Budgeting

How do you budget for necessities and wants? How do you monitor your spending while building your savings? A guide to making a realistic budget you can follow.

How to Budget

A budget is a plan for how you will use your income each month. Setting a budget can be as simple as creating a spreadsheet with your total income each month and then dividing it into different categories of spending, starting out with your necessities and then your wants. 

The goal of a budget is to create monthly goals for each category of spending and to track those goals. Learning how to follow a budget can take some time, and you need to adjust your budget every few months. To make sure you are setting yourself up for success, use your current spending as a guideline for how much you should allocate for each part of your budget. A useful guideline is the 50-30-20 rule: you should spend 50% of your net income on necessities, 30% on wants, and save the remaining 20%, but these percentages will vary based on your financial situation and goals.

Budgeting for Necessities

Necessities are the things you need to survive, such as housing, food, transportation, childcare. This category also includes your minimum debt payments, the minimum amount you are required to pay towards loans. Try to spend no more than 50% of your net income on necessities. 

Food and transportation can also eat up your budget, but there are ways to limit your spending in these areas. For example, preparing your own food is often less expensive than eating out. Using public transportation usually costs less than leasing or buying a car. Depending on where you live, what your occupation is and how much you earn, your family may have access to subsidized child care.

If necessities are taking up most of your income, consider developing new skills to obtain a higher paying job, moving to a less expensive area, or seeking help from others in your family or community. 

Budgeting for Wants

Wants are things that you purchase each month that you could probably live without but improve your quality of life, such as television subscription services or expensive new clothes. When you are reviewing your expenses and creating your budget, set aside a certain amount of money for wants. Don’t eliminate your wants entirely because drastically reducing your quality of life might make you less motivated to stick to your budget.

For example, Casey spends $300 per month on groceries and $300 per month at restaurants. While food is a necessity, dining out is a want. She decides to reduce her spending on dining out by $100 a month and add $50 to her grocery budget to make up for the meals that she would have paid for in a restaurant. That way, she reduces her overall expenses by $50, but she still can dine out occasionally.

Reducing Spending

One of the main goals of budgeting is to reduce your spending, especially on your wants, so that you can save more money towards your goals. 

There are several ways to identify areas where you could spend less. First, review any subscriptions you pay for on a monthly or annual basis such as streaming services, gym memberships, or even delivery services. Consider how often you use these services. If you notice that you don’t actually use what you’re paying for very often, you could save money by canceling that subscription.

Second, you can identify patterns of overspending and look for ways to reduce your spending in those areas. For example, if you realize you are spending too much on books, you could use your local library instead of purchasing new books.

No-Spend Periods

A no-spend period is a certain period in which you decide to not spend any money on a particular category of spending. It works similar to a diet where you give up a certain kind of unhealthy food for a short period, such as ice cream, but you don’t stop eating it forever. After the no-spend period is over, you can buy products from that category in moderation.  By reducing how often you buy certain products, you can spend less. 

For example, Casey realizes that she spends too much on clothing each month. She designates one month as a no-spend month for clothing and sees how it feels to wear the clothes she already owns. After one month of not buying any new clothes, Casey feels good about her spending, so she extends her no-spend period for a few months. She still allows herself to buy clothes for every new season, but she doesn’t buy as many items overall or spend as much on clothing. 

Mindful spending

To follow your budget successfully, keep it in mind whenever you are spending money. You should review your budget and current spending for the month at least once a week to see if you are staying on track. Practice spending mindfully so that you are not tempted to go over your budget. Spending mindfully means deciding in advance how much you want to spend before you attend an event that involves spending money. If you have a general target in mind, you will be able to keep yourself within your budget. 

When you are shopping online, keep your items in a cart for 24 hours before deciding to purchase them. If that is not possible because there is a special discount, pause before you buy it at least for a few minutes to consider whether you would be buying it if there were not a special deal.

Budget Analysis

At the end of every month, review your budget to determine how well you followed it. 

If you were not able to follow your budget for every category, don’t give up hope. You might have gone under-budget in some categories and over-budget in others, leading you to generally spend the amount of money in your budget. If you find yourself regularly going over budget, consider a no-spend month for certain categories where you try not to spend at all on that category for one month. Also consider adjusting your budget if there are factors out of your control, such as increasing food or energy prices.

When you analyze your budget, one thing you should look for are unexpected expenses. These expenses, such as birthday gifts or auto repair, should become categories you can plan for in your budget in the future, even if they don’t occur every month.

Savings

One area that you should include in your budget is your savings. Ideally, savings should be at least 20% of your net income each month but saving any percentage of your income is useful. Use a savings account to separate the money you are using for your daily living from your savings. Each time you receive income, deposit a certain amount into your savings account. 

It will earn a small amount of interest and create a psychological barrier between you and your money. If you do tap into that account, you will know you are exceeding your budget. If you are paid on a regular basis, you can automate this deposit to “pay yourself” at the beginning of each pay period. If you contribute to a retirement account, you should also count this money as savings in your budget.

Bank Accounts

Right now, you may only have one bank account, a checking account, in which you receive direct deposits of your income. Opening a savings account, or even multiple savings accounts, can help you to reach your budget goals. To help you reach your financial goals, designate different savings accounts for different goals, and once you have transferred savings into them, try to avoid withdrawing money from them if possible.

For example, Casey creates different bank accounts for her different goals. In her checking account, she keeps enough for her monthly expenses. Then every month, when she gets paid, she automatically transfers money into her two savings accounts. In one account, a high-yield savings account that earns a higher interest rate, she keeps her emergency savings. In her other savings account, she saves for her goal of going on vacation for the summer.

Certificates of Deposit

Certificates of Deposits (CDs) are a form of savings that provide higher interest rates. If you deposit money in a CD, you will earn a certain percentage of interest over a period. Most CDs do not allow you to access the funds you deposit until the CDs mature at the end of the period. If you need to withdraw your deposit early, you will lose some or all of the interest. Liquid CDs, on the other hand, allow you to access the money in your CD the entire time it is deposited but usually have lower interest rates.

The main disadvantage of traditional CDs is that they restrict access to your deposit until the CD matures, However, it can be beneficial to put cash that you don’t need immediately in CDs  since they usually offer higher interest rates than regular savings accounts. For example, if you know you are planning to buy a house in a year from now, you could put the money for a down payment in a 12-month CD so that it will gain interest and will be accessible when you are ready to use it.

One strategy to take advantage of the higher interest rates on CDs while not losing access to all of your cash is called CD laddering. CD laddering means opening multiple CD accounts that mature at different times. 

What to do with extra cash flow

If you are spending less than you budgeted, or if you have more income than you expected, instead of spending more, use your extra cash flow towards your goals in the order of most to least important.

For example, Casey earns a bonus at the end of the year. She is tempted to spend it all on gifts for her family, but she decides that she needs to direct most of it towards her financial goals. Her first goal is to increase her emergency savings, so she saves half of her bonus in a high-yield savings account. Her other main goal is to reduce her credit card debt. 

She uses the remaining half of her bonus to pay off most of her remaining credit card balance. While she still wants to buy gifts for her family, she recognizes that she already budgeted for spending on gifts from her regular paycheck.

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