Does money seem to slip through your fingers and out of your bank account month after month?
Has your income increased, yet you still do not have enough money?
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Budgeting may be what you need to take your finances to the next level. While not the most thrilling activity, Budgeting is the cornerstone of financial planning.
Budgeting is simply a spending plan for your money. It allows you to compare your income against your expenditures and savings to give you a clear picture of your finances. This picture is vital for you to plan, track your progress, and achieve your financial goals.
Reasons why you need a budget
- It helps you avoid spending more than you earn
Seemingly small expenses tend to add up quickly and often unknowingly! When you create a budget, you find out exactly how much income you bring home each month and how much money you can spend to stay within your spending plan.
- It helps you to stay focused on your financial goals
Did you know that an average person is exposed to over 6,000 ads every day?
It is no wonder that any money received seems to sift through your fingers, and before you know it, you are already counting down to the next payday.
Does this sound familiar at all?
If yes, then a budget may be the solution you need to keep you focused.
- It helps you develop good spending habits
Have you ever looked into your closet only to find way more shoes, handbags, dresses, etc. than you need?
Do you have subscriptions to services that you do not use?
A budget helps shed light on your spending habits and reveals things that may be unnecessary and probably even wasteful.
The budgeting process allows you to rethink your spending patterns and to develop good money habits.
- It reduces stress
Do you ever feel guilty about buying something you fancy?
With a budget, you can buy things that make you happy (that designer handbag, dining out, lattes, etc.) guilt-free by allowing room for flexible spending.
How about feeling uncertain whether you can afford something soon?
A budget can remove such anxiety from your mind by being aware of exactly how long it will take you to make any special purchases.
It takes the guessing out and allows you to take the right actions to achieve your goals with peace of mind.
Self-assessment: what you need to know before creating a budget
Identify your “why”
You need to know why you are creating a budget. Most people will set up a spending plan to achieve specific financial goals, such as:
- Save for an upcoming vacation trip.
- Build an emergency fund (enough to cover at least 3-6 months of expenses).
- Make improvements to your home, office, or vehicle
- Save for a down payment to buy a house.
- Payoff debt (credit card debt, student loans, etc.)
- Achieve financial independence (even retire early for some people).
A famous Zig Ziglar quote says, “if you aim at nothing, you will hit it every time.” It may sound cheesy, but it holds a lot of truth.
It is essential to know what your goals are and, even better, have them written down.
Having a goal gives you a target to focus on and a sense of purpose for doing anything in life generally.
Setting financial goals has a powerful psychological impact as it directs your attention to steps that lead you to achieving those goals.
Another cheesy quote that illustrates this well, “what the mind believes, the body follows.”
When setting financial goals, they need to be as specific as possible. For instance, instead of “save for an upcoming vacation,” the specific goal should be “save $3,000 for a trip to Paris by December 31st .”
Examine your current income and spending habits
This analysis is a crucial step in creating a realistic budget. It would be best if you found out (as precisely as possible) how much you bring in and how much you spend each month.
A forgotten expense in this step could throw your savings plan entirely off course.
The best way to do this is by looking back at 6 -12 months of your income, particularly your expenses. This review allows you to capture intermittent costs (such as insurance payments, property tax payments, etc.) billed quarterly or semi-annually.
So roll up your sleeves and pull out your bank statements, recent receipts and utility bills, credit card statements, investment accounts and, any financial files that show all your income and expenses.
Determine your after-tax income, which is the actual amount of money you usually receive in your paycheque.
Include any additional income sources such as self-employment income, dividend income, side-job income, etc.
Next, calculate your average monthly expenses by adding up each category’s costs and then divide it by 12.
For instance, add up all your hydro bills for the past year and divide that total by 12 to determine your average monthly hydro expense.
Add in a bit of cushion of about 10 percent to allow for flexibility (because life happens!).
The four steps to set up your budget
- Determine your total (after-tax) income from all sources.
- Sum up your expenses, including quarterly and annual amounts.
- Create a budget using one or a combination of the budgeting strategies discussed below.
- Track your expenses to ensure you stay within your budget plan.
There are many types of strategies in the budgeting world. Here are some of the standard and most effective budgeting approaches you should consider.
Zero-based budgeting is a strategy that assigns “a job” to all your income to end up with zero. It is also known as zero-sum budgeting.
Zero-based budgeting does not mean spending all your income. But instead, it means assigning your income to various categories such as savings, investments, and expenses.
For example, if your income is $1,000, below is what a zero-based budget could look like:
|Savings & Investments||(200)|
If you come in under budget in any area, the extra funds can be allocated to another category, ideally savings and investments.
Zero-based budgeting is an excellent strategy for beginners, especially if you do not have a good relationship with money. It forces you to assess your finances monthly and to be in control of where your money goes.
The 50-30-20 budget is a simple strategy that allocates after-tax income as follows: 50 percent to needs, 30 percent to wants, and 20 percent to savings.
Needs are those expenses that are essential for survival. These will include housing, transportation, groceries, insurance, healthcare, minimum debt payments, and utilities.
These should not include gym memberships, dining out, Netflix, Starbucks, etc.
Wants are things that you spend money on to make life more enjoyable and comfortable, but they are not essential.
These could include takeout dinners, fun tech gadgets, that new designer handbag and pair of shoes, vacations, tickets to concerts and sporting events, etc.
Savings is the portion of your income that gets allocated to your financial future.
This section will include paying down debt, building up your savings, adding to an emergency fund, investing in the stock market, etc.
TIP: If you have extra money leftover in the needs or wants sections, you should add those funds to your savings.
The Envelope System
The Envelope System is a cash-based budgeting system that works in the same manner as zero-based budgeting.
The main difference is that cash is often literally put in various envelopes for different categories with the envelope system. Once you run out of money in a given envelope, you cannot spend any more in that category until the following month.
It is a tried-and-tested system that has been around for a long time. The main advantage of the envelope system is you cannot overspend. It also makes you more conscious of your spending as cash in envelopes is tangible.
For convenience, you can use separate chequing accounts instead of envelopes.
The “Pay Yourself First” Budget
The “pay yourself first” strategy is the easiest to implement as it does not require an analysis of your expenses.
You only need to allocate a set proportion of your income to savings and investments. Once you “pay yourself first,” you are free to use the rest of your income at your discretion.
This budgeting strategy for:
- People whose expenses are small in comparison to their total income
- Anyone who has mastered their spending habits
Budgeting Tools and Resources
Excel spreadsheets (such as the one provided below) are simple to use, free and do not have much of a learning curve. They are also a great way to come up with your allocation amounts.
If you need a guide to start your budgeting journey, you are welcome to download the free budget tracker below and adjust it accordingly to suit your needs.
If you are looking to track your expenses in real-time, there are various budgeting apps that you could look into as well. I have listed some of the popular budgeting apps below for you:
Common Budgeting Mistakes to Avoid
Not keeping a budget
Yes, it is true, few people will find creating a budget exciting. Many people will find it downright scary as they do not want to confront the reality of their finances.
However, if you do not plan for your money, it will be gone before you even realize it.
Furthermore, it better to confront your financial reality and take the necessary action than to live anxiously, not knowing your actual financial position or, worse, sinking into crippling debt.
Setting unrealistic expectations
If you set a highly restrictive and unrealistic budget, you set yourself up for frustration, which could lead you to abandon your plan altogether.
Allow yourself room for entertainment, guilt-free spending on fun items and activities.
These splurges make up for a balanced and happy life, as long as you make sure to plan for them in the wants section of your budget.
Using your gross income instead of after-tax income
It can be an easy mistake to plug in your gross income amount into your budget calculator.
However, the after-tax amount gets deposited into your account and is the amount you get to spend.
Always budget based on your take-home pay.
Approximating numbers instead of using hard data
If you are working with the wrong set of numbers, your budget will not help you achieve your goals.
It is essential to use your actual expense amounts rather than approximating what you think or remember those amounts to be.
Not including one-time expenses
Annual expenses such as subscriptions, memberships, vacations, birthday gifts, Christmas gifts, etc. often get left out.
Excluded expenses will throw off your budget in the month incurred.
TIP: Breakdown annual bills into 12 amounts set aside each month, leading up to the payment date.
Not reviewing and revising your budget regularly
Change is constant in life and your finances as well.
You could receive a bump in your salary, a bonus payout, and your expenses could fluctuate up or down.
If 50% on your after-tax income becomes more than sufficient to cover your needs, consider allocating the overage to your savings.
With each change to your finances, you need to adjust your budget accordingly.
How to stick to your budget
Some people will be naturally good at sticking to their budgets; hats off to you. Other people will need to take an extra step to keep up with their plans.
Below are some common tips and tricks that can help you stay true to your budget and financial goals:
1. Track Your Spending
Know exactly how you are spending your money as compared to your budget in real-time by using apps such as Mint, YNAB, PersonalCapital, etc.
2. The Envelope System
The envelope system is based on the idea that people will spend less when using cash instead of plastic. It works by allocating cash into actual envelopes for each expense category. You can only pay from the appropriate envelope, and once the money is gone, you are done spending in that category for the month.
3. Automate your Savings Plan
As savings are generally for long-term needs, it is easy to let it fall through the cracks from time to time.
Automate your savings to avoid falling short of your financial plan. With every paycheque, a portion is automatically redirected to your savings (or investments) before it even hits your chequing account.
Automation ensures that you are saving and investing instead of spending unnecessarily.
If you enjoyed this article on budgeting or have any questions, please leave them in the comment section below! I’d love to hear from you! Also, please feel free to share this with anyone that may benefit from it as well.
“The secret of getting ahead is getting started.” ~Mark Twain
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