Learn how to make a budget that helps you reach your goals and avoid debt problems.
Budgeting is one of the best financial habits you can have. A good budget makes it easier to save money, achieve your financial goals and manage your debt. It’s often the key to financial stability. But most people think budgeting is a phenomenal hassle. They think that maintaining a budget takes a lot of work and time. However, with today’s technology, building a budget can be hassle-free and it’s definitely worth the effort you put in!
The 4 elements of an effective budget
There are four basic elements that make up any budget:
- Income – what you earn and bring in each month
- Fixed expenses – necessary expenses with a set monthly cost
- Flexible expenses – necessary expenses with no set cost
- Discretionary expenses – your wants
These four elements need to be balanced in order for you to be financially successful.
Fixed expenses are easy to budget around because you know exactly how much you need to pay each month. Here are some examples:
- Mortgage or rent payments
- Car loan payments
- Insurance payments
- Student loan payments
Flexible expenses are more difficult because there is no set cost. Since the cost can vary from month to month, it can make it harder to budget ahead. Then set that as a target and try to stay below that amount. Here are some examples of flexible payments:
- Credit card payments
- Mobile plans
- Household goods
- School or office supplies
Discretionary expenses are all the nice-to-haves in your budget. These are the first things you should cut when you need to cut back.
- Online media subscriptions
- Event costs (movies, concerts, sporting events)
- Dining out
- Beauty products
Setting targets for flexible and discretionary expenses
Flexible expenses and many discretionary expenses have no set cost. So, how do you determine how much you should be spending each month? Well, it depends on the expense.
For most expenses with no set cost, the easiest way to factor them into your budget is to look at the total monthly spending amount for the past three months. Then you take an average of those three months and set that as your target. For example, let’s say you spent $400, $425 and $450 for groceries over the past three months. The average would be $425, so you would set that as your monthly target. This would let you know when you’re overspending on groceries, so you know to cut back and coupon for the rest of the month if things are getting expensive.
For a few flexible expenses, however, the 3-month average doesn’t work. You can’t exactly cut back on electricity in the middle of summer because your bills are high. In this case, you want to look at the past year of bills and set the target as your highest bill from last year. This will ensure you can always afford things like electric bills, utilities and gas for your car. On months where you have lower costs, that’s simply free cash flow that you can either save or use for other things.
Starting a budget
When you first start budgeting, it’s good to take stock of where you stand. You want to see just how much of your income you’re spending each month. The easiest way to do this is with some basic budgeting worksheets.
As you plan your budget, there are two key expenses that you need to build in.
- Savings – saving money shouldn’t be an afterthought. Leaving savings for whatever you have left at the end of the month is a good way to ensure you never save anything at all! Instead, you need to use your budget worksheets to determine how much money you have available to save each month. Ideally, it should be about 5-10% of your income. However, even 1% is better than nothing. Once you know how much you have available, set this as a fixed expense in your budget. It’s like a bill you pay yourself.
- Credit card debt payments – If you aren’t currently carrying balances, then credit cards are a flexible expense; you ideally want to pay off any charges you make in a month to avoid credit card debt. But if you’re already carrying balances, then you may want to make credit card debt payments a fixed expense. Determine how much money you have available to pay off your balances each month, then set this as a fixed expense in your budget. You divvy up the money each month based on how many balances you owe. In general, the fastest way to pay off credit card debt is to make the minimum payments on all your cards except the one with the highest APR, then you devote as much money as possible to paying that debt off in large chunks.
Deciding where and how to set up your budget so you can maintain it
Pen and paper budgeting is a huge hassle. It’s a good exercise to do at the beginning to see where you stand, but technology makes it easier to maintain a budget day-to-day. You can use:
- Spreadsheets to create your own customized budget
- Budgeting software that sets up those spreadsheets for you
- A personal financial management (PFM) tool, that’s generally an online budgeting tool or smartphone app
Customizing spreadsheets is generally the most time and labor-intensive, but it gives you the most control. Budgeting software and PFMs make budgeting easier. In fact, these tools can connect and sync to your financial accounts, so they basically make budgeting automatic. You categorize expenses and the system learns as you go. Then you set targets and receive alerts anytime you’re about to overspend.
Find a tool that fits your needs and goals. Remember, you want budgeting to fit your lifestyle and be as easy as possible to ensure you maintain your budget long-term!