No matter where you are in life – whether you’re getting started with your first job, planning for a big change, or simply validating your incomings and outgoings – creating a budget is an important way to lay, and maintain, your financial foundations.
What is a Budget?
A budget is a written plan that helps you establish boundaries and guides the amount you spend on both your fixed and variable expenses. Budgets can be prepared on paper, on spreadsheets or via one of many apps or tech tools geared up specifically for this purpose. See the end of this post for some suggestions of templates and tools.
Why Bother Budgeting?
About 40% of households don’t bother budgeting according to Bankrate. However, we’re aligning with the 58% that said they do!
By determining the expected (or budgeted) amounts of your income that you will spend on certain categories ahead of time, you are developing a framework to keep your spending under control. Doing that allows you to meet savings goals and any debt repayment goals. If you don’t have savings and debt repayment goals, understanding your financial situation by budgeting is an important step in setting goals.
Isn’t this going to be restrictive and painful?
That’s certainly a glass-half-empty way to look at it. Manisha Thakor thinks differently – she says, “setting boundaries can sometimes be just what you need to have real financial freedom.”
A budget helps you set rules for what you can and can’t afford. If you know what you’re spending ahead of time, when spontaneous money decisions come up, you have an anchor for your choices. A budget can make it easier to say, “No,” to a dinner out or a pair of shoes that you don’t really need. Plus, it allows you to feel guilt-free about the money you do spend because you have planned for it.
Looking at the bigger picture, a budget will help you make plans to leave a job to fulfil your ambition of becoming an entrepreneur, or perhaps save towards the wedding of your dreams.
OK, I’m in… So, what should my budget look like?
Everyone’s budget will be personal to them because we all have different financial circumstances, expenses, liabilities and goals. Cost of living, student debts, mortgages, income levels and personal dreams will all impact your budget. However, there are some core categories upon which you can focus to get started. These are:
- Fixed (or “foundational” expenses, as Manisha calls them) – for example housing, medical expenses, transport, child-care, mandatory debt pay down.
- Variable (including “fun” expenses) – this will include things you might be able to cut down on such as expensive coffee habits, shopaholism, magazine subscriptions and socializing.
- Savings – for example, money you’re putting away for short-term needs, for an emergency fund or long-term planning for retirement.
Manisha recommends the following, simple spending formula to keep things balanced:
- 50 percent – the ideal amount of your take-home pay that goes to needs (“fixed” expenses)
- 30 percent – the ideal amount that goes to wants (“variable” expenses)
- 20 percent – the ideal amount to set aside for savings (which can be adjusted for debt pay down, if necessary)
All-in-all your budget should reflect your spending priorities and what brings you joy. If you love food, you may budget higher for it than your friend who never eats out but prefers to spend more on entertainment and sports.
A budget should also be flexible. If you go over budget on dining out for the month, you may find that you are under budget on your groceries, as a result. If you start to see patterns like this emerging, consider adjusting your budget going forward so that it more accurately reflects your spending priorities. Similarly, you’ll need to make adjustments if a significant change occurs in your expenses, for example, if your rent is cut in half because you move in with a roommate, or you make the final payment on a debt.
One golden budget rule is the proportion of your income you should spend on housing. Typically, you want to keep your total housing costs (including insurance and utilities) to around 25%-30% of your total income. Since housing tends to be the largest line item in a budget, keeping this cost under control is essential to setting the rest of your budget up for success. If you are spending 50% of your income on housing, you’ll have a lot less left over for things like food, entertainment and, most importantly, savings.
What about irregular expenses?
We’re going to look at two types of irregular expenses.
If you have an irregular expense that is not due every month – for example, car insurance – you can easily calculate the approximate monthly cost of the insurance and set that aside as part of your budget. Then, when the semi-annual payment is due, you already have the money to cover it.
A budget, if followed consistently, ensures you will save consistently, which means you will quickly build up an emergency fund. Having this stash of cash available when an unpredictable expense such as a car repair or a hospital visit comes up mitigates incurring debt or worrying about where the money to pay for it is coming from.
How detailed should my budget be?
Some people like to spell out every last category into which their spending falls (for example, housing, gas, cable, electric, renters’ insurance, car payment, car insurance), while others group expenses into broader categories, such as housing and auto. Some people choose to simply make a high-level goal of saving a certain percentage their income and, as long as they attain that, they feel free to spend the rest on whatever they please.
Whichever method you think is most likely to help you best achieve your spending and savings goals is completely acceptable. Just keep in mind the housing rule and trying to save at least 20% of your income.
And, if you fall off the wagon, just get back on again as soon as possible.
This post originally ran on GoGirlFinance. Here are some other posts from GoGirl to inspire you into action:
Kate Furlong is a freelance writer and blogger with a strong interest in personal finance. She loves finding ways to save and enjoys learning about investing and how to make money work for her instead of the other way around. In her free time, Kate enjoys spending time with family and friends, reading, traveling, and working out.