Personal Finance – Importance of budgeting
Budgeting is one of the key tools of personal finance. It’s a pivotal tool to control your money. It helps you control expenses, pay off debt, and eventually lead you to invest excess money.
Many people find it hard to set the right tone with budgeting. Some think of it as a restrictive measure, others may not foresee any benefits attached to it. However, budgeting is an essential part of personal finance.
Budgeting doesn’t only create discipline in your financial life, it also lets you make better financial decisions. When done properly, you’ll be able to prepare for emergencies, save money, pay off debt, and start investing.
What is Budgeting?
Budgeting is the process of assessing your income and expenses. It is a formal plan to help you manage your money.
Budgeting is the estimation of expected income against expenses. However, you can use budgets to manage and control your money. It can help you spend money wisely and create a cushion for savings and investments.
Unlike the common notion, budgeting is not only a restrictive measure. It can be used to develop a financial plan that leads you to achieve personal financial goals. These goals can be paying off debt, buying a new house, or retirement planning.
So, how do you choose the right budgeting plan? And how can you create a budget?
Budgeting Strategies – How to Choose the Right Budget Plan for You?
Personal finance presents unique scenarios to every individual. So does the budgeting, it’s different for every individual and family. You can’t adopt a budgeting plan just because it worked for someone else. There is no one-fits-all formula when it comes to choosing budgeting strategies.
There are a few tried and tested budgeting strategies. You’ll need to assess your finances and spending habits to choose the right one. You may adopt one to see if it works well for you. If not, you can choose the other one. Remember, budgeting requires a consistent approach for a longer period.
It is one of the most widely used budgeting strategies around the world. In this approach, you’ll first estimate your total income. Then, you’ll categorise your income into three categories of necessities, wants, and savings.
In this approach, you’ll spend 50% of your income on necessities or essential expenses. These are the expenses that you cannot avoid for living. Next, you’ll spend 30% of your income on your wants or discretionary expenses. These are the expenses that you can avoid but want to spend on to make life easier for you.
Finally, you’ll set aside 20% of your income for savings. If you have any high-interest debt, you can contribute a portion of it to pay off debts faster.
A zero-budget approach means there should be a wise use of every dollar you earn. In other words, you’ll track every dollar of your income and record it to know where your money is spent.
This approach will make you spend wisely. You can create different categories and allocate your income accordingly. This approach gives you control over your spending habits.
Envelope budgeting is a traditional budgeting tool. You make an estimate of your total expected income first. Then, you set aside cash for each spending category, in envelopes. It seems an old-fashioned technique but it works wonders for budgetary controls.
Envelope budgeting is simply creating spending categories including one for savings. You should aim to create as many categories as possible. You must stick to the budget created for each category to gain control over overspending habits.
Choosing a budgeting strategy is only the primary step in creating effective budgets. Next, you’ll need to learn the art of creating a budget that works for you.
How to Create a Budget? Step-by-step Guide
Creating a budget starts with an assessment of your personal finances. You’ll need to make estimates of your income and expenses. Then, you’ll create a plan to spend, save, and invest the money.
Step 01: Estimate your Income
Estimating your income doesn’t mean listing your existing sources only. It means you should find out ways to create stable income sources. Be realistic in your approach as you wouldn’t find additional income sources quickly.
Your income sources should include every payslip you receive including child support, social security, and dividends. If you do not have a monthly income stream, take an average of your last 12 months’ income.
Step 02: Estimate your Expenses
Just as you listed every possible income stream, you should list every expense you incur. These expenses must include your personal, family, and other expenses.
For simplicity, begin with the essential monthly expenses such as rent, utilities, groceries, mortgage, and credit card payments. You can then add other expenses such as luxury shopping, travel, and entertainment expenses.
Make sure to add a cushion of emergency funds here.
Step 03: Categorise your Expenses
It is important to prioritise your expenses. You should create at least three broader categories of expenses as essential needs, wants, and savings.
You can set aside your monthly income for each category in proportion. For instance, as we discussed above in a 50-30-20 budgeting approach. Else, you can create several expense categories and set aside cash for each category.
Step 04: Track your Spending
Budgeting is all about creating financial controls. One way of achieving these controls is to track your spending. Once you develop the habit of tracking spending, you’ll bring control. It will help you to achieve budgetary control and financial goals.
Step 05: Adjust your goals
Personal budgets will always show variance in results, especially when you’ve just started. It’s time to go back to the drawing board again. You should look for places to cut expenses.
Ideally, you’ll need to set a financial objective first. For instance, to repay a high-interest credit card bill in 6 months. For that, you’ll need to cut some expenses such as dining out, luxury shopping, or switching to a cheaper insurance plan.
Step 06: Review and Revise your Budget
Finally, you’ll need to review your budget performance over a set period. If you didn’t succeed at first, you should try another budget system. The key here is to never give up. Budgetary controls take time to achieve results.
Importance of Budgeting
So, you have learned to budget with different budgeting strategies. But, why are budgets so important in personal finance? Probably, you’ve heard the same advice from every financial advisor; follow budgets.
If you have not yet started budgeting, you have missed on great financial achievements. Unlike the misconception, budgets help you achieve financial freedom, not restriction.
Here are a few key reasons to follow budgets in personal finance.
Budgets Help you Achieve Financial Goals
You create budgets to achieve financial goals. You can set a specific financial goal for a set period. For instance, you want to save money for a house mortgage down payment. Budgets help you keep an eye on your financial goals.
Financial goal realisation starts with budgetary controls. Once you start spending wisely, you’ll move closer to achieving financial success.
Budgets Bring you Control over Overspending
Without budgets, you’ll always spend money where you never intended. Budgets help you gain control over overspending habits. As you follow a strict spending plan, there is little room for unplanned spending.
At the same time, budgets give you flexibility as well. You can choose to spend money on your chosen categories. The point is to stick within your means and don’t overspend.
Budgeting Help you Get out of Debt
Debts are an inevitable part of our lives. Getting out of toxic debt can be a challenging task for many. Budgets are one of the key tools to get out of debt. Once you start spending money wisely, you’ll rely less on new debts. It will eventually lead you to pay off existing loans faster.
Budgeting Lets You Save Money
Everyone wants to save money. Someone wants to save money for emergencies, some for investments and others for retirement planning. You cannot achieve financial freedom without savings.
Budgets are essential tools to achieve long-term savings. You can commit to saving money out of your monthly income but you’ll hardly achieve effective results. That’s because you aren’t controlling your spending habits.
Budgets challenge your spending habits. Thus, giving you more control over your spending habits. In turn, you bring savings with a predetermined goal.
Budgeting Lets You Invest Money
Investing is one of the pivotal parts of wealth building. If you cannot meet ends with limited resources, it will be hard for you to invest money. Budgeting lets you invest money through controlling expenses and savings.
You can accumulate savings over time with monthly budgeting. If you want to achieve financial freedom, you must invest these savings wisely. Your investment plan will also depend on your financial goals. For instance, if you want to invest in retirement planning, you must invest in capital market instruments such as bonds or real estate for the long term.
In a nutshell, savings and investing money are directly connected with your budgeting. If you’re successful in achieving effective budgetary controls, you’ll be able to save and invest your money.
Budgeting is all about developing financial habits. You may find it hard to adapt to budgeting but it is one of the most effective tools to achieve financial success. You can choose any budgeting system and experiment. The key to success is to keep trying until you succeed.
Budgets are important to achieve savings and investment objectives as well. Once you start saving money, you can put it into investment. You can invest that money for short-term financial gains such as in stocks or long-term investments such as bonds or real estate.