Introduction
Most Americans are set up to fail financially. Did you know that 72% of households do not have a written financial plan? What can you do to avoid Financial failure? The answer is to create a budget.
In this post I will show you exactly how to create a budget. This will be the foundation for your financial plan.
I’ve helped people get their finances together, along with my own. Although I’m not a financial services agent (this is my weak disclaimer) like I used to be I still have the knowledge that has helped me to go from being broke to thriving and growing financially.
So, let’s dive right In.
What is a budget?
A budget is a Financial tool that helps you keep track of the money that comes into your life and the money that goes out of it.
Some people make a lot of money, but can’t seem to track where it is going. When you create a budget you are able to see clearly where your money is coming from and what you are spending your money on.
Why do you need a budget?
It’s been said that money answers all things as a matter of fact this was said by the wisest man that ever lived, King Solomon. What does it mean, though?
Simply put, wealth is a powerful tool that can meet many needs. It can help you purchase food, shelter, clothing, Etc. The bottom line is that money is great. However, if you lose or abuse it, not so much. A budget helps you to get a grip of your finances and stay on top of your money game. Here are a few ways:
A budget tells your money where to go
I’m a firm believer that you need to tell your money where to go. I’ve learned that your money will listen, if you tell it where to go.
If you do not, it will leave the safety of your care and run around town wreaking havoc like a disobedient child who knows nothing but how to shame their parents. When you create a budget you decide where each dollar goes.
This Is a huge step in helping you to decide where you want to go financially instead of just dealing with the crumbs that are left over after you’ve spent the majority of your money.
A budget helps you track and adjust
I believe there is a secret weapon to help you create the momentum that you need to make any change that you’ve decided to make. This secret weapon is called tracking.
I learned this one from Darren Hardy of Success magazine. He is a firm believer in the idea of tracking. As a matter of fact it was his confidence in this one step that convinced me to give it a try once and for all.
A budget helps you measure your success
We all have financial goals. Unfortunately, some people give up on themselves. On the other hand, there are those who stick to the plan until they are successful. For those people, a budget is like a road map that helps them see how far they’ve come and how far they have to go.
Once you create your budget, you then have to execute it. It’s not supposed to be a piece of paper that you just sit back and admire. You actually have to follow it.
Your budget helps measure success. It helps you to know how much you must spend on specific expenses. So, let’s say for the month you allocate $120 on eating out. That means, for the month, you get to eat either 3 meals at $40, 4 meals at $30, or 6 meals at $20.
Imagine you are 21 days in and you only spent $80 on meals. You know how much money you have left to spend on eating out for the remaining 9 days. That number is 40 dollars. It may seem simple and insignificant, however, some people value knowing the exact number of days and the exact number of dollars they can spend and still be within the budget. Knowing that you have some. You have to
Know where to make changes
A budget is so helpful because you can plan your finances from top to bottom. Once you have your budget, you’ll be able to spot areas where you can make changes.
Pinpointing where you should make Financial change is sometimes the hardest decisions to make. When you know where your money is going to every day of the week, you have a better handle on where you can pull money from.
It’s the foundation that helps you calculate your wealth building
Knowing how Financial changes you make will affect you is a major benefit of having a budget. Once you plan out your income and your expenses, you get a clear picture of what is left over at the end of the month.
Let’s call this your profit. This is the number that you are essentially trying to protect and grow. This is the number that your wealth building comes from.
When it comes to saving and investing, this is the number that helps you to keep score. Everything will be out of place when you analyze your spending before you create your budget.
Once you start to establish the financial plan you actually want, you will see where your money is going. Once you see this score (your profit) you’ll naturally want to grow this number.
So the overview of the timeline is as follows:
- Increase your income
- Track your spending
- Compare it to your income
- Find out what’s left over
- Try to rescue more dollars by cutting frivolous purchases
- Grow your monthly profit
- Use your monthly profit to save
- Once you reach your savings quota, Invest the rest
So the budget helps you discover your foundation for wealth building which is the amount of profit that is left over after your expenses.
Know how financial changes will affect you
Let’s say for example you bring in $1,000 per month. Your expenses come up to $950 per month. This means your monthly profit would be $50 per month.
This simply means that if you were planning to save, your savings would only grow by $50 every month. Let’s put that into perspective for you. That means at the end of one year you would only have $600.
You can, however, make some Financial changes. Since you have created a budget you would know exactly how that would affect you.
Getting back to our example, you decide to make some tough decisions and hard sacrifices. You cut $150 of spending out of your expenses. Now you have $200 of profit every month to put towards your wealth building. Your savings math will look different.
if you saved $200 every month for 12 months you would have $2,400 at the end of the year. That’s four times more than the $600 you would have saved you’re if you only had $50 a month left over.
Some poor souls will never get the confidence to make those sacrifices. They won’t have the clarity to make the connection between their sacrifice and the benefit.
They just won’t be able to see the value in making the changes. It’s sad but true.
Types of budgeting systems out there
There are different ways to create a budget. Again, it means to account for your money and your spending habits.
50/30/20
This budgeting method seems to be a fit for more loose and straightforward thinkers. It doesn’t really get down into the tedium of calculating all expenses and income.
So if you like to keep things simple this might be the method for you. You will start with your after-tax income and divide it into 50% 20% and 30%. 50% goes to necessities, or bills. These are the expenses that keep the house running and keep your life in order.
Next, 30% to wants. Whether you like having fun going out to eat or taking trips. Finally, 20% goes to savings, investing and debt repayment.
Let’s say for example you make $1,000 a month after taxes. $500 would go to your bills. $300 would be available for you to get the things you want and go the places you want to go.
$200 would go toward paying yourself investing or paying off credit cards. Simple enough, right?
Savings First
You will hear a phrase in the financial Circles that go something like this, “Pay Yourself First!” This phrase is a fun and fancy way of saying, “Prioritize your retirement.”
That last phrase doesn’t sound so cool now does it? When you pay yourself first you decide you will take your money out before the rest goes to all the other expenses in your life. The savings first budgeting method starts with you centering your approach around your savings.
Deciding how much you want to put away each month toward your retirement. Once you have set this amount and collected it every month the rest goes towards paying your bills and taking care of your wants.
This is another casual budgeting method that helps to prioritize your own financial goals over the financial goals of your creditors and vendors.
Envelope Method
If you’re the type of person that needs a bit more of a tactile system, the envelope method may be the right fit for you. In this budgeting system, you place your cash into different envelopes which represent each expense categories.
Once the money in that envelope is spent, you cannot spend anymore for that category until the next paycheck fills it in. The act of pulling the physical cash can be an annoyance to some people.
Others seem to prefer the physical realism of having very tangible cash and consequences. Goodbudget is an app for the envelope method.
Traditional Zero-Out Method
Finally, the tried and true method of zeroing out your expenses with your income is my personal favorite. This system seems to give a greater level of clarity on how we spend every single dollar.
That’s because in this system we are accounting for every single dollar. You would start by taking your income and applying it to each expense until every single dollar is allocated. This method forces you to be conscious of how you spend and where you are spending your money.
Nerd Wallet has created an amazing Budgeting Worksheet. This is actually the model I endorse. We talked about tracking your expenses earlier. I believe this method honors the diligence that you apply to your finances.
If you’re going to take the time to write down and record everything you spend your money on, you should have an equally paired budgeting system to respect the detail of getting down to the final dollar.
How to create a budget
So we’ve gone through all of the benefits. I’m fairly confident that you would actually want to create a budget. It informs your decisions on what to spend. It helps you to make the right Financial changes with confidence.
Choose A Budget Method
First you have to decide which budgeting system you prefer. Some people prefer the Simplicity of the 50/30/20 rule. Others like to feel the cash as they stuff it into envelopes in the envelope system.
My personal favorite is the zero out method where you tell every single dollar where to go. There’s nothing wrong with trying out a couple of different methods until you land on the one that best fits your personality.
The Nuts And Bolts Of A Budget
Next, every budgeting system deals with two things: Your income and your expenses. Find out what your After-tax income is.
This is the money that’s left over after your federal and state taxes are taken out. You know I like using analogies. If this was a meat grinder then your income would be the chunks of meat that you place into it.
Uncover What You Are Spending
After you get a clear number for your income, it’s time to work on the expenses. This is like the disgusting part of the meat grinder.
Similarly, this is the part that gives most people the ick. No one likes to come to terms with how bad they are handling their money. This is exactly what a budget does.
It’s natural to want to suppress or avoid this reality. But you’re stronger than this. It’s time to put on your big boy or big girl pants.
Research like an archaeologist. Dig up the real numbers. Find out what you are honestly spending in each category of spending. By the way, this step requires you to be as honest with your self as possible. An example of some Expense categories are:
- Utilities
- Housing
- Healthcare
- Insurance
- Food
- Property taxes
- Transportation
- Gas
- Debt payments
- Entertainment
- Saving
- Travel expenses
- Car payment
- Cellphone
- Mortgage
- Pets
- Retirement
- Clothing
- Emergency fund
- Gifts
- HOA fees
- Memberships and subscriptions
- Oil change
- Cable
Find out exactly what you spend in these areas. Even if you just write this stuff on a napkin, you have a budget. Obviously, dealing with us, you’ll have a more sophisticated budget.
The Most Important Part Of Creating A Budget
Finally, the most important part of your budget is finding out what is left over after your income has gone through the meat grinder of your expenses.
In my opinion, this is the reason for doing everything. Tracking you’re spending is no fun. Going into your statement i.e. the crime scene of your spending is no fun, either.
It’s all worth it when do you finally discover how much money you have to contribute to your wealth building.
Conclusion
We learned about the purpose of a budget, it’s benefits, and how to create one. I hope you all agree with all of the benefits explained in this article.
If you don’t already have a budget, create one. Your future Financial Freedom will thank you for it. What stage of the budget are you at right now?
