Break Free From Money Stress with a Budget

Break Free From Money Stress with a Budget

When learning about managing your finances, many experts will recommend you begin with a budget. A budget is a tool that tracks your income and expenses, and it allows you to set goals and make plans for the future. Developing a budget for a specific project, a special event, or to help you with your monthly spending are all examples of using a budget to help you manage your personal finances.

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Your Personal Budget

When you mention the word “budget” to anyone, you probably get a negative response. That’s because people often associate budgeting with restrictions. They feel that if they go on a budget, it’s like going on a diet. They won’t be able to spend money the way they’d like. But a budget is really a financial planning tool.

Every person or household should have a personal budget, not just to help keep spending under control, but also to help achieve what’s important financially. Whether that’s saving for college, buying a second car, or going on a Hawaiian vacation. An effective budget will give you a clear picture of your expected income, a detailed look at where you spend your money, and it will help you set and achieve realistic savings goals.

There’s a reason that the word “personal” is used with budgeting. Although guidelines are often provided to help you determine how much to spend in different areas of your life, the choice is really yours. Your budget is designed for you, based on your goals. So, if you have enough income to spend more on your transportation needs, then go ahead and buy a Tesla. 

The purpose of having a budget is to have a plan for how you spend your money. This helps you avoid debt and achieve what you want to with your money.

In order to build your personal budget, you will need to gather your financial records, spend time categorizing and analyzing your current spending, create a balance between earnings and expenses, consciously plan for expenses that you might be facing in the future, and put everything together while considering your long-term financial goals.

A Tale of Two Budgets

Budgets can look very different depending on how much income a person or household has available.

Imagine two people who both want to improve their finances. One has a lower income and finds that housing, transportation, food, and other necessities use most of their monthly pay. Their first priority may be cash-flow stability, making sure essential bills are paid on time and gradually creating room for savings.

Someone with a higher income may have more money remaining after covering those same basic needs. Their budget may provide more flexibility for saving, investing, paying down debt faster, charitable giving, or other wealth-building goals.

Neither budget is automatically better. A useful budget reflects the person’s actual income, expenses, responsibilities, and financial goals.

Gathering Your Financial Records

Your financial records include items like receipts from your last few months of spending, credit card and bank statements, your recent pay stubs, and your rent and cell phone contracts. When building your budget for the first time, gather as much information as you can on your past spending, if possible for the past few months.

Your goal when gathering your financial records is to have a complete picture of how you spend your money right now. The biggest challenge of building a good budget is making sure it’s realistic. Having accurate records of how you spent your money is the best way to plan moving forward.

Categorizing and Analyzing Your Spending

Once you have your records in front of you, it’s time to categorize your spending. Your goal is to separate all of your spending into needs versus wants, and then into fixed versus variable expenses.

Needs and Wants

Needs are the things you must purchase to survive. They include necessities such as rent, utility bills, groceries, and medical expenses. They also include legal responsibilities such as paying taxes.

Wants are things that you chose to spend money on, but they are items you don’t really need. Eating out, holiday gifts for friends and family, TV/streaming subscriptions, and new clothes might be in this category.

Once you have sorted your records into needs versus wants, you need to look closer and divide them into fixed and variable expenses.

Fixed and Variable

Fixed expenses are items where the cost stays the same from one month to the next. This means you can reliably plan for these expenditures. They include expenses such as rent, your cell phone bill, or a subscription fee for a video streaming service.

Variable expenses change from month to month, so it’s hard to plan accurately for these expenses. They might include how much you spend on fashion, how many times you go out to eat, or how much you spend on gas for your car.

Some of your expenses may need to be split into smaller categories. For example, food is a need, so you could try to lump all the money you spend on eating into one category. But it’s more realistic to separate your food items into categories such as groceries, coffee, and eating out.

Try It: Fixed-Cost Tradeoffs

Housing and transportation are often major fixed costs. The more income committed to these expenses, the less flexibility you have for other spending and financial goals.

Compare these two situations:

• Person A: $2,500 monthly take-home income and $1,500 in housing and transportation costs.
• Person B: $5,000 monthly take-home income and $2,000 in housing and transportation costs.

Person A uses 60% of their income on these two costs, leaving $1,000 for everything else. Person B uses 40%, leaving $3,000.

Consider the tradeoffs: Which person has more flexibility to handle groceries, entertainment, savings, debt payments, and other expenses? What could each person change if they wanted to increase the amount available for savings?

Putting It All Together

Once you finished sorting your records, list the categories of everything you’ve spent money on, placing the information in 4 different boxes, fixed needs, fixed wants, variable needs, and variable wants. Every penny spent in the months you’re analyzing should be included in these boxes.

Choosing a Budgeting Method

Once you understand your income and spending categories, you can choose a budgeting method that fits your needs. Three common approaches are:

• 50-30-20 Budget: A general guideline that divides after-tax income among needs, wants, and savings or debt repayment. It can be useful for someone who wants a simple starting framework, but the percentages may need to change based on income, housing costs, location, and personal goals.
• Zero-Based Budget: Every dollar of expected income is assigned a purpose, including expenses, savings, investments, and debt repayment. This can be helpful when you want detailed control over where your money goes.
• Envelope or Cash-Stuffing Method: Money is divided among spending categories, traditionally using physical envelopes but also possible with digital accounts or budgeting tools. When the money allocated to a category is gone, you stop spending in that category. This can be useful for controlling variable expenses and impulse spending.

There is no single budgeting method that works best for everyone. You can adjust or combine methods as your income, expenses, and financial goals change.

Try to complete this spending analysis for the past six months if you can. What you’re looking for is enough data so that you can determine your average spending in each category. The more months you can look at, the better your future budget plan will be!

Balance Against What You Earn

Once you have taken an honest look on how you spend your money, you can start to balance these numbers against how much you earn.

If you earn all your money from one single full-time job, this part is easy – just look at your most recent pay stubs. But if you have a part-time job or some side hustles, estimating your income each month gets a bit harder. Remember, the more months you can look at, the more accurate the numbers will be for your future budget.

When reviewing your income numbers, take an average of what you’ve been earning. Do not assume you will always make as much as you did last month or in your best month. Be honest with yourself. It is better to have extra income at the end of the month than to always be expecting more income than you actually received.

Once you’ve determined this average income number, you can compare it with your normal spending. If the result shows that you earn more than you spend, great! If your income is less than your spending, you will have to cut back on your spending. Either way, there is still more planning to do.

Looking Ahead

Budgeting helps you make a definite plan to save money for those things you want and need in the future. There are several strategies to help you plan for unexpected and irregular expenses, but most come down to spending a few minutes planning.

A simple way of preparing for unexpected expenses is to create a chart of irregular expenses, determining when they need to be paid, and identifying how much the expenses will most likely be. You can use last year’s numbers to help you estimate this year’s costs. Think about what holidays are coming up, and how much you want to spend on gifts. If you visit the dentist twice a year, include that in your chart so you have the extra cash set aside before the visit.

Here’s an example of what this budget planning chart might look like.

Remember that being honest with yourself and including as much information as possible will make your budget a valuable document to help you with financial decisions. Pretending expenses are smaller than they really are, or forgetting to include them in your plan, is the fastest way to break your budget. Effectively planning for your variable expenses is one of the cornerstones of success!

Setting Your Savings Goal

Now that you have an honest understanding of how much money flows in and how much flows out, you can set a realistic savings goal for every month.

The amount you can realistically save depends on your income, necessary expenses, and personal financial goals. There is no single savings percentage that works for everyone. Someone with high essential expenses may need to start with a smaller amount, while someone with more discretionary income may be able to save much more.

People are often more successful at saving when their goals are specific and barriers to saving are reduced. Instead of simply saying, “I want to save more,” you might set a goal to save $1,200 for a laptop within 12 months. Automatic transfers, a dedicated savings account, and regular progress checks can make that goal easier to follow.

Your savings goal will come from two concepts, Pay Yourself First and creating your Emergency Fund.

Pay Yourself First

Pay Yourself First means that you make your savings goals your #1 priority. This strategy has consistently proven to be the most effective way to achieve long-term financial goals. A pay-yourself-first strategy means that before you pay any bills or address any of your expenses, you set aside money for your savings. You no longer wait to see how much money is left at the end of the month to put into your savings account. Savings is taken care of before everything else.

Following the Pay Yourself First strategy means treating savings as a regular part of your budget instead of waiting until the end of the month to save whatever happens to be left. Your savings goal should be realistic enough that you can contribute consistently while still paying your essential bills and financial obligations on time.

How much should you save? 

A good savings goal should be at least 10% of your expected income every month. If you have never been consistent with saving, you may need to find ways to adjust your other expenses so you can always hit your savings target.

What you do with the money you have saved is up to you. Investing can help your savings grow, but investing includes risks. Keeping your money in a savings account is safe, but it is not the fastest way to build wealth.

Your Emergency Fund

An Emergency Fund is savings you set aside in case of true emergencies, which are large, unexpected expenses that may completely break your budget. In the beginning, your first goal should be to save enough money to cover one month’s worth of expenses. Try to reach that goal by the end of your first year. Your long-term goal is to save enough money to cover six months’ worth of expenses. Do this as quickly as possible, but target to reach this goal within the next five years.

Your emergency fund is not part of your regular savings. It is money allocated for those unexpected expenses like a major car repair, traveling home for Grandma’s funeral, or physical therapy following your broken ankle. If you currently have no emergency fund, or your emergency fund contains less money than needed to cover one month’s worth of expenses, then cut back on spending in your variable wants category. 

The sacrifice now will help you relax later when you need that money and it’s available for you. If you’ve had to use money from your emergency fund to cover unexpected expenses, you will need to cut back on spending in the following months in order to replenish your fund.

Unlike your regular savings, money in your emergency fund should not be invested. It should be set aside in a savings account, available for immediate withdraw in case of emergencies.

Basic Budgeting Strategies

We have a whole other lesson focusing just on budgeting strategies, but when you build your first budget keep these tips in mind:

• Be honest with yourself. If you are not honest with how much income you have or how you are spending money now, you will never be able to effectively control your spending in the future.
• Focus on cutting fixed expenses. If you need to make budget cuts, focus on your fixed expenses first. If you can shave money off your rent or downgrade recurring monthly subscriptions, it will have a much bigger long-term impact on your savings goals than if you skip going to the restaurant once or twice a month.
• Automatic monthly contributions to savings. Set-up automatic transfers to move money from your checking account to your savings account either every time you make a deposit or at a fixed time each month. If you don’t need to remember to transfer the money, it makes it much easier to hit your savings goals.
• Monthly budget status checks. Spend a few minutes each month checking your bank account balance, credit card balance, and review what bills still need to be paid. This will give you a good feel for how much money you can safely spend without breaking your budget.
• Extra Money. When you spend less money than you budgeted for, you have freed up money that can be saved or invested. This is a win-win for you. 

Your Budget Is a Living Document

A budget is not something you create once and follow forever. Income, expenses, priorities, and financial goals change, so your budget should change with them.

For example, suppose your rent increases by $100 per month. If your income stays the same, you will need to decide where that additional $100 will come from. You might reduce entertainment by $40, eating out by $30, and another flexible spending category by $30. Or you may choose a different combination based on your priorities.

Review your budget regularly and revise it when your circumstances change. The goal is not to follow the original numbers perfectly. The goal is to keep your financial plan realistic.

If you go over budget by spending more than you planned for, it means you will potentially have less money the following month. You may need to make sacrifices and do with less. Thinking about opportunity cost, and doing some comparison shopping, will be more important as you now have less money than was anticipated.

If your course includes the Budget Game, you can use it to practice adjusting a budget when unexpected financial events occur.

For a deeper look at connecting your everyday spending decisions to short- and long-term financial goals, see Achieve Financial Goals with a Spending Plan.

Challenge Questions

1. Define the word budget in your own words?
2. How might a budget help you with your financial goals?
3. How can you relate opportunity cost to budgets?
4. How would comparison shopping help with your budget?
5. If you pay yourself first, are you more likely to make smarter money decisions with the money that is left and why?

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