Budgeting 101: Why Do I Need a Budget?
Since you’re here, you’re probably wondering why it’s so important to start a budget. “Why do I need a budget anyway?” or “Isn’t the key just to spend less than I make?” are a couple common questions people have.
So you’re definitely not alone and I’ll share 6 reasons why budgeting is important and how you can get started.
I also want to point out that budgets are not about removing all the fun things you have going on in your life. It’s about gaining control over your money so you know exactly where it is going.
Chances are, when you’re done reading this page you’ll be able to keep more of your money so you can do even more fun things with it!
What Is A Budget?
A budget is simply taking your income and comparing it with your expenses to create a plan that you can follow so you don’t spend more than you make.
Most people fail to make a budget, even though it is a recommended practice by most financial advisors.
6 Reasons You Need a Budget
The truth is, if you don’t keep an eye on where your money is going, it will grow legs and wander off. Most people waste so much money and don’t even notice.
It has become so easy with credit cards these days to just spend, pay the statement (or a portion of it) and repeat the process the next month without ever looking to see what has been charged.
A good budget changes all of that and allows you to…
1. Keep Track of Expenses
Living paycheck to paycheck is a term I’m sure you’ve heard before. Maybe that even describes you. No worries if it does, we’ve all been there before!
Knowing exactly how your money is being used for bills allows you to decide a few things.
Is this really important? If not, then cut it out.
Could I get a better price by switching services? Maybe switch from cable TV to a streaming service. Or if nothing else, usually a call to the cable company will at least get your bill reduced if you threaten to cancel service.
Another example, chances are you’re paying too much for your cell phone bill. I was able to switch two lines from Verizon to Spectrum and saved over $100 a month.
Once you start putting a watchful eye on where your money is going, chances are you can keep hold of more of it and start redirecting it to savings or debt payments.
2. Identify Wasted Money
Have you ever caught yourself subscribed to some sort of streaming service you never watch for months on end?
$14.95 a month, just continuing on…that money is leaking right out of your pocket.
I know I’ve been guilty of just paying my credit card statement and not even looking at all the charges.
That’s the sort of thing your budget will help track to make sure you know exactly what your money is being spent on.
3. Prepares You For Emergencies
Life can catch up to you quickly.
Maybe your car breaks down and needs some unexpected repairs.
Or the A/C goes out in your home and you need to replace the unit.
Either of those expenses can wind up being thousands of dollars.
With a good budget you’ll start setting some money aside for a rainy day. And be grateful when you need it!
4. Less Anxiety With Your Finances
Money is often one of the biggest stressors in our lives. If you’re wondering how to make ends meet then that is going to cause some mental anguish.
Who wants to lie awake at night wondering how to put food on the table?
Or, if that payment you made is going to bounce or not?
According to this study, over 55% of divorces happen because of financial problems. Most people think they’ve “got it under control” but really they don’t as you can see in those divorce statistics.
When you get your budget setup and everything is accounted for, you can sit back and relax much more than if you’re letting those unpaid bills live rent free in your head.
5. Budgets Prevent Bad Spending Habits
(Or helps to identify them if you are just now starting a budget.)
Maybe you like to get a coffee from Starbucks every morning or you go out to grab something for lunch every day.
However, maybe when you do your budget you discover you really should only be allocating $100 total per week to food.
Now you can start to look at maybe skipping the Starbucks or bringing your own lunch more often.
These expenses were identified because you took the time to sit down and make an actual budget for yourself.
6. Helps You Achieve Financial Goals
I’m sure you plan on retiring some day, right?
Are you putting some money towards a 401k or IRA? Maybe you want to contribute more.
Work it into your budget.
Want to save up for a down payment on a new car?
Work it into your budget.
Maybe you’re saving up for a house.
Work it into your budget.
You get the picture.
What Are Some Common Budgeting Systems?
There are three main systems that people use for budgeting. Almost all apps or systems are going to be based off these concepts or a variation of them.
The 50/30/20 Budget
This is by far the most simplistic system around. You allocate all of your after tax income into three buckets.
50% goes to necessary expenses such as rent/mortgage, food, transportation, utilities like power and water, insurance, minimum loan payments (IE credit card or HELOC) and child care costs.
30% goes to wants. Believe it or not you don’t NEED cable TV, so anything along those lines (or the 5 different streaming services you’re probably subscribed to) – travel/vacations, eating out at restaurants or generally any “fun” entertainment/activities would fall in this bucket.
20% of the remaining amount goes towards debt repayment or savings. It’s important to tackle any debts first before you worry about savings (beyond an emergency fund.)
You may also hear this called a zero-sum budget but either way the goal is to have your income (after tax) – expenses = $0.
Every penny goes somewhere, and that doesn’t mean you should just blow any excess in your budget. Send it into a savings fund, invest it, pay down debt, any of those work.
You can also use this system side by side with the 50/30/20 budget as a means of allocation.
Envelope Budget System
This system is geared more towards old school folks or those that maybe work better through visual representation of dollar bills in front of them.
The concept is simple though. You literally take envelopes and start writing expense categories on them. Then you divvy up your after tax income into these envelopes.
You can break it down however you want. You can follow the 50/30/20 rule again here or you can get very specific.
For example, let’s say my monthly income post tax is $4000 a month and rent is $1500 a month, I could simply write “Rent” on an envelope and place $1500 in there.
I spend $800 a month on groceries so that would go in a separate envelope. The remaining amount will get split up more between utilities, loans/credit cards, savings, and “fun” stuff.
As we move towards a cashless society this method is getting harder to pull off but if you feel like this system is best for you, there are digital versions you can try such as Goodbudget (free plan) or Mvelopes (paid plan.)
Creating Your Budget
Figure out your preferred way to actually make your budget. Are you old school and want your budget in a notebook or piece of paper?
Something like this makes for a nice physical budget journal.
You can always download some templates and print out at home also.
We are working on putting together a free package for you to download, but until that is ready here is the best free template I could find: click here.
Or would you prefer an app on your phone? Your budget can be with you no matter where you go.
Popular Budgeting Apps
These all cost money, and I know that sounds odd to spend money on an app that’s supposed to reduce your expenses.
You Need a Budget
They’re all going to offer roughly the same features. The cool part is you can link your bank accounts and credit cards so you get a more automatic picture of your finances.
From a personal perspective I think PocketGuard has a nicer interface.
Your Financial Self Assessment
First things first, you need to get a clear picture of your financial landscape. This means doing a self assessment or self audit of your credit cards and bank statements.
Go line by line through every statement you have for the last three months and start looking at your expenses.
Determine if there are any hidden expenses in there you may have forgotten about. A trial service that converted to a recurring payment that you never even use.
You’ll probably be shocked at how many little $7-$20 payments start showing up.
If you can get rid of something, do it right then and there before you forget. Putting off cancelling it is probably how this started in the first place.
For the items you know you’re keeping, highlight them and you’ll transfer them to your new budget.
Set Financial Goals
It’s important to set financial goals along the way too.
For example, maybe you’ve accumulated some credit card debt that you want to pay off. Let’s say it is $2000 at 19% interest. If you’re looking to pay that off in 12 months, you’re looking at almost $185 a month in payments (without adding to the balance.)
Now, ask yourself is that realistic? If yes, that’s great, let’s add it into the budget. Or would that be too hard to make that work? Maybe a goal of 18 months ($128/mo) or 24 months ($100/mo) is more reasonable?
On the flip side, maybe you want to reward yourself with a nice vacation. Or leveraging credit cards to improve your credit score?
To properly budget for your vacation you’ll have to do some research.
- How many people will be going?
- Will you be flying or driving?
- How much will it cost to stay there?
- Add in any fun activities or excursions you may want to go on.
Come up with a true number. Maybe it is $5000. Now you can start to plan out how much extra per month you can kick in to your vacation fund.
How To Avoid These Budgeting Mistakes
Here are some of the common pitfalls people make when trying to create a budget and some advice on how you can avoid those same mistakes.
Set Realistic Expectations
If you have champagne tastes on a beer budget then I’m afraid no amount of excel spread sheets or budget apps are going to fix that.
You have two options at that point. Raise your income or cut expenses.
Also, don’t get discouraged at trying to pay off credit card debt and realizing it might take several months/years.
The important part is to get started on the right track! You can’t fix what you don’t know is broken.
Net Income vs Gross Income
This is probably one of the most common mistakes people make when setting up their budget.
Make sure you’re using net income figures and not gross income figures.
In case you’re wondering what the difference is…
Gross income is your “salary” – so if you make $1000 a week, that would be your gross income.
Net income is your “take home” – after all the taxes and social security and Medicare sums get deducted. The only exception to this is if you have insurance/401k deductions as you then would either add those back in or simply not count them as an expense against your income.
Be Honest With Yourself
Sometimes you’ll have to look at the cold hard facts of the situation.
Maybe you just spend way too much for your income. If you’re an impulse buyer, work on getting that under control.
The sooner you realize it and have an honest conversation with yourself about it, the quicker you can start to make changes for the better.
Maybe the car payment you have is just too much? Consider getting rid of it for something cheaper.
Rent killing you? Maybe there is a cheaper place you could move into. Or a place closer to your work that would save on (or maybe even remove) transportation costs.
If you let pride get in the way of things, I promise you that you’ll just wind up with more debt.
Make Sure You Properly Set Up Your Monthly Income
There are two ways this can get confusing and I’ll offer you solutions for both.
If you make $1000 a week, what do you put for a monthly income?
Some weeks have 4 pay periods, some have 5, how do you decide what to go with?
For me, the simplest solution is to take the $1000 a week salary, times it by 52 weeks, and then divide it by 12 months. (1000*52)/12 = $4,333.33 a month.
How to determine monthly income for freelancers or gig life workers (Uber/DoorDash)?
Maybe you get paid hourly or work a gig life and your income changes a lot…how should you plan that?
For me, I’d take the average of your last 3-6 months income (more is always better) and round down.
Just for a quick example let’s say maybe your weekly income looked something like $536, $392, $510, $201, $798. That averages out to $487 a week.
To be safe I’d consider that $450 a week, which back into our formula (450*52)/12 = $1950 a month. This way you’re working off some historical averages and rounding down helps you with any off weeks you may encounter.
For any excess funds you wind up with, contribute it to debt payments or savings if you can.
Review Your Budget From Time To Time
Another mistake we see happen a lot is people think making a budget is just a set it and forget it item.
Things change, expenses change, income changes, etc.
Hopefully, you’ll get a raise at your job. You should update your budget then.
If an unexpected expense popped up, adjust your budget to prepare for that going forward.
It’s always best to think of your budget as a fluid set of guidelines.
Try and review it once a month if at all possible. If you go too long without reviewing your budget it might as well be like not having one at all.
Putting It All Together
Now that you understand what’s involved with setting up a budget and are eager to get started, here’s the steps we covered.
- You should decide if you’re going to go physical or digital with planning your budget.
- Choose the system you’ll use to allocate your income towards expenses (50/30/20 rule, zero-based budget, or the envelope method.)
- Honesty time: review your financial statements and look for hidden expenses you can clean up. Start recording your other items either by hand or in your app.
- Stick to your budget. You didn’t do all this work just to abandon things in a month or two.
- Review your budget every month if possible and make minor changes if needed.
I hope now that you’ve made it this far you have a good grasp of budgeting and you see the benefits in creating your own budget.
“Why do I need a budget?” should now be “I’m going to start making my budget right now.”
We look forward to being there with you as you move forward on your financial journey.
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