Why Budget?Submitted by Affiance Financial on May 7th, 2014
By Omer Abramovich
No one likes to budget. Not only does it take time, energy and effort, but to make matters worse, it’s boring. Nonetheless, creating a budget is still a good idea and can help you with the following.
Five reasons to budget:
- Fulfill your goals and dreams. Whether it’s a vacation home in Florida or a new-model luxury car, we all have dreams and goals. And the only way to achieve them is to know how much money we spend versus how much we make.
- Retire comfortably. Start saving now for a better future. Creating a budget with specific contributions to your IRA or 401(k) can enable you to get to reach your goals more quickly.
- Expect the unexpected. Most of us have experienced a surprise expense in our lives. Whether you were sick, injured or experienced a lay-off at work, the impact of these events can be reduced significantly if you prepare ahead of time. Creating an emergency fund with at least 6 months’ worth of cash reserves can ensure at least some sort of cushion.
- Understand what you’re spending on. Whether or not we like to admit it, we all have our guilty pleasures. The problem starts when we don’t know how to budget for them within our means. Setting a specific dollar amount will force you to take a close look at how you’re spending your discretionary income. You may not realize just how many times a week you’re going out to dinner, or how many new pairs of earrings you bought last month.
- Ensure that you live within your means. Admittedly, changing spending habits is no easy task, especially in today’s environment where a skinny plastic card enables you to buy things you didn’t even know you wanted. But creating and following a budget can help. Each month, you will see how much money is coming in and how much is being spent. Think of it this way: Do you really need the most expensive drink at the bar? Or that new pair of shoes? If you spend more than you make, it will be glaringly obvious that you need to reverse the trend.
QUICK POINT: Budgeting involves a lot of self- discipline and oftentimes personal sacrifice. The financial crisis of 2008-2009 was a reminder that emergencies can strike when we least expect them, and when cash is tight. Folks who followed a budget plan prior to the crisis were better off than those who hadn’t budgeted appropriately. It may sound simplistic, but budgeting correctly = financial security.
Where do I start?
The most important factor is to create a budget you can actually stick to. After all, no help ever came from a budget that wasn’t followed. Here are some easy steps to take:
- Decide what matters to you most (your values).
- Write down your goals, making sure to divide them into short-term, intermediate and long-term—and prioritize them in the right order. (If you are in your 30s, retirement will not necessarily be your number-one goal at this point).
- In order to know how much you can spend, you need to know how much you make. Make sure that you use your take-home amount (after withholdings/contributions).
- Determine how much you spend every month. This is where the “three buckets” approach can come in handy. The idea is to divide expenses into three sub-categories: essential expenses, flexible expenses and financial expenses:
- Essential Expenses. These include housing, utilities, groceries, etc. The idea is to not exceed 45-50% of your total expenses on this category.
- Flexible Expenses. This category is also called discretionary income. These include lifestyle-related expenses, which are personal and voluntary, and can vary each month. For example, cable, charitable giving, entertainment, gym fees, hobbies, restaurants and bars, etc. are all spending choices we make. Try not to exceed 30% of your total expenses on this category.
- Financial Expenses. These include retirement contributions, savings contributions and debt payments. The most important thing to remember is that these expenses need to come after you have already budgeted for essential items. Don’t exceed more than 20-25% of your expenses here.
5. Create your budget. Try working with your new budget for two or three months to see if it’s realistic, tweaking as you see fit. It may be that you under-budgeted for social outings with friends, but over-budgeted for groceries.
QUICK POINT: If you’ve already tried creating several budgets and still find yourself spending above your means, you might want to try a cash budget. With this approach you would withdraw the amount of money you have in your account for discretionary expenses on a weekly or biweekly basis, and when it’s gone – you’re done. The idea is to focus on your most-flexible expenses, such as entertainment, restaurants and bars, and gifts.
How often do I re-visit my budget?
There is no magic number, but be sure to re-examine your budget regularly. Budgets can and should be changed because of circumstances. Changes in income or expenses definitely need to be considered. While you don’t have to re-visit your budget every couple of weeks, you do need to make sure that it still meets your needs and that you are on track to meet your goals. This will create the most accurate picture of your financial well-being.
QUICK POINT: Fortunately, in today’s world there are many software programs available to help you budget. Look into personal finance programs that offer free budget-tracking options that also categorize your expenses, such as Mint.com. This is just one great tool that can help you know exactly where your money is going.