Plan it nicely – go out in the park and do your calculations or promise to watch your favorite show after you are done with the maths.
This will push you to put your best foot forward and motivate you to stick to a budget.
Have Everyone on the Same Page
A budget is hardly about one person – it’s about the whole family.
You should take everyone under confidence and explain to them why it is important to stick to a budget.
Everyone must work together to save and reduce expenses. There will be arguments and troubles if not everyone agrees to your budget, hence it may be a good idea to discuss your plan with others before you finalize it.
Use The Credit Card To a Minimum
About 83% of people prefer to pay with credit cards rather than cash. This habit can leave you broke and force you to deviate from your budget.
Hence, stop counting on plastic money. It may even be a wise idea to get rid of the card altogether – why pay the fee when you have other alternatives?
Keep Reviewing Your Budget and Make Adjustments
Your budget is not a document etched in stone. It can and should be reviewed from time to time.
Make a new budget if you see or expect a change in your income or earning. If you earn more, know where you want to divide your money. It’s important to be responsible.
Similarly, if your expenses increase then take steps to increase your earnings or reducing expenses from other categories. The budget will help you determine when you’re spending most of your money and from where you can deduct it.
The Importance Of Sticking To a Budget
Budgeting is not a mandatory chore but a choice. No one will force you to make a budget. However, it’s in your own benefit as it would allow you to live a life free of financial woes.
A budget can help you know where you stand financially and what you need to do to reach your goal. You may even need it if you wish to apply for a loan, etc.
Plus, a budget can motivate you to work harder or better. It gives you a clear picture of what needs to change. The roadmap can help you do better to achieve your goals as they will begin to look possible.
It may be hard to save $10,000 to buy a new car, but if you plan to save $10 per day, you will have $10,000 in less than three years only. It’s easier to save $10 per day than it is to save $10,000.
It may, however, be difficult to ensure you do not end up spending this money on other expenses. You will need a nerve of steel to stick to your goal.
Budgeting appears intimidating and reading the wrong tips on the internet will not simplify it for you. But, you have to start somewhere.
Get moving today and make things happen.
Budgeting isn’t only about keeping up with your monthly expenses. It’s about improving your financial situation.
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Founder of The Modest Wallet, Ricardo is an entrepreneur and investor who enjoys working out, spending time with his family and friends, travelling and creating great content. He’s passionate about helping others achieve their financial goals.