6 second take: We often overestimate the efficacy of good budgeting. Here’s a refresher on what every personal financial plan should accomplish.
Budgeting is a fundamental financial planning practice. Without a budget, it is hard to manage other aspects of personal finance including credit, insurance, saving, investing, and achieving goals such as a new car or a comfortable retirement. Financial goals cannot be reached if there is no money set aside for them.
Research conducted by the American Association of Family and Consumer Sciences has also found that budgeting has been found to be associated with the performance of positive health and financial practices.
People who budget their money may be inclined to “budget” their calories and self-restrict their food consumption and/or adjust their physical activity to stay within their daily calorie “allowance.”
Below are 10 things to know about budgeting:
Positive Cash Flow Is the Goal
A budget is a plan for future income and expenses, including savings. The goal is positive cash flow, i.e., income greater than spending. Ideally, a budget has specific categories of income and spending as well as dollar amounts rather than loose, amorphous numbers.
Individual Factors Are Important
Examples include individual needs and wants, whether you have a stable income (the same amount in each paycheck) or a variable income that fluctuates every month, and whether you prefer to use a “paper and pencil” worksheet, an Excel spreadsheet, or a budgeting app.
Savings Is a Fixed Expense
How much you need to save per month or per paycheck to fund future goals should be set aside as a fixed expense that stays the same from month to month in a budget. A general online financial goal-setting calculator can determine the correct amount to save.
There are also specialized calculators for specific financial goals such as educational expenses and retirement.
Budgeting Methods Vary
Many people use the same budget format from year to year, adjusting for changes in income and expenses.
For example, twice a year, I project income and expenses for the next six months and work in irregular income and expenses.
What matters most is that you have a budget, not how you budget.
COVID-19 Impacted Budget Priorities
Because of the ongoing pandemic, many people are working less (or not at all) and are struggling to make ends meet. Others have earned as much or more than they did pre-COVID-19 and/or are saving more money due to decreased spending.
Not surprisingly, there is increased interest in beefing up emergency funds.
Unexpected Expenses Always Occur
It is not a question of “if” but “when” unexpected expenses will happen. For this reason, financial experts recommend including a “fudge factor” dollar amount (aka, a “miscellaneous budget category) in household budgets. If the money is not needed, it can be rolled over into savings.
Expenses Can Be Trimmed
Experts recommend starting with flexible expenses such as heating/cooling, subscriptions, streaming fees, food, and memberships.
Also, look for less expensive shopping options (e.g., thrift shops), cook more often (and order takeout less frequently), and consider ways to reduce fixed expenses such as refinancing a home mortgage, moving to a less expensive apartment, driving a cheaper car, and shopping around for insurance policy discounts.
Income May Be Able to Increase
Options include increasing human capital through degree and certification programs, “leaning in” (i.e., asserting oneself professionally) to get promoted, and/or starting a “side hustle” or getting a second job as long as it does not violate your primary employer’s outside employment rules.
Benefits Can Supplement Income
People who are struggling financially can receive public benefits (e.g., utility assistance or food from a food bank), if their income qualifies. This frees up funds for other expenses.
Other ways to increase income are to barter goods and services in lieu of spending cash and to sell unneeded items.
Budgets Affect Credit Scores
A budget can prevent negative credit report data by including funds to repay debt as a fixed expense. Also, if followed, a budget can help avoid overspending on credit, which reduces a credit cardholders’ credit utilization ratio, worth about 30 percent of a FICO credit score.
Finally, a budget can include funds to build an emergency fund so people are less likely to use credit when emergencies happen.
To start creating your own personal budget, track your income and expenses for a month or two to get accurate data.
Additionally, you can use this Spending Plan Worksheet from Rutgers Cooperative Extension.
