The thought of budgeting doesn’t need to strike fear in your heart. Think of it as a blueprint for building your future peace of mind. Even for those with low income, financial security is attainable, and sound, realistic budgeting is essential. Every household can benefit from using the 50/30/20 strategy.
Every household should know how to budget. Determining your income, defining your expenses, and planning for tomorrow will ease much of the anxiety involved in budgeting. The 50/30/20 rule is a generally accepted, simple method of gaining control of your finances.
In the same way that successful businesses monitor income and expenses, profit, and loss, you can easily take control of budgetary concerns. Whether you use a spreadsheet or notebook, the first thing to do is figure out exactly how much money is coming into your household and precisely where it is going out. This will enable you to more efficiently control the flow and prepare you for emergencies.
How to Budget Money
Budgeting applies to everyone. It doesn’t matter if you are a teenager with your first job or a senior looking forward to retirement (or anyone in between); your life will improve with a plan for managing your resources.
Step 1: Calculating your monthly income is the first step in setting up your budget. Look to your paycheck stubs to figure out how much of your earnings make it into your bank account. This is the net income, or “take-home” pay because it is the amount you take home. Gross pay is the amount received before taxes or deductions.
The Internal Revenue Service uses this number to determine your annual income. Even though gross pay includes money that you do not receive, it is also used to assess home mortgages and car loans eligibility. In reality, net income is pretty much the figure you have control over.
Many websites offer a free income calculator, so if math isn’t your best subject, you can quickly determine gross and net income with a few quick entries.
Step 2: If you prefer the old fashioned way, you can compute your disposable income by multiplying your weekly pay by 4.3% to arrive at your monthly income. It is used by accountants and bookkeepers and takes into account that there are more than four weeks in each month since there are 13 weeks in every quarter.
For those who receive pay every two weeks, multiply by 2.17%. A simple method of calculation is to just add up the net pay listed on your check stubs, or even easier, use the final one for the year, which is listed as “Year-to-date.”
Step 3: The next task will be arriving at the total of your spending. Track expenses, save receipts, and you will soon be able to see your spending habits and trends.
The 50/30/20 Rule
This strategy offers a guideline to how much you ideally should be spending on three main categories. In a nutshell, these are needs, wants, and savings. Developed by US Senator and former law professor Elizabeth Warren and detailed in her book “All Your Worth. (The ultimate lifetime money plan.)” This rule offers a simple way to gain control of your finances and applies to everyone who has any type of income, from earnings to pensions and retirement.
50% of your resources should Housing, utilities, food, and transportation go in this section. At half of your total income, this one is critically important. Also included would be childcare, loans and car payments, credit card payments, medicines, and prescriptions.
30% goes to luxuries and conveniences. Entertainment, dining out, and vacations fall under this category. Consider this category as the things you can do without, such as gym memberships, cable television, and cellular telephone plans. Any reductions you can manage from this part goes to the savings category.
20% is to be used for a variety of things. Savings, retirement, and extra payments on high-interest debts are in this portion. This is your “get ahead” area and can be used for an emergency fund for the future as well as actual savings in a regular savings account or a 401k.
Understanding the Budgeting Process
Simply put, a budget is a tool to ensure future income and spending are in line, preventing a crisis when unexpected costs arise, such as car repairs or insurance deductibles. You will feel much more confident building wealth and not living paycheck to paycheck. You can do it!
Don’t be intimidated by the vastness of the subject. It’s merely a list of how much money you make, minus how much money you spend. What could be easier? The trick to effective budgeting is to keep it simple but be consistent.
No matter what style of budget you decide upon, remember that each household will be different. Customize yours to fit. Perhaps you live in a high rent neighborhood, and your housing is more than average, or you live in a cold climate where your heating costs fluctuate, or maybe the sunny south where you pay a bigger cooling bill. Your circumstances could dictate a plan closer to 60/20/20, possibly a different method altogether. The main goal is to understand your finances better to be more prepared for things to come.
Once your budget is in place, you will want to keep good records so that you can go back and check your progress. After a few months, revisit the details. Maybe you forgot something that doesn’t happen every month, or you had unexpected repairs or maintenance.
Adjust amounts as needed, and consider ways to conserve. The only thing you have control over is your outgo since most people’s income is relatively fixed.
The Guide to the 50/30/20 Budget
According to this method, 50%, or half, of your disposable income ( the portion you receive after withholding taxes, social security, and Medicare are deducted from your pay) is devoted to the essentials. A place to live, heating and cooling expenses, groceries, and transportation mode top the list.
This group includes items such as childcare, car insurance, auto loans, gas and maintenance, or carfare and public transportation. Young college students could have student loans. If you have older children, you may be paying for sports fees, school clothes, and supplies.
Empty nesters may find themselves paying Home Owners Association fees, property taxes, or health and life insurance premiums. Whatever your circumstances, the ratio will be about the same.
30% of your money is suggested for any money you spend that is unnecessary for survival, the things we desire but don’t have to have. Dining out (and even daily lunches or fancy coffees), plus entertainment, concerts, and even movies, going to clubs and gym memberships fall into this category. You have a little wiggle room in this section. If your housing eats up more of your 50%, additional funds would logically come from here. Alternatively, any excess would roll over to your savings.
The final 20% is your debt repayment/savings/get ahead fund. Pay a little extra on your loans, credit card debt, and high-interest obligations. Contribute to a 401k plan if it should be available at your workplace.
A 401k is a great way to save for your future needs because your employer matches the amount you put in, virtually doubling your investment. (A 401k can also be a bit of a risk, so be sure to consult your financial expert for advice before jumping in.) Last but not least, whatever is left after your obligations should be regarded as your fun money. Treat yourself to a new outfit or a trip to the nail salon.
Alternate Methods of Budgeting
The Zero-Sum. This strategy involves allocating each dollar to an expense account. Much like a financial statement, with its debits and credits, your total income equals your total expenditures using the zero-sum method.
Create several reports to cover all the things you spend money on, and record how much each one is consuming. If you do so, you will be able to determine where you can make savings or improve spending power.
Envelope Budgeting. The method of tracking your bills is basic but quite useful for some households, especially for young people just beginning their careers. Cash is placed in marked envelopes when using this method. Rent, the electric bill, grocery money are all designated separately.
The reasoning behind the use of cash has to do with the visual of spending real money, as opposed to swiping your debit card for each purchase. We might become accustomed to the ease of using a credit card or debit card and overlook how much things really cost.
The Anti-Budget Method– for those that truly hate budgeting, but still wish to be fiscally responsible.
The Benefits of a Budget
1A financial plan can enable you to afford big-ticket items like new appliances, furniture, a new vehicle, or a vacation.
2Whether you are moving into your first apartment or your dream home, you will need to save up for a security deposit or a down payment.
3Reduce your spending by sticking to a budget and give your family a cushion in case of emergencies.
4Improve your credit score by reducing your debt. Many companies base your interest rate on your credit score. Even automobile insurance premiums are determined by how much debt you carry.
5Eliminate the stress and worry of unmanageable obligations when you pay off loans and credit cards. Break the paycheck to paycheck merry go round and gain some peace of mind.
Review your progress
1After about six months, examine your financial situation but try not to expect a miracle. It took time to get into the situation you may find yourself in, and it will take some time to change it.
2Adjust accounts where needed. By reducing pleasure spending, you can devote more of your funds to your budget’s savings portion. Consider an automatic transfer from your primary checking account to interest-bearing savings plans regularly, perhaps monthly.
3Remember that each family will have unique circumstances depending on where you live, your family’s size, and your place in the workforce. No two households are alike, and no two budgets are the same. There is no “one size fits all.”
When to get help
The time to call an expert is before you are in dire straits. Don’t wait until the mortgage is in foreclosure or your car is in danger of being repossessed. When you find yourself in the hole, it is time to stop digging. There is no shame in admitting when things are getting out of control. Contact your financial institution for guidance and recommendations.
Don’t give up
A healthy budget will enable you to be better prepared to face the unexpected. The benefits include increasing your spending power and allowing you to sleep better at night.