Guide to Building a Budget
At first glance, managing your finances well seems rather simple. You have a list of fixed expenses to cover each month as well as regular take-home income. However, you and I both know that preparing a budget and living on that budget is easier said than done. Regardless of your income level, managing finances can be a challenge.
When you fail to live within your means, you may accrue debt unnecessarily. You may also not save regularly and prepare for the future as well as you should be doing. The hallmark of personal financial health is rooted in how effective your budget is. How can you build a solid, realistic budget?
1. Determine Your Income
Calculating your take-home income is an important step in the budget preparation process, but many people have made critical errors in this step. Regardless of whether you have multiple jobs, you are salaried or you are a freelancer, you must utilize the same strategy to determine take-home income.
The income figure that you need to input in your budget is the amount of money that you can rely on each month and that takes into account all relevant deductions. If you have a salary or an hourly wage, your employer likely takes out taxes, health insurance premiums and retirement account contributions. If you are a contract worker, you must ensure that you account for these expenses yourself. Remember to include the base income that you can rely on monthly. For example, do not count overtime pay unless you are guaranteed overtime hours.
2. List Your Fixed and Recurring Expenses
A budget is comprised of two primary components, and these are income and expenses. You must list reasonable figures for all fixed expenses as well as recurring expenses, but this is easier said than done.
Like most other people, you and I may have a few fixed expenses like payments for housing, student loans and car loans. Your utilities, food, gas and other regular expenses may vary, but you are required to pay them regularly. Taking an average of these expenses is a smart approach. Most people also have various other expenses that should be budgeted for, such as vet expenses for pets, co-payments for doctor visits, clothing, home maintenance and more. You could estimate a monthly average for these and other recurring expenses by reviewing bank statements and credit card statements for the trailing 12-month period.
3. Choose a Budgeting Plan
While some people end their budgeting efforts by subtracting expenses from net income, you could elevate your money management efforts by selecting a thoughtful budgeting plan. A budgeting plan allows you to actively manage your funds based on your needs and goals.
One of many budgeting plans that you can choose from is a 50-30-20 plan. With this plan, 50 percent of your net income is applied to necessities, 30 percent is applied to extras or wants and the remaining amount is saved or invested. Generally, this type of structure allows you to live comfortably within your means. It can help you to avoid taking on debt unnecessarily, and it provides for your financial well-being in the future. This is only one of several plans, so you should choose or create a plan that is aligned with your needs and preferences.
4. Adjust Your Spending Habits
If you are like many people who are focused on improving personal money management, following these steps may have been an eye-opening experience. You may have realized that your expenses are greater than or very close to your net income and that you have little or no money available for savings and extras.
There are numerous strategies that you can take to reduce spending in a situation like this. For example, you could take out a personal loan to consolidate credit card debt. You may refinance auto loan payments, move into a smaller house and shop for lower insurance rates. In many cases, most or all fixed or recurring expenses can be adjusted downward with effort. Some of these changes can be uncomfortable initially, but they may be required in order for you to move toward healthier financial management.
5. Automate Savings
Managing finances effectively through smart budgeting can help you to start saving for the future or to increase savings as needed. After you have walked through the previous steps, consider automating savings so that it is not overlooked.
Many people who save regularly have established an automatic funds transfer from their checking account to a savings or investment account. The best time to do this is immediately after your paycheck is deposited into your account regardless of how frequently you are paid. When the funds are moved into savings immediately, you are less likely to spend that money on frivolous items. As a rule of thumb, work toward a savings balance that covers three to six months of take-home income or a figure that sets your mind at ease. Once you have done so, you may allocate these funds into other fairly liquid assets.
Are You Living by Your Budget?
Managing finances well involves preparing a budget as well as living by that budget. This means that you must actively monitor your budget and make adjustments as you experience changes in income and expenses.
When you live by your budget regularly, you can expect to:
- Improve your credit score or maintain a good credit score
- See your debt balances decrease regularly or avoid taking on new debt
- Watch your savings and retirement account balances increase over time
- Live comfortably while still enjoying a few extras
Have you prepared a realistic budget that is based on your current income and expenses, or do you need to update it soon? Are you struggling to live within the budget that you have established? Because of how important proper budgeting is to overall personal money management, this is an area that requires close attention today and regular review going forward. Do you have any budgeting tips that would benefit our readers? Leave your tips in the space below.