How well do you understand your finances, really? Perhaps you’re only vaguely aware that money is coming in and going out each month, and that the rent and cable bill somehow get paid. Can you, however, tell me right now how much you spent on food last week? For that matter, how much did you put into vending machines or fork over at restaurants, both places where the cash-strapped individual can save some moolah?
Chances are that you can think of two people you know who have roughly similar lifestyles and incomes; one of them a nervous wreck at the end of each month while the other rarely seems to worry about money at all. The difference might well be that one knows how to make a budget, while the other just sort of hopes that things will be okay.
Table of Contents
- 1 You Really Can’t Just Wing It: Creating a Budget Is Essential
- 2 Identifying What to Include in a Budget: The First Step
- 3 Budget Guidelines
- 4 How to Set up a Budget
- 5 How to Make a Budget Last: Identifying Possible Savings
- 6 How to Create a Budget Plan if You Don’t Have a Regular Income
- 7 Actually Sticking to the Plan
- 8 Budgeting Is for Everyone
You Really Can’t Just Wing It: Creating a Budget Is Essential
Simply put, you can’t control what you don’t measure. This is why cars have speedometers, medicines have dosage instructions and households have budgets. Creating a budget involves dealing with numbers and a few decisions that may make you uncomfortable, but don’t worry: it’s actually quite easy and most certainly worth it.
Let’s say you’ve just taken a new job; the salary on the contract looks really comfortable and you’re walking on air. Almost immediately, though, you’re hit with a flurry of deductions you might not have kept in mind: income and state taxes, Social Security, 401(k) payments and who knows what else. Suddenly, what looked like a fortune at first has been cut down to what’s still a tidy sum, but one that’s probably not enough to make your every dream come true.
Before you know it, though, you’re reminded of how much the things you absolutely have to have a cost: rent, transport, childcare, food , utilities, insurance…once you add all of those up, you’ll most likely find that these non-optional expenses set you back more than you thought. It’s not like you have a choice, though, so okay.
Next, let’s say that you add up all you spend on things that you don’t really need but will find hard giving up: nights out with friends, a little shopping, coffee made by a barista rather than the bilge water you get for free at the office. Yoinks! Who knew Candy Crush was so expensive?
If you’re lucky or reasonably frugal, your take-home pay will still be higher than all of these necessary and gratifying expenses combined, with a little left over. If not, however, you’re treading water financially and things are bound to go wrong sooner or later.
Creating a personal budget is all about knowing where your money goes each month, thus converting your careless spending habits into deliberate ones.
Identifying What to Include in a Budget: The First Step
You know, hopefully, how much your take-home pay is each month: your basic compensation minus taxes. It’s time now to make a list of each of your expenses separately. If you save all of your receipts, good for you! If not, you may have to make an educated guess on some items. This step alone might show you a few ways in which you can spend less money each month.
- Loan repayments. Here, you might want to make a distinction between longer-term obligations, like your mortgage and car loan , and high-interest, a short-term debt like that on credit cards . The latter should be paid off as early and as fast as possible, even if it means scrimping on some other expenses.
- Rent and utilities: probably the largest single item on your list, but inescapable unless you go and live in the woods.
- Insurance: car, health and whatever other policies you’ve taken out. Remember that these financial products actually save you money in the long run.
- Cable and phone bill.
- Transport: this could be a train or bus fare, but it becomes a little more complicated for a car. You’ll have to determine a monthly figure for everything from gas to parking to tires. If you need an oil change costing $50 every 5,000 miles and you drive 1,000 miles per month, for example, your monthly oil cost is:
$50 × (1 000 : 5 000) = $10/month
- Groceries, excluding optional purchases like most clothing.
- Fast food: any meal you don’t prepare yourself, including ordering in, sit-down restaurant meals and (perhaps especially) all the snacks you pick up without thinking.
- Pet and child expenses…oh wait, those are actually separate categories.
- Non-fashion clothing: the socks, shirts, and sweaters you buy not to look good but to stay warm and keep up with your job’s dress code.
- Impulse purchases: the amount people spend on candy, haircuts, alcohol and “sale” items often comes as a surprise to them. You may think your brain does a good job of tracking these expenditures automatically – it doesn’t.
- Lastly, don’t forget treats! Being financially responsible doesn’t have to mean becoming a monk (or nun, if that’s easier for you). Everybody needs to relax now and again, so set a reasonable sum aside for movies, drinks, books and whatever you need to make life feel worth living.
Some of these categories may not apply to you, while you will probably be able to add a few of your own. If you need prescription medication or take sculpture classes, pencil those in. It’s very important to be thorough in this step; you can’t actually save money fast just by forgetting about an expense.
While there are several different ideas on what a budget should look like, one of the simplest and most sensible approaches comes from former Harvard professor and current presidential hopeful Elizabeth Warren. According to her, a budget that will lead to long-term financial stability looks like this:
It should be pretty obvious what each color means. “Needs” are the things you can’t do without (though it may still be possible to pay less for them). Most of the items listed above fall into this category; note that some of them, like life insurance , may be deducted from your paycheck automatically. Unless you can easily increase the amount you earn (ha, ha), you should look into ways of bringing the total amount to 50% or less of your after-tax income.
“Wants” means anything you can give up without impacting your quality of life in a major way. These are not always easy to distinguish from needs, which is why many people fail at budgeting or simply refuse to go through the process to begin with. If you’re honest with yourself, though, you can probably cancel your cable subscription and still find some way of amusing yourself in the evenings. Not paying for car insurance, on the other hand, can result in serious inconvenience if you get into an accident, so that is a “need”.
The “savings” category requires a little more explanation. Saving up for something you want but don’t need falls into the 30% slice. A new fishing rod or a trip to Milan won’t help you build a comfortable retirement or cushion your fall if you’re hit by an unexpected financial setback. What does fall into the 20% category is any debt repayment above the minimum. Not keeping up with the base installments may cause your car to be repossessed or having to pay far more later; this, therefore, falls into the “needs” segment. Financially speaking, however, paying off interest-bearing debt sooner than you have to is almost the same thing as putting your money into a short-term investment .
How to Set up a Budget
The principle of budgeting is not difficult to grasp: the money you earn should be more than the money you spend, preferably by a comfortable margin of 20% or more. Remember that we’re talking about after-tax income here, which is not necessarily the same as what turns up in your bank account each month. If your employer deducts money from your salary for a 401(k) and health insurance, those items should go into the “savings” and “needs” segments of our pie chart.
This is exactly what you now need to do with every expense you’ve identified, perhaps in a table like the following:
In the example above, we can clearly see that Jim’s budget is out of whack, with the “wants” and “needs” totals being too high. Notice how going even a few percentage points over these suggested figures eat into “savings” in a major way. Jim is presumably still young, but that is actually the best time to start saving for retirement.
How to Make a Budget Last: Identifying Possible Savings
In Jim’s case, simply taking sandwiches to work and cooking dinner himself rather than ordering pizza will be enough to get his savings over the 20% level. Things aren’t always that easy, though, and it might be better to get creative rather than simply cutting something you truly enjoy out of your life.
That 50-30-20 split is indeed a little arbitrary; perhaps your circumstances are exceptional enough to ignore it. Maybe there’s just no way you can squirrel away spare money right now, or your retirement is somehow assured. For 95% of us, though, keeping to that ratio is the best budgeting advice there is, and here are a few ideas to get you started on the right path:
- Get a side hustle: If you need to take a second or third job just to make ends meet, it might be better to dial back your lifestyle instead – your free time is too important to your happiness, never mind mental health, to waste. If, on the other hand, you have a special skill or hobby , it might be possible to convert that free time into cash without it becoming a grind.
- It’s often possible to save a ton just by replacing one product with one which is almost identical but doesn’t have a flashy commercial. Where you shop also plays a major role: try buying your vegetables at the farmer’s market or get grocery staples in bulk.
- Dating: Many men and some women blow a large part of their 30% “fun fund” on impressing potential partners. This is neither necessary nor actually all that meaningful: low-cost alternatives like taking someone on a nature hike or going to a free concert are just as romantic.
- Buy durable: Assuming that you’ve been following your budget for a while, you should have the necessary cash money available to opt for items that will keep working and looking good for years. In the long run, this works out much better than replacing cheap junk all the time.
How to Create a Budget Plan if You Don’t Have a Regular Income
If your work is highly seasonal (like, you run an ice cream stand in Alaska), you work as a freelancer or your job isn’t very secure, budgeting holds some unique challenges. If a particular line of work dries up, you’ll most likely have to dip into your savings to cover your living costs. This is fine as long as it happens only now and then, but overspending either while you’re temporarily out of work or when the money is rolling in can place you in real danger.
One way to smooth out the bumps is to divide your savings into two parts: one comprised of the normal 20% of income everyone should set aside as well as an immediately accessible fund holding three or more months’ worth of living expenses. Alternatively, you can also look into payday loans, which are an easy way to tide you over but will end up costing more. Many of these options make it easy to apply for a new loan once your first has been approved.
You may have to average your business expenses and income over the last six months or a year to get an idea of what your pre-tax earnings should be for budgeting purposes. It makes no sense to always spend 30% of your income on discretionary expenses when this will amount to $2,000 in some months and $5 in others.
Lastly and importantly, people in this position will most likely be responsible for their own retirement planning, insurance of all kinds and paying taxes. Neglecting any of these is a very bad idea – never try to repair your budget by skimping on something that’s truly essential.
Actually Sticking to the Plan
Have you noticed that any sentence with the phrase “best of intentions” inevitably includes the word “but”? That’s just human nature, unfortunately: things don’t always work out how we plan, often because we ourselves fail to live up to our own expectations.
Don’t beat yourself up if you happen to overspend. The point of having a budget isn’t to lock yourself into some kind of unbreakable blueprint for spending money. It’s merely a guide to let you know how well you’re doing and show you where you could be spending less. The objective is, eventually, to achieve true financial freedom, not confine yourself to a set of numbers you yourself created.
Still, in case you struggle with self-discipline, here are a few tips known to work:
- Never go shopping or order food when hungry. Food waste is a major yet invisible expense for many people. Planning your meals ahead of time is not only good for your wallet, but your waistline will also thank you too.
- If you must occasionally have a donut or a lottery ticket, fine, but track these expenses and tally them up at the end of the month. There are a number of apps available to help you keep impulse buying in check.
- Pay in cash. Swiping a card doesn’t feel any different whether you’re spending $10 or $1,000; physically counting out the bills drives home how much you’re actually handing over.
- Importantly, no matter how broke you are, budget at least some money for things that give you joy. There are plenty of simple pleasures out there: you can trawl second-hand bookstores instead of chasing the latest bestseller or buy a juicy porterhouse to cook at home instead of going to a restaurant. Trying to do without the nice things in life completely makes you that much more likely to splurge in a moment of weakness.
Budgeting Is for Everyone
It’s an utter mystery to us here at ProMoneySavings why many of the topics we deal with aren’t covered in school. Creating a budget is certainly one of these: it’s one of the most basic and useful financial tools, yet many people never learn how. By now, hopefully, you know all you need to draft yours – do this today, and start following it tomorrow. With this one simple step, you will gain more control over your money than you ever thought possible.