How to Budget: The Step-by-Step Process
There are literally thousands of personal finance books, blogs, podcasts and ‘money coaches’ out there. Most of them have similar advice, when you how to budget and manage your money effectively you are more likely to achieve your short and long term goals. That is why having a personal budget is SO important!
People tend to think of their finances as somewhat disconnected from their everyday reality. Once your paychecks are automatically deposited and fixed expenses are taken out, what’s left generally becomes discretionary income.
However, we tend to spend our discretionary funds unconsciously and neglect to consistently track our spending. This keeps us from developing a comprehensive understanding of patterns, and it becomes difficult to plan for expenses. It also leaves us totally unprepared for situations that may arise from time to time, whether it be an unexpected vehicle breakdown or an emergency trip to the dentist. With a little foresight and small changes in the way we think about our money, we can completely change our lives.
Bottom line, you need to track your spending. You’ll identify income-draining expenses that you could happily do without (especially when it puts an extra $150/month in your pocket). You may have heard that creating a budget feels like getting a raise. It’s because you eliminate every expense you don’t care about. What are you spending money on that you don’t care about? Start tracking your expenses to find out.
The Good News: Learning How to Budget is Easy
The good news is that anyone can make a budget, regardless of their personal financial circumstances. When done effectively, a budget is an excellent way of taking control of your finances and helps you achieve objectives much quicker.
Budgeting doesn’t have to be a daunting exercise, and is actually pretty easy to learn as long as you’re willing to be disciplined and follow these 5 steps. Done step-by-step, a budget will become an invaluable tool to help you manage your finances.
1. Determine Your Goals
Setting goals for your money will help you make smart spending choices. It’s best to start with what you would like your finances to look like in one year’s time. Decide what is important to you in the short and long term, and make saving for those goals a part of your budget.
For example, your goals may include paying off debts, saving for a down payment on a new home, grad school, or even something simple like a new toy or a trip you’d like to go on.
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2. Evaluate Your Expenses
Unfortunately, most budgets fail because they often don’t reflect realistic or actual spending habits. Once you have identified your goals, the next step in formulating a budget is to identify your income and expenses.
Life is busy. Quite often, it’s easy to lose track of small expenses such as a daily latte or occasionally eating out. Little by little, these expenses add up and can very quickly derail your budget.
A good place to start is to track your everyday expenses. Spend a few weeks tracking what you spend to identify your spending patterns. Make purchases as you normally would on an everyday basis. You’ll start seeing where you can improve almost immediately.
There are a number of great online tools and smartphone apps (e.g. Mint, YNAB) that can track your expenses. This helps to determine what and where you are spending your discretionary income. Also, you can identify opportunities that will accelerate the achievement of your financial goals.
3. Focus On Conscious Spending
Now that you have determined your financial goals and are tracking expenses, it is time to consider your needs and wants.
Needs refer to things that cover the basics of survival such as adequate food, clothing, and shelter. Conversely, a want is simply a desire for something, not necessarily a must-have.
Ask yourself the following questions to determine whether a purchase classifies as a need or want.
- Do I want this, or do I need it?
- Will spending this money get me closer to my financial goals?
- Can I live without it?
Remember that your needs and wants may change over time. The answers to these questions become clearer once you have set priorities for your money.
Also See: Frugal Living Guide: 34 Tips to Save Money Every Day
4. Design Your Budget
The basic principle of a budget is to consciously spend less than you make. Now that you have determined your goals and priorities, it is time to develop a plan for your money.
Determine your monthly net income (after taxes) and allocate money to the needs you identified previously. Also, any minimum payments that are required to service your debts should have appropriate funds allocated. The expenses you have tracked will come in handy here. They will help you decide what can be trimmed from your monthly spending.
From time to time, expenses may ‘come up’ like school expenditures, unexpected medical bills or others. Set aside a small portion of your budget into a separate account for these potentially inevitable expenses. There are a number of high-interest savings accounts available that can help you accumulate money for this purpose.
As a general rule, your emergency fund should cover living expenses for 3 to 6 months.
5. Look to The Future
Once you have established a budget, it may take a few weeks or months to adjust to the new spending plan. Be patient! It is important to have realistic expectations, and sometimes that means sacrificing something you want for awhile.
You are more likely to stick with your new spending plan and avoid frustration if you give yourself enough time to adjust. Think of your budget as a living document. Don’t hesitate to adjust what isn’t working, providing that you continue to work towards the goals identified in step one.
Now You Know How to Budget, It’s Time to Get Started!
Managing money effectively isn’t all about the amount you make but what you do with it. Money is a resource. Proper management of that resource doesn’t involve a magic formula. Not at all, it simply means getting the most from the money you have. This is why learning how to budget is of crucial importance.
A good budget will protect you from going into debt and relying on credit for everyday living expenses. This is not to suggest that credit (e.g. loans) is bad. They have their uses and can accelerate your income to allow for investments in assets.
At its core, a budget should be simple and easy to use, while reflecting current realities, including alignment with future goals.
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