Budgets. They are incredibly important.
Not so fun fact, only 26% of households keep and stick to a budget (Source). I believe there are two reasons. They either don't know how or don't want to adjust their lifestyle.
In this article, we're going to go explain in detail how to budget why it's important. I'll also go into budgeting alternatives for people who "don't want to."
Tracking your spending through the month may be one of the more important items on this list. By tracking your spending, you can see, in a snapshot, where all of your money is going.
This is how I break it down:
- Bills - rent/mortgage, utilities, cell phone, car payment, insurance, etc.
- Debt - money used to make payments on student loans, credit cards, or other loans.
- Savings - any money that you put into savings accounts, retirement accounts, etc.
- Food - grocery store only. Don’t include take out or restaurants here.
- Transportation - gas for your car, bus passes, parking spaces, or ride-sharing.
- Clothing - Any money you spent on clothes and accessories.
- Eating out - what did you spend at bars, restaurants, take-out, etc. Food or drink not bought at the supermarket.
- Everything else - There shouldn’t be much in this category, but for whatever is left, put it here.
By breaking down your expenses into categories, you can see what category costs you the most money. If it’s eating out or clothing, it’s time to make some changes.
Most people can make adjustments to their monthly spending. The average person spends about $250 per month on groceries (Source). I think this is high. In my experience, if you pay attention to prices and sales, you can keep a food budget well under $200 per person.
Eating out should be kept to a minimum. Clothing, unless required for work, should be kept low also.
List necessary expenses
We referenced this a little in the last section, but here we will start to build our budget. The first place to start is to list your necessary expenses.
- Transportation - gas, bus pass, ride-sharing, and/or parking
- Debt payments
- Food (groceries)
- Cell phone plan
- Other bills
These are things you HAVE to pay for. The only exception is the savings portion, though I do not recommend it. I’d rather you cut in other places than stop your savings. Even reducing the amount you save is better than none at all.
List monthly income
After you’ve listed all of your necessary expenses, list your monthly income. How do the two numbers compare? Do you have anything left over after your necessary expenses?
If you do, congratulations! The next step is figuring out what to do with that money left over. Here’s what I would do.
- Emergency fund - If you don’t have one, now’s the time to start one.
- Debt - Make extra/bigger payments so you can get rid of your debt.
- Retirement savings - If you are behind in this category, use the leftover money to catch up.
- Spend it - It’s usually a good idea, after paying down more debt or saving more, to treat yourself. If you continue to delay fun in pursuit of your financial goals, you’ll either burn out or lose the motivation. Small rewards along the way are important for your mental health and to refill our motivational tank.
On the other hand, if you have no money left or don’t have enough income to cover your expenses, you’re not alone. It’s reported that 50 million Americans can’t afford basic living expenses (Source).
If you are having trouble paying bills, saving, or paying down debt, read this article here.
Having a goal can be a real game-changer. Paying down debt, saving for retirement, and cutting expenses are not the most fun things in the world, but having a goal that you work towards is HUGE.
A goal can give you motivation, and it also gives you something to compare your progress. For example, your goal is to have $100,000 in your retirement account in 10 years. At the end of each year, you can check your progress and witness that you are getting closer and closer to that goal.
Here are a few great goals to set:
- Save $1.5 million for retirement
- Have $5,000 saved for a vacation
- Pay down all of you non-mortgage debt
- Have $10,000 in savings for emergencies
- Save $50,000 for a down payment
Be advised: The numbers listed are just examples, your numbers will vary depending on your particular situation and your goals.
Automating your finances has gained a lot of traction over the last few years and has become a wide recommendation across the personal finance community. I’ll break it down into two parts below.
What can you automate:
- Debt payment
- Bill pay
- Savings of all kinds
Why should you automate:
- Automating your debt payments ensures you are on time, which helps you avoid late payments, penalties, and going to collections. All of these are bad for your credit.
- Automating bill pay guarantees that you pay on time and avoid late payment penalties.
- Automating your savings takes care of saving for retirement, short-term goals, and/or emergencies before you have a chance to spend it away. It’s especially effective if you set it to take place at the beginning of the month or right after payday.
U.S. Senator Elizabeth Warren is responsible for the origination of this method. It’s broken down as follows:
- 50% of your income is used for needs - bills, housing, utilities, transportation, food, etc.
- 20% of your income is used for debt and savings - this portion goes towards paying down debts and saving for retirement, emergencies, and other goals.
- 30% of your income is used for wants - eating out, going to the bar, clothing, and other fun stuff and activities.
Essentially, the 80/20 rule combines the 50 and 30 from above. This is to be used for all of your spending (i.e.) bills, housing, debt, fun money, etc. The remaining 20% is to be used for savings only.
To further explain this method, I’ll link to the originator's article here.
Tools and resources
Each article briefly explains each app or program, and give the highlights, costs, and who it benefits the most.
Alternatives to budgeting
Give yourself an allowance - Rather than listing all of your expenses, comparing, and squeezing every dollar out of your income as you can, give yourself an allowance.
For example, you set aside $200 per month to use on yourself in any way you please. The rest of your income must be used on necessary expenses, debt, and savings.
Envelope system - Each category of spending is given a dollar amount. Get out several envelopes and label each one with a different category (food, gas, eating out, etc.). Inside the envelope, you place how much you want to spend on a given category (cash).
Once the money is gone from the envelope, you don’t spend any more money on that category. This is slightly outdated because online bill pay and credit cards have taken over the financial system.
There is a new app in the article from The Balance that was created using this system. Check it out.
Make adjustments as needed
Regularly review your budget, spending, and/or whatever system you use. Make sure you are sticking with it.
If your income changes, your goals change, or expenses change, make adjustments.
The most important part to all of this is to end the month in positive territory and a little closer to your goals than when you started.
If you have questions send me an email. Don’t forget to subscribe to our newsletter to get updates about future blog posts and to receive our ‘video of the month’ email.