STEP 2: Create a Solid Budget
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Budgeting is essential to proper money management. Although some are initially turned off by the term budget, those who’ve effectively mastered this task know how crucial budgeting is for one who seeks financial independence.
The most common reasons budgeting may not work for some doesn’t have anything to do with the budget itself. It’s due to limiting beliefs and excuses. Some feel they don’t have enough money to budget, or they associate budgeting with restrictions or being poor. Those are just a few examples of how one’s thoughts can limit their ability to master this important concept.
Budgeting can actually help you save money, afford the things you want, give to those in need, and build wealth simultaneously. With a budget, you’ll learn how to make the most of your money instead of staying stuck in a paycheck to paycheck cycle.
There are multiple budgeting styles to choose from, so if budgeting hasn’t worked for you in the past, it’s probably because you haven’t found the right budget for you. Your budgeting style can determine how successful you are at budgeting because there is no one size fits all solution when it comes to money management.
Choosing a Budgeting Style
While a lot of budgets are similar, not all budgets are created equal. That’s why I recommend something called the Zero-Based Budget.
Zero Based Budgeting
Zero-based budgeting isn't as hard as it may sound, but it does require you keeping track of every single dollar you spend. Does this sound like you at the end of the month — "I don’t know where all my money went”? If so, this style of budgeting is perfect for you.
What you do is give an assignment to every dollar you earn. No money comes in without you telling it where to go. When you receive your take-home pay, you create a budget and budget down to zero dollars.
For example, let's say your take-home pay was $2,000 and you budgeted for all of your bills, and you paid on a few credit cards. After you're finished, you still have $100 left over.
If you have money left over, you haven’t completed your budget according to this type of budgeting style. To complete your budget, give an assignment to the remaining $100 you have after meeting all of your wants and obligations.
For instance, you can put $50 towards your emergency fund, $25 towards your future insurance payment, and the remaining $25 towards your future car taxes.
Even though you’ve met your needs and obligations, make sure you include future expenses into your budget. If you don’t, you run the risk of not having enough money to cover things like taxes, registration, and premiums in the future.
Before moving forward, let’s look a few other budgeting styles you can use to manage your money.
With a 50/30/20 budget, your budget is split up by percentages to cover three main categories — necessities, life, savings/debt. The amount you allocate depends on the amount of your take-home pay, with the goal to spend no more than is allowed for the specified categories mentioned.
50 percent - this percentage of the budget would cover necessities. These expenses would be things like housing, transportation, or utilities. You would include any associated expenses as well. If you have a car, there will be car taxes, registration, and insurance. The same applies to housing.
30 percent - this percentage of the budget would cover life expenses. According to this style of budgeting, life expenses would include things like entertainment, groceries, shopping, dining out, cable, etc. Many items listed in this category would be considered wants.
20 percent - this percentage would be allocated towards your debt and any savings goals you have. It may not sound fair to have to share your savings with debt repayment, but this budgeting style will give you an extra incentive to pay down your debt so you can keep more of your earnings.
Envelope (Or Cash) Budgeting
This style of budgeting is as easy as it sounds. You simply use cash. There are no percentages or mathematical equations involved. The term envelope comes into play for those who need a little guidance when spending their cash.
If you struggle with overspending in certain categories, using the envelope system would be beneficial to you. You put the amount of cash in your envelope that your budget says you should spend for the month. Once it’s gone, it’s gone.
Of course, there are some expenses that cannot be paid in cash, but this system can be tweaked to your liking. You can use cash for certain categories like groceries, entertainment, shopping, and dining out. This works well for individuals who are saddled with debt and need to stick to their debt repayment plan.
If you get paid on a bi-weekly basis, you may find it difficult trying to figure how to manage paying your bills. The secret to overcoming this problem is to set aside half of a payment for every bill each pay period, which is essentially known as creating a bi-weekly budget.
You would divide all the bills you pay by two. Set aside your half-payments into a separate account or keep it separate from your spending money.
To make this style of budgeting more efficient, arrange to have half of your bills due during the first half of the month and the others due during the second half of the month. This will eliminate your worries of having more bills than cash on hand at any given time during the month.
Creating Your Budget
Basic Components of Your Budget
Your budget is made up of two major components — income and expenses. The main take away should be that your expenses should never exceed your monthly income. Remember this because it's key in making your budget work for you!
Here are common types of income sources:
Passive income streams
Freelance or side-hustle income
Here are common types of expenses:
Car – You should include all car expenses such as your monthly car payment, petrol, insurance, tax road and maintenance expenses.
Transport – If you go to work by public transport or you use it very often, include this category in your expenses.
Food – This category would Include all groceries, including groceries you may pick up at drugstores and non-traditional grocery stores. This doesn’t include dining out. If you regularly eat out, you should include a dining-out category to manage your expenses.
Clothes – This category includes all clothing, shoes, accessories, etc. purchased for your family.
Home essentials – Include house cleaning products, shower products, etc. Anything you use in your daily home life.
Communications - This would include internet and cell phone costs.
Entertainment – Include dinners, cinema, going out for drinks, parties, gifts, etc.
Traveling – Include this category if you love traveling. Budget for the expense and keep the money in a separate account until ready for use.
Debt Repayment - This category would include all of your other non-mortgage and non-automobile debt like credit card payments, student loans, personal loans, etc.
Savings - Include emergency, retirement, and other long-term savings goals in this category.
Now that we’ve discussed the more common budgeting styles and the basic components of your budget, it’s time to create one for yourself. But first, let’s make sure we’re clear on one major thing — you need to differentiate between wants and needs. This will make creating your budget a lot easier.
Identify Your Wants vs. Needs
Go ahead and make a list of your expenses and categorize them as wants or needs.
Your needs include:
· Housing (rent or mortgage)
· Utilities (water, sewer, trash, etc.).
· Food (groceries only – no dining out)
· Personal products (shampoos, household items)
Anything else on your list would fall under wants.
Reduce Your Wants
Review your list and look at the wants. These are items that you might be able to reduce or eliminate from your budget, but let me clear the air. This is where budgeting seems to get a bad rep, and I think it's important to address this.
Budgeting shouldn’t be synonymous with elimination. When you think about budgeting, think of it as having choices. You’re getting to choose the things that matter most to you. If you’re saddled with debt, here is where you are allowed to make a choice to eliminate some of your wants so you can fulfill a true desire — becoming debt free.
Some expenses you may choose to reduce or eliminate include:
· Cell phone
· Dinners out
While you may not choose to change all of these, eliminating or reducing things like dining out or subscriptions could make all the difference in the world. Sometimes the small choices add up to significant savings that can help you achieve financial freedom quicker.
Making Your Budget Work
Regardless of which budgeting style you choose, here are some tips to make your budget work for you:
Remember, the sole purpose of your budget is to ensure that your expenses don't exceed your income.
Always include your regular and irregular bills in your budget. If you have quarterly bills or yearly premiums, take the total cost and divide them by twelve so they can be accounted for in your budget.
Keep your spending money (money you typically use to purchase wants) separate from your funds for necessary expenses. It’s easier to scale back expenses like groceries than it is trying to figure out how to pay your mortgage when all of your paycheck is gone.
Consider your savings a necessity. You will need funds in the event of a job loss. If you don’t have an emergency fund, saving for one shouldn’t be optional.
Track your expenses every day. Money easily slips through the cracks when we are not paying attention. Tracking your expenses is easy to do with the use of free tools like Personal Capital. Learn more about this tool at PersonalCapital.com.
Once you’ve created your budget using this information as a guide, you’re ready to move to step three - your emergency fund.