With statistics indicating that most households do not have enough money to cover a $1,000 emergency and a substantial percentage of Americans battling with debt, the importance of setting and sticking to a budget has never been clearer.
Creating a household budget can serve various purposes, including getting out of credit card debt faster, saving for a long-term goal such as a house or retirement, or simply ensuring that you are financially prepared to deal with whatever life throws at you. Surveys suggest that those who keep to budgets are less likely to express financial difficulties or to live paycheck to paycheck, and they are more likely to fulfill their financial goals.
So, exactly what is budgeting? At its most basic, it is a ledger that details the spending decisions you intend to make. It forecasts how much money will be received in the coming months and budgets for expenses such as food, housing, transportation, and insurance.
A smart budget also incorporates monthly savings allocations. In effect, a budget not only lays out a path to a specific financial destination, but it also serves as a lantern to illuminate the path and keep you on track. Without one, you’re more likely to be in the dark about your financial situation and lost in the wilderness of debt and uncertainty.
Is it any surprise, then, that more Americans are turning to budgeting in their pursuit of financial happiness? While a budget will not be able to buy you love, to paraphrase The Beatles, it may be able to alleviate a typical cause of tension and strain in relationships: disagreements over money.
Why is budgeting necessary?
Despite the fact that the national economy was experiencing one of its longest periods of growth in 2018, a Bankrate study found that over two-thirds of Americans were reducing their monthly spending. And, as economic fortunes shift, that number is only certain to rise.
Stagnant salaries, mounting debt burdens, and rising housing and medical costs are just a few of the reasons why so many Americans have been looking to tighten their belts in recent years, regardless of what the GDP and employment data suggest. But, just as it’s tough to lose weight when you don’t know how many calories you’re consuming, it’s as difficult to trim the fat from your expenditures and whip your finances into shape if you don’t have a budget to show you where your money is currently going.
Here are just a few of the reasons why, regardless of your financial situation, setting a household budget is a sensible decision:
Simple and effective debt management or debt avoidance: The reason millions of Americans are burdened with huge interest payments on credit card accounts is that they simply spend more each month than they bring in, leaving them unable to pay down their card balances. A fundamental budgeting guideline is to ensure that your monthly spending does not exceed your disposable income.
Assume you want to save money for a down payment on a car next year or a home in five years, or you want to ensure you can live your golden years in comfort by building up your retirement nest fund. A budget is useful for estimating how much of your income you need to save each month to meet your goals and how to spend that money.
A budget forces you to make compromises, whether it’s cutting back on Starbucks lattes or restaurant meals, cutting back on pricey vacations, settling for a lower cable TV package, or keeping that outdated automobile for a few more years. A budget can also help you predict expenses such as car payments, utility bills, and phone bills.
Can help you save for a rainy day: The fact that so many Americans live paycheck to paycheck, with so few having an emergency fund, highlights the need for more households to save for the next time the car breaks down, the home plumbing breaks down, or, in the worst-case scenario, you lose your job or health insurance.
Encourages you to become invested in your own finances. Simply put, budgeting teaches people the discipline and drive to handle their funds more efficiently and responsibly. According to research, those who stick to a budget are more likely to achieve their financial goals, in part because they become emotionally invested in the process.
Monthly Budgeting Process Steps
There is no one universal method or tool for budgeting; you will most likely select an approach that best suits your skills and preferences, whether it’s budgeting apps like Mint, programs like Quicken, a budget worksheet like the one provided by InCharge Debt Solutions, or good old-fashioned pencil and paper. You can also use InCharge’s budget calculator to aid with the calculations.
Whatever technique you use, you’ll need to take some basic measures to ensure that you’re establishing a clear and accurate picture of your money.
Financial Statement Collection
This is as simple as gathering all documents pertaining to your monthly income and expenses, such as bank, credit card, and investment accounts, pay stubs, benefits statements, and electronic payments. The accuracy of a budget will determine its strength. Examine three months’ worth of credit card and/or debit card expenditures to ensure you’ve captured all of the areas where you normally spend money.
While some of these income and spending items may vary from month to month or reflect one-time or irregular transactions, compiling a paper trail is the best method to gain a bird’s-eye view of how much money is entering and leaving your financial house each month. Then you can get into the finer details of creating a budget that will put that house on a solid foundation for the future.
How to Work Out Your Monthly Income
When it comes to budgeting, take-home pay is the only thing that matters. Forget about earnings before taxes. Your take-home pay is the amount of money you have available to spend or save in addition to what you may already be contributing to a retirement account at work.
Include other sources of income for computing income, such as social security, disability, pension, child support, regular interest or dividend profits, and alimony. Any money that you get on a regular basis can be considered revenue for your monthly budget.
Here’s how to figure out your monthly take-home pay:
If you are paid biweekly, multiply your weekly take-home income by the number of payments in a year: 26. Then multiply this figure by 12 to get your monthly income.
If you are paid weekly, multiply your weekly compensation by the number of weeks in a year: 52. Divide this figure by 12 to calculate your monthly income.
If Your Pay Varies: If your pay varies due to tips, varying hours, and/or commissions, you can still compute an expected monthly income by adding three months of income and dividing by three.
Make a list of all of your monthly expenses
You can now confidently calculate how much you typically spend each month on various expenses, such as mortgage, rent, and car payments, as well as utility bills, insurance, prescriptions, groceries, dining out, and student and other loans, once you’ve gathered all relevant financial statements and other documents. Don’t forget to account for irregular bills that you may have to pay on a yearly or semi-annual basis, such as property taxes, car registration, and insurance fees.
Tracking your expenditure in different categories might help you have a better understanding of which areas consume a large portion of your income. To make the procedure easier, the Consumer Financial Protection Bureau offers a useful expenditure tracker worksheet.
Expenses should be classified as either fixed or variable
You must first decide which expenses are permanent and which are variable in order to calculate how much wiggle space you will have to change your budget to fulfill specific goals.
Fixed expenses are payments that are quite consistent from month to month. They frequently represent “needs” rather than “wants,” but some categories are ambiguous. The greater the proportion of your entire budget occupied by fixed costs, the less freedom you will have to make modifications unless you make major lifestyle changes (such as selling your car, taking on a roommate, or moving to a city with a lower cost of living).
Examples of fixed expenses include:
- Payments for a car
- Automobile insurance
- Health coverage
- Bills for utilities
- Internet, television, and cell phone service
Variable expenses, on the other hand, vary greatly from month to month depending on your lifestyle, preferences, and spending habits. They are often classified as “wants” in your life and may thus be altered and reallocated in your budget more readily depending on your unique goals, whether it’s to pay down debt, save for a big-ticket buy, or build up a rainy day fund.
Variable expenditures include:
- Add the income(s) and expenses columns together.
Now that you’ve recorded all of your spending and income, it’s time to total up each column and face the music: If your income exceeds your expenses, you might want to whistle the Kingston Trio’s “Put Your Money Away” as you figure out how to best spend that extra cash. If your expenses exceed your income, it’s time for a more somber song like Destiny Child’s “Bills, Bills, Bills” or Lou Reed’s “The Debt I Owe” and some difficult decisions. Expenses should never surpass 90% of your take-home pay.
But don’t allow that depressing tune to get to you. You’ve taken the most critical step toward creating a budget that will allow you to sing “Happy Days Are Here Again” one day by adding up your income and expenses and determining where the difference is.
Analyze the results and make the necessary adjustments
Keeping track of your income and expenses can be enlightening, humbling, and empowering all at the same time.
You might realize that you’re in a better position to save than you thought, and that with the correct plan and dedication, you can attain your long-term goal of a new home or car. Alternatively, you may realize that too much of your money is going toward variable expenses such as pricey meals, clothes, or shows that you can easily live without, providing the impetus you need to reduce your spending and save for a rainy day fund or retirement. And if your worries are realized and you discover that you’ve been living beyond your means, you now have the knowledge to make the required decisions to restore that failing foundation.
Whatever the data suggest, your responsibility now is to construct a budget in which the amount you set aside each month for variable and fixed expenses, as well as short- and long-term savings goals, matches what you earn.
Begin by reducing variable expenses if necessary, and then search for ways to supplement your income with a side business or a safe investment that produces regular dividends or interest. If it isn’t enough, look at what improvements you can make to your fixed expenses. Can you search around for a lower-cost auto insurance policy? Have you cut the cord with your cable provider? Or, if necessary, downsize to a less expensive house, apartment, or car?
It’s also critical to ensure that your budget monitors bill due dates so that you don’t skip payments and accrue late fees or other penalties, which will quickly throw your budget out of sync. Consider implementing a bill calendar into your budget to keep track of due dates and verify that your revenue flow is sufficient to make individual payments each month; the Consumer Financial Protection Bureau has a sample here.
Making the decision to make a budget and assessing your income and expenses is only the first step. The quest will fail if you do not ultimately set the correct financial health goals in your budget. Choosing the correct budgeting technique for distributing your income is crucial to having the process pay off.
The 50-30-20 model pioneered by the United States is one strategy that has risen in favor in recent years. Sen. Elizabeth Warren (D-MA) in her book “All Your Worth: The Ultimate Lifetime Money Plan.”
The simplicity of the approach contributes to its popularity: you divide your income into three pots and allocate it as follows: 50% goes toward “needs,” such as rent, food, and minimum payments on credit cards and other debt; 30% goes toward “wants,” such as trips or entertainment; and the remaining 20% goes toward savings, which can include debt repayment. Your savings should contain an emergency fund capable of covering at least three months of costs if you lose your job or suffer another financial setback.
Of course, most rules include exceptions, and the 50-30-20 model is no exception. For low-income households with debt, it may be necessary, at least temporarily, to allocate a higher percentage of income to “needs” and less to wants and savings. Similarly, if more affluent households can afford to save more than 20% of their income, it may be a better long-term investment than purchasing a new Mercedes, reserving that five-star European hotel, or upgrading to a larger home. If you already contribute a significant portion of your pre-tax salary to a 401(k) plan or other workplace retirement vehicle, you should factor it into your savings target as well.
The 50-30-20 allocation may need to be altered on occasion to accommodate emergencies or unexpected expenses, such as a roof repair or large medical bills. However, while no rule is absolute, the 50-30-20 model can serve as a tried-and-true rule of thumb.
Don’t mix luxury and essentials. Eating is a requirement. It is a privilege to dine at a four-star restaurant. If you need to cut costs, cut back on frills.
Keep an eye on the details. If you enjoy spending time in coffee shops, keep track of how much you spend each month. The total of all those $4 lattes may surprise you. So drink water occasionally, or work from home and brew your own coffee.
Keep your cool. Just because you get a raise doesn’t mean you have to spend it in new ways. Consider saving a portion of it or increasing your contributions to a 401(k) retirement plan at work.
Make use of cash. Credit and debit cards are convenient, but they can also be overused. When you spend cash or make checks and put them into a register, you can see what you’re doing with your money more accurately. Finally, spending cash isn’t an excuse to go to an ATM whenever you want to spend money. Set limitations for yourself with your budget and keep receipts to track your success.
Take charge of your own debt. If you have an increasing amount of unpaid debt on your credit cards, a portion of your budget should be devoted to reducing the balance to zero. Paying off credit card debt is one of the most inefficient ways to spend money.
If your debt has gotten out of hand, look into debt consolidation programs that will cut your interest rate and monthly payment.
A budget calculator can assist you in rapidly adding up your income and expenses. InCharge’s online budget calculator will assist you in recording all of your costs and determining how much revenue is required to cover your expenses.
Spreadsheet for Budgeting
A spreadsheet is a useful tool for budgeting since it allows you to adjust your assumptions and see how they affect your surplus and/or deficit. A well-designed budget spreadsheet will have pre-programmed formulas for adding up your spending and subtracting it from your income. You can see how cutting costs by 5–10% in tiny sections of your budget adds up to significant savings.
Consider having two budget spreadsheets: one that reflects your actual income and expenses and another that reflects your goals: expenses you want to reduce (monthly debt payments, for example) and revenue opportunities you want to expand. Your goal budget can help you see the power of compounding savings over time. Remember that any expense you can eliminate permanently represents recurring savings: savings divided by twelve months of the year.
Consult a credit counselor about your budget
While there are numerous resources available to assist you in developing and adhering to a budget that will put you on the path to your financial objectives, the process can still appear intimidating, particularly for those who are currently dealing with debt or other issues. If this is the case, free credit counseling like that offered by InCharge Debt Solutions may be the solution.
Credit counselors can offer specific advice on cutting spending and increasing income in each major budget category, as well as assistance with debt-relief programs such as a debt management plan or debt consolidation, which may be a key component in making your budget work.
A budget cannot perform miracles. It can’t make money grow on trees, make your boss give you a raise, or tell you how much your next car or trip will cost. However, it can have a huge impact on your financial health, which may also affect your mental and physical health. Finally, a well-planned and executed budget may achieve for you what the Rolling Stones sang about in their single “Can’t Always Get What You Want.”