Last Updated on August 14, 2020
Having a budget is like keeping a food diary – we all know it would be good for us, but few of us do it. Who wants to have it thrown in their face that they ate 69 M&M’s out of the communal candy jar over the course of the day? The point of a budget (and a food diary…to be fair) is not about shame and punishment. It’s about education and awareness. What can seem like a very restrictive practice on its face is actually a very freeing one. Once you understand that the purpose of a budget is to take away the stress of your financial decisions, you can start to enjoy what you do with your money.
What is a budget?
In a nutshell, a budget is a plan that takes into account your current and future income, as well as your expenses. It can be short term, like budgeting for a vacation. Or it can be long term, for things like saving up for a down payment on a house. Long term budgets are created with the intent of keeping your current and future finances in check. Both short term and long term budgets are incredibly valuable, but this article will primarily focus on long term budgets.
How to develop a budget
The first step in developing a budget is to calculate your expenses and figure out exactly how much you spend each month. Scrutinize those credit card and bank statements. But just like the stock market performance can swing seasonally, so can your spending. It’s a good idea to average out your monthly spending for at least 6 months.
The next step is to determine your income. Be sure to include only your take-home pay (net income). Calculate all income streams including from your job, social security checks, alimony, and child support. However, it’s not good practice to count on irregular or unpredictable funding, such as proceeds from garage sales, one-off gifts, or your annual Vegas winnings… It may feel good to see that money coming in, but it’s not consistent. Income streams of that nature will likely alter the accuracy of your monthly take-home pay and throw off your budget.
Set your savings, debt payoff, and investment goals. Financial advisors suggest saving up 3-6 months’ worth of expenses, paying down your ‘bad’ high-interest debt first, and calculating your retirement expectations based on salary, age, and anticipated benefits. Even though this is step 3, these should never take the backseat to any extraneous or unnecessary expenses you tallied up in step 1. Pay yourself first.
Slash, cut, and burn where necessary. If your expenses exceed your income or don’t leave enough money to target your savings, debt payoff, and investment goals it’s time to get ruthless. That $5 daily cup of coffee at the local cafe might not seem like much. But over the course of the year, that daily cup of coffee will cost you $1300. Instead, that $1300 could have been a mortgage payment or retirement plan contribution.
If this seems like a lot of work, you’re right. But no one else is going to do it for you (unless you pay for it!). The good thing is that if you do the work upfront, you’ll continue to reap the rewards far into the future.
Once you’ve got your budget set, there are tons of tools to help you keep yourself on track. The important thing is to pick a tool that will make things easy for you. Apps are a great way to do that because let’s be honest – we keep our phones on us 24/7. So there’s no excuse for forgetting to add transactions to your paper and pencil or excel sheet budget.
4 reasons we all need a budget
1. Knowing what you spend and spending less than what you make is not a budget
Obviously, it’s a very good practice to spend less than you make. We shouldn’t spend money that we don’t have. But this method doesn’t provide you with any control over your financial future. The 50/30/20 budget is a simple budgeting technique to help the average person determine what is an appropriate amount of money they should spend and save.
This ratio dictates that 50% of your take-home pay goes to your needs, 30% goes to your wants, and 20% goes towards saving and paying down debt. Without proper allocation, such as the 50/30/20 budget, how will you know if you’re on track to meet your retirement goals? You won’t. This allocation isn’t right for everyone, but it’s a good rough measure to get you started. Speaking with a certified financial advisor will be your best bet to determine what’s appropriate in your specific situation.
2. It keeps you prepared for the unexpected (emergency fund)
One of the many perks of budgeting is that it helps you to better prepare for the unexpected. Making saving a priority, and being diligent about your spending habits will help you keep your emergency fund healthy. If you don’t have an established emergency fund, you should use this time to begin building one. Having an emergency fund gives your money a specific purpose, that way you’ll be less inclined to spend said money in an impromptu shopping spree.
3. It makes your good (and bad) spending habits easy to see
One of our favorite phrases here at Mulling Over Maybe is: if it isn’t measured, it won’t be managed. Budgeting allows you to very plainly follow the money. You can easily start to see where your good and bad spending habits occur. Mind you – not all of these ‘bad’ spending habits are done on purpose.
For example, Sarah bought an older home 2 ½ years ago. The irrigation system was springing minor leaks from time to time, but the cost to replace the whole system ($2000) seemed wholly unnecessary at the time. So Sarah kept the old irrigation system and continued to fix the leaks as they occurred. Spending $40 every few months to fix the leaks didn’t jump off the page begging to be noticed.
However, at the two-year mark, Sarah felt like the leaks were starting to occur more frequently. She did a quick tally of her irrigation expenses over the last two years and realized she had spent over $700 in repairs. It became clear to her that had she been paying attention to her spending more closely, she would have realized that it made sense to replace the irrigation system a long time ago.
Budgeting opens your eyes to reality. It highlights when you may be putting a bandaid on a bullet hole.
4. Budgeting keeps you excited about the future
The purpose of a budget is to provide you with an awareness of your financial situation and takes away the stress of agonizing over every money-related decision. While it can seem intimidating to get started, once you’ve laid the groundwork, it provides you with a tool to view your progress. Watching your debts decrease and your assets grow is an incredible feeling.
Do the work and set yourself up to enjoy the fruits of your labor.