BUILDING A STRONG FOUNDATION
WHAT’S IN YOUR BUDGET?
Personal budgeting refers to managing your finances by creating a plan to allocate income toward various expenses and savings goals. It involves diligently tracking and controlling costs, identifying areas where savings can be made, and adjusting the budget as needed.
Personal budgeting is crucial to financial management, as it helps you make informed decisions about your spending habits, reduce debt, and achieve your financial goals. It requires discipline, organization, and a willingness to prioritize financial goals and make necessary sacrifices to achieve them. For example, let’s say you love to explore and want to travel across your country. In this case, you must arrange how you will get to each destination, where you’ll set camp for the night, and what adventures you’ll experience along the way. Your relationship with your finances is the same.
Personal budgeting and road trip planning share many similarities regarding the steps involved and the mindset required to succeed. Here are a few:
- Setting Goals: In budgeting, you might place a goal to save a given amount of money each month, while in planning a road trip, your goal is to visit a specific destination or see certain landmarks along the way.
- Mapping Out a Plan: With budgeting, you might use a spreadsheet or a budgeting app to track your income and expenses and spot areas where you can adjust. While with a road trip, a map or GPS comes in handy to plan your route, identify places to stay along the way, and schedule activities at specific locations.
- Managing Resources: Budgeting requires balancing your income and expenses to ensure you have enough money to cover your bills and save for your goals. With a road trip, you must manage your time, fuel, and other resources to ensure you reach your destination on time and without spending over your budget.
The Importance of Having a Budget
If you pay close attention, you’ll notice the recurring emphasis on budgeting in your surroundings, society, and daily life. This practice holds immense significance and offers substantial advantages that far outweigh the investment of time in the short and long term.
While some may view budgeting as restrictive, it offers many benefits. It is one of the most important financial habits to develop from an early age.
However, maybe you’ve never experienced the transformative impact and advantages of living on a budget. In that case, you may question its prominent role in personal finance. But there’s no need to worry; I’ll explain why budgeting is so important:
- It Shows You Where Your Money is Going: A budget provides a clear overview of your finances, including your income, expenses, and savings. It helps you see the bigger picture.
- It Helps You Spot Where Your Money is Wasted: A budget clarifies your financial situation and enables you to make informed financial decisions, avoiding unnecessary expenses.
- It Provides Confidence & Peace of Mind About Your Money: When you have a budget, you can rest easy knowing that you have a set plan in place for your money. This lets you focus on sticking to your budget and progressing toward your financial goals. This sense of control can be empowering and make you more confident about your financial future.
- It Helps Individuals Avoid Overspending: A budget can help you avoid overspending by limiting your spending and ensuring that your expenses do not exceed your income. It is an excellent tool to help you avoid debt and financial stress.
- Budgeting Helps You Prepare for Unexpected Expenses: Every budget includes a savings category. Utilizing this savings option in your budget, you can prepare for unforeseen expenses, such as medical bills. This can help you avoid financial emergencies and ensure you have enough funds to rely on when unexpected expenses arise.
- It Helps You Plan for the Future: When you include money for long-term goals in your budget, you’re already setting plans for the future, ultimately helping you feel more secure about your financial future and ensuring a safety net for significant life events.
HOW BUDGETS BUILD FORTUNES WITH THREE INGREDIENTS
Now you know that a budget is essential for effectively managing your money. However, it’s important to understand that a budget comprises three components, each vital in ensuring you use your income responsibly. Next, we will explore each of these components:
Income
Your income, which is the money you earn from jobs and other sources, is one of the components that make up your budget. Your payment could be in salary, bonuses, cash gift, allowance, or birthday gift money. It could also come from your investments, such as stock dividends or payments from rental properties.
Expenditures
Second, on the list is expenditures. These include money spent on goods and services, household bills, travel expenses, vacations, etc. There are two types of expenditures:
- Fixed expenses: These are regular monthly expenses that remain the same each month, like rent or mortgage payments, car payments, insurance premiums, and subscription services. You must point out these expenses and include them in your budget.
- Variable expenses: These are not constant every month; instead, they vary monthly. Examples of variable expenses include groceries, entertainment, and travel. You might not be able to tell precisely what you will spend in the future, but with your past spending habits, you can estimate these expenses. You can track your variable expenses by reviewing your bank statements or using budgeting apps that categorize these automatically.
Savings
This is any amount of money put aside for future use. To have a budget that will steer you towards financial freedom, it’s crucial to set aside monthly money for savings, be it for an emergency, a down payment on a house, or retirement. By prioritizing savings, you can build a solid financial foundation for the future. Now that you know a budget’s essential components let’s see exactly how they contribute to wealth accumulation.
Needs, Wants, & Savings in Building Wealth First, what is wealth?
Wealth refers to the accumulation of financial resources and assets that can provide a sense of security, freedom, and opportunities. It’s like a measure of financial abundance and well-being.
Wealth is about having more than enough resources to meet your needs and pursue your dreams. It’s not just about money but also includes valuable assets like knowledge, skills, relationships, and opportunities.
When you’re wealthy, you’ll be able to create unique experiences and enjoy a fulfilling life. You’ll also be able to build a solid foundation that empowers you to live the life you want and positively impact the world around you.
When planning a budget and assigning a single dollar to any category, you must separate needs from wants. You should know what exactly you need and want to be able to tell which parts of your monthly expenses would go for needs and which items would be lovely to include but are not necessary. So, how will you be able to identify your needs from your wants if you don’t know what they are? Don’t panic! Let’s clearly define these terms before moving forward.
Needs are essential expenses for your basic living and survival; it is anything that you genuinely have to have to fulfill basic human requirements. Needs are fundamental and universal, shared by individuals across different cultures and societies, such as housing, food, clothing, healthcare, mortgage payment, utilities, debt payments, and transportation.
On the other hand, wants refer to expenses not vital for basic survival but can enhance one’s life. They are personal desires, preferences, or discretionary spending, such as entertainment, dining out, travel, hobbies, and luxury items. While wants may not be as critical as needs, they still have a part to play in a budget.
Pointing out your needs, wants, and savings plays a crucial role in building wealth over time, and here’s how:
Addressing your needs when setting up your budget ensures that essential expenses, such as food, housing, and healthcare, are always covered. This effective management of your expenses helps you avoid unnecessary debt and financial stress while also allowing you to maintain a stable financial foundation for building wealth.
In wealth building, allocating a portion of your budget for wants, such as entertainment or dining out, allows you to enjoy the present while maintaining a balanced financial plan. By budgeting for wants, you can avoid impulsive or excessive spending that could hurt your financial well-being and hinder your wealth accumulation efforts.
Saving is essential to building wealth, perhaps even the most important one. By consistently reserving a portion of your income for savings, you create a pool of funds that can be used for future investments, emergencies, or long-term financial goals. Savings provides you with a financial safety net, giving you the means to seize any opportunities that may arise in the future. Over time, as your savings or earned interest accumulate, they contribute to the growth of your wealth. Ultimately, building wealth is about maximizing your income and making wise financial decisions.
The 50/30/20 Budget
This budgeting system provides a simple and flexible approach to assist you in managing your finances. It helps you strike a balance by allocating your income across different spending categories, such as necessities, discretionary expenses, and saving for long-term goals. In this section, we will explore the 50/30/20 budgeting system in depth. This budgeting system divides income into three main categories: needs, wants, and savings. Let’s explore each category:
Needs (50% of Your Income)
This category encompasses expenses necessary for basic living and survival. It includes housing costs (rent/mortgage payments), utilities (electricity, water, gas), transportation expenses (car payments, fuel, public transportation), groceries, health insurance, and minimum debt payments.
Once you understand your income, assessing your monthly expenses, such as rent or mortgage payments, car-related costs (including payments, fuel, and insurance), utilities, and phone bills, is vital. Additionally, estimate your monthly expenditure on groceries, as they are among your essential needs. Calculate the total sum of these expenses, and if it amounts to half or less of your take-home pay, you are on the right track for a 50/30/20 budget.
However, if your expenses exceed half of your income, it’s time to evaluate where adjustments can be made. Consider your car’s necessity—does it serve a vital role in your job, or is it primarily for leisure? Can you limit the times you fill your gas tank a month? Assess the expenses of owning a vehicle, including maintenance and parking fees. Another practical step is to be conscious of your budget when shopping for groceries. By carefully considering these variables and allocating 50% of your income to cover essential expenses, you can meet your financial obligations within your budget.
Wants (30% of Your Income)
Assuming your needs take up half of your after-tax income, it’s time to consider how you spend the rest. The wants category represents discretionary spending for enjoyment, entertainment, and lifestyle choices. It includes expenses such as dining out, entertainment, vacations, hobbies, shopping for non-essential items, and other personal indulgences.
Accessing your bank and credit card statements can help you assess your expenses for entertainment, eating out, travel, shopping, and self-care. Now, look back over several months to see how much you’re spending on average and how it compares with your income. If it’s over 30%, you must cut your spending in subsequent months.
Savings (20% of Your Income)
The savings category is critical for long-term financial security and achieving future goals, so it requires some discipline. It’s tempting, particularly if you’re starting, to push off saving and limit debt payments to the barest minimum each month, but don’t do that. Instead, think about what you’re saving for, and you’ll find the courage to go on.
In this category, 20% of your income is allocated to savings, including emergency funds, retirement contributions, investments, debt repayment beyond minimum payments, and saving for major purchases or milestones. Building your savings is essential to creating a rock-solid financial foundation.
Steps for Creating a 50/30/20
Budgeting System Creating a practical 50/30/20 budgeting system involves several steps. Here, we will look at each stage with examples to illustrate the process:
- Step 1: Figure out how much money you’re making Start by determining your monthly income. This includes regular earnings, such as salary, freelance and side-hustle pay, or allowances. If you don’t have a job but receive an allowance, cash gift, or bonus, consider that as your income for budgeting purposes. The same applies if you have a part-time job earning you $1,500 monthly.
- Step 2: Track how much you’re spending To have an in-depth knowledge of your spending habits, track your expenses for a month. You can achieve this by reviewing your bank and credit card statements and keeping receipts for your cash purchases. Categorize your expenses into needs, wants, and savings to analyze your spending patterns. For example, during the tracking period, you may spend $800 on rent, $200 on utilities, $300 on groceries, $100 on transportation, $200 on dining out and entertainment, and $100 on miscellaneous expenses.
- Step 3: Divide your costs and income according to the 50/30/20 guideline
Allocate your income to the three main categories—needs, wants, and savings—based on the 50/30/20 guideline:
- Needs (50% of your income): Allocate 50% to cover necessities such as housing, utilities, groceries, transportation, and debt payments. For instance, if you earn $1,500 monthly, allocate $750 (50%) to your needs. Considering the example of expenses mentioned earlier, this amount would cover rent ($800), utilities ($200), groceries ($300), and transportation ($100), totaling $1,400.
- Wants (30% of your income): Reserve 30% of your income for discretionary spending on wants, which include dining out, entertainment, shopping, hobbies, and other non-essential items. For example, from your monthly income of $1,500, allocate $450 (30%) for wants. For example, $200 was spent on dining out and entertainment, leaving $250 remaining for other discretionary expenses.
- Savings (20% of your income): Now, you are left with a balance of 20%, which will be allocated to savings, including emergency funds, retirement contributions, investments, and debt repayment beyond minimum payments. Still considering $1,500 as your monthly income, give $300 (20%) to savings. You can save this amount for emergencies, retirement, or a high-interest debt.
BUDGETING APPS
Managing your finances effectively and allocating your income can be challenging, so you need a budget. Your budget is a valuable tool that will bring order to your financial affairs and improve your financial situation. However, it’s essential to acknowledge that budget creation can be demanding and time-consuming. It can be just plain stressful!
Fortunately, several companies have created apps to handle this budgeting process to encourage users to adopt responsible spending habits. These budgeting apps are equipped to automatically track and classify your transactions by interacting with your bank accounts and credit cards. By giving you a thorough breakdown of your spending, they make it easy to track it. So, instead of manually entering financial information into a spreadsheet, you can save time by using the features of a reliable budgeting app. Now, let’s explore a few of these innovative budgeting apps together.
Rocket Money
Rocket Money is my favorite finance app, which explains why it conveniently sits at the top of my list. It is a budgeting app that empowers you to reduce expenses and offers bank-level security with 256-bit encryption to protect your data. Rocket Money is an excellent choice with impressive features. For instance, this app allows you to track your savings and closely monitor your expenses, particularly those made through card transactions. Then, it uses this information to create a budget for you, even showing you where your money is going to waste.
Mint
This innovative application can help you set up a budget effortlessly. When you budget with Mint, you can link your bank accounts, credit cards, loans, and investment accounts to understand your financial situation and net worth better.
The app also offers personalized insights on adjusting your budgets to boost savings, payout debt, and more. In addition, it categorizes your transactions automatically and allows you to create your categories based on your spending habits manually.
Goodbudget
This impressive application prioritizes financial planning over simply tracking past transactions. Its foundation lies in the envelope budgeting system, where you allocate your monthly income into designated spending categories called envelopes.
This app is handy for individuals new to budgeting or seeking to enhance their money management skills. In addition to its core features, Goodbudget provides a wealth of educational resources such as podcasts, articles, and online courses, ensuring that users are equipped with the knowledge to handle their finances wisely and make the most of every dollar.
Budgeting is often associated with complex financial documents. Still, it is a valuable tool for individuals of any income level.
