Making budgets aren’t easy or fun, at least not at first, – you need one of the budgeting methods to guide you. People normally use budget systems when saving for a large purchase or just trying to pay down debt. Either way, it’s best to have a plan to accomplish your goals. But, it’s also important to keep track of expenses and know where your money is going. Once you change your mindset you might find yourself a little addicted to planning and budgeting.
Instead of thinking of a budget as a burden or hindering your freedom, think of a budget as a way to achieve success. As long as you budget correctly and start saving (and/or investing) in the right things budgeting will lead you to financial success.
Five (5) Reasons People Budget
- To gaining control of your finance and spend according to priorities. Your budget should be a financial road map that guides you to your destination. When you do your budget if you realize you are spending $400 a month on eating out and $300 on groceries. If able, you might want to cut back and redirect some of the money spent on food to other things. Instead of spending, that much money on eating out, perhaps cooking at home would is a better move.
- Budgeting will help you achieve goals/plan for retirement. Achieving financial goals like paying off school loans or paying off a car before the financing period is over. If you want to take several vacations every year, planning for these trips is essential.
- Budgets help keep you honest/ and help build wealth. Saving alone will not get you rich. You will definitely want to invest some money as well. If you have an honest budget and see you are spending excessive amounts eating out – stop that activity. Start out by putting half into a retirement account such as a 401k or IRA. If you already investing on both of these you don’t have to rely solely on those two account. There is a big world of investments out there, like forex.
- Budgeting helps you improve habits and gives you peace of mind. Once you have a good budget in place, making decisions should be easier. Should you buy that flat screen TV or should you put that money aside for an emergency fund? Maybe you’re emergency fund is already in place. Nut, the budget can still help forecast what major purchases will do to your bottom line
- Budgeting helps you avoid debt, improve credit and reach financial goals. Having a good budget will help you understand how much in debt you are or how close you are to being in debt. If you are currently living paycheck to paycheck having a strong budget will help transition out of that state.
The Envelope System
The envelope system is fairly simple and is great for people who like to use cash. When you make different categories, put the budgeted amount of money in that envelope. For example, if you decide your grocery budget is $500 and your entertainment budget is $400 have an envelope for each and put the money in it. Whenever you go grocery shopping take that envelope and use only that money. Put any change back in the envelope. When you are out of money in the respective envelope then that’s it for the month – no more spending. But, if you have extra then it carries over to the next month.
If you don’t want to use actual envelopes there is app for the envelope budget system, called Goodbudget. Goodbudget is free for up to 10 virtual envelopes. After that the cost is relatively cheap at $5 a month or $45 for the year. This system operates the same as actual envelops, but the app creates a virtual environment.
This budgeting system can be the most beneficial to some people. The goal of this budget is to have zero at the end of every month. Zero-sum budgeting forces you to spend every dollar you make, but not in a bad way. You want to make every dollar work for you and have a specific purpose.
When you have a zero-sum budget, everything is put into a category. You will allocate money to go to savings, paying off debt, paying bills, entertainment and so on. You will always know exactly how much you spend in each category. One main aspect of a good zero-sum budget is to use last month’s income to pay the current month’s bills. This means you will have a good cushion in case of an emergency starting off.
The extra money not spent needs to go toward something such as paying off a credit card, a car or mortgage. At the very least, you can put extra money into a savings account. If you feel comfortable with your savings and debt payments, there are tons of investment opportunities for you to choose from. Are you fully funding an IRA or a 401k? If you are, then maybe you are ready to move into other investment opportunities.
The 60% Budget
The 60% budget is popular because you use rations rather than categories to manage your money. Instead of create a several categories for debt or specific bills, you split your money by 60/40. The first 60% of your income accounts for all your living expenses. The next 40% is further broken down into four (4) simple categories.
The first 10% of your income goes to retirement savings. A second 10% goes to long term savings. The third 10% goes to short term savings. The final 10% goes to anything you want.
If you want to put a slight spin on this solution, try to put the other 40% to one thing instead of further categorizing. If you want to buy a car, put the entire 40% to that. You want to buy a house – great! Save the money towards that purchase.
The 50/30/20 Rule
This is a very simplistic rule to follow. It is very high level compared to some of the budgeting systems and techniques used. However, once you start with these main categories you can get more granular with the budgeting later. The 50/20/30 or 50/30/20 it doesn’t matter how you write it, the rule creates these categories:
- Essential Expenses (Needs) – 50%
- Lifestyle Expenses (Wants) – 30%
- Financial Expenses (Savings/Retirement/Debt) – 20%
Essential expenses are living expenses such as; housing, health insurance, utilities, car payment, insurance and groceries. This is pretty straight forward in that respect. However, essential expenses can expand if you already have debt that requires a minimum payment. You should not try to do anything that jeopardizes your credit score. Therefore, if you have credit card or loan payments then minimum payment becomes a need.
Lifestyle expenses can sometimes get confused with essential expenses. Yes you need groceries, but do you need the beer you buy at the grocery store? A car payment is a need, but do you need a new 2017 Cadillac or can you buy a used Civic or Hyundai? If you can avoid it, make sure you do not affect (or increase) your essential expenses because of a lifestyle choice. This is especially important if you are working on tight budget or have specific goals in mind.
Financial expenses can vary depending on your situation. If you have left over income then you can save this portion. If you have debt, you would likely use this income to pay that debt down. Do not confuse this category with lifestyle choices or even some essential expenses. For example, if you have a credit card payment and the minimum payment is $35 a month that’s a need. If you decide you are paying $70 instead then half of that payment is financial expense.
A Real Life Example of the 50/30/20 Rule
The purpose of the following example is to show how the system is set up. This will not work out for everyone because no family situation is the same. One of the goals of Realty101blog is to help you purchase home. So, let’s look at a real life example of how the 50/30/20 rule helps you out in more ways than one. If you do already have a home, the skills here will still apply because you still have rent or mortgage payments. If you have no living expenses, the skills will still help you budget.
This example will expand on/add to the example given on the No Money for a Mortgage Payment page. This example uses a person making the federal minimum wage for covered nonexempt employees of 7.25 an hour. But, there are a couple of differences in the two scenarios.
First, an entire budget on the 50/30/20 while making $7.25 an hour is very difficult. That fact is not lost in this article. Although one person making $7.25 could survive off some very frugal living – it is difficult to pull off. This is especially true when you add the mandatory healthcare cost, which is not included in the budget below.
Let’s look at this income on a simple budget sheet, as shown here, and discuss the breakdown of the monthly income. The person here makes $914.54 a month after taxes – this is a tight budget.
As discussed in the No Money for a Mortgage Payment article, this person has a mortgage payment of $338.00 a month – which is cheaper than rent in most place. Even with the cheaper mortgage it doesn’t help much. Very quickly we can see there is not much room for much else. If two people come together, this is definitely possible; still tough, but a much better scenario.
Let’s look at someone making $36,000 a year, on a bi-weekly pay schedule – again in Georgia.
A single person making $36,000 a year brings home approximately 2032.70 per month after federal and GA state taxes. Sticking to the 50/30/20 rule, the breakdown is as follows:
- Essential Expenses (Needs) – 50% is $1031.35
- Lifestyle Expenses (Wants) – 30% is $618.81
- Financial Expenses (Savings/Retirement/Debt) – 20% is $412.54
As we saw from No Money for a Mortgage Payment purchasing a $50,000 condo is about $340 a month. Since this person is making $36,000 – let’s increase the mortgage payment to $400 a month. There is still $631.35 left of your 50% for a car payment $125, health insurance $210, groceries $180, and utilities $110.
Additionally, your lifestyle expense budget is 618.81 which can include anything from movies, shopping or coffee. Maybe you are saver, so instead of using the full 30% you put extra towards retirement.
Finally, you have $412.54 for loan payments $175 and savings of any kind – even vacation accounts $75, retirement funds (401k or IRA’s) $185.
The Purpose of This Article
The purpose of this article is to show you what’s possible. Hopefully you can employ some of these methods in your budgeting. Because everyone’s situation is different, none of these strategies may work for you. But, the worst thing you can do is nothing. If you are having trouble keeping up with payments, seek debt counseling before things get out of hand. It is much easier to handle a situation before you get behind on your payments and your credit is hurt.