Chapter 2: Why is it important to live on a budget

Does following a budget really make a difference in your financial future?

Have you ever asked yourself, “How can I pay for housing, food, insurance, health care, make my debt payments, and still have fun without running out of money if I make $2,100 a month as my take-home income?

That’s a lot to fit in with a small amount of cash, but there is an answer to make it work.

The solution is to create a budget.

Budgeting allows you to make a plan for your income so there is always enough money for food, bills, and other necessities.

A budget is also an excellent tool for avoiding credit card debt and other toxic debt, and it provides a path for building a savings account and growing any extra money.

Can you answer yes to any of these questions?

1. I feel like I never have enough cash to get to the end of the month.
2. I need to make a higher monthly income to pay all my bills.
3. I wish I had more money to make investment contributions to a retirement plan.
4. Saving money feels impossible.
5. I’ve tried creating a spending plan before and it just didn’t work.
6. I don’t know how to stop spending money on things I don’t need.
7. It feels like I have money problems all the time.
8. I love taking trips but until I gain control of my money it just isn’t possible.
9. It seems like my financial decisions aren’t helping me get rid of my credit card debt.
10. I worry that if something breaks on my vehicle or house I will be in big trouble with how to pay for it.

If you answered yes to at least two of these questions, you are on the road to learning the importance of living on a budget.

Creating a budget helps you keep track of where you are spending every dollar you earn.

Once you start budgeting, you will know exactly where you spend your money and your financial health will significantly improve.

Budgeting helps you:

1. Create realistic goals for both short term and long term expenses
2. Make better financial decisions with your hard-earned cash
3. Improve your finances to prepare for retirement
4. Start investing so your money grows over time
5. Know exactly how much money you have to spend on necessities, wants, emergencies, and savings
6. Have enough money to afford fun activities

What is a budget?

A monthly budget is a specific spending plan for every dollar you make each month.

Budgeting is important to keep you on track; however, it doesn’t guarantee you will reach all your long-term financial goals overnight, but when you follow a budget you will undoubtedly have a lot less financial stress in your life.

Here is an overview of how to get started with your own budget. Each step is covered in detail in the following chapters.

How to budget money

• Figure how much money you make each month
• Decide which budgeting method you want to use
• A simple budget strategy to start with is the 50/30/20 rule
• Keep 50% of your salary to use for needs
• Keep track of your progress
• Use 30% of your income for wants
• Designate 20% of your income to savings and repayment of debts

Understand the budgeting process

Budgeting your money is a simple process, although not necessarily easy. Once you understand how to keep track of your income by using a budget, the importance of budgeting will be clear and likely move to the top of your priority list.

Figure out your after-tax income

If you have a steady salary, the amount of your check is likely your after-tax earnings.

However, if you allow automatic deductions from your paycheck such as health or life insurance, savings, retirement, etc., add up the total of these items and add them back into your income amount to get a true picture of how much you are saving and spending.

If you earn wages from other things such as side hustles, figure out how much that take-home income is by subtracting taxes, business expenses, or other expenses that come out of it.

Pick your budgeting method

The type of budget you pick should meet each of the budgeting criteria:

• It must cover all of your needs (housing, food, etc.)
• It should allow money for some of your wants (fun things you enjoy doing)
• It needs to allow money to be put into savings for emergencies and retirement
• There should be money allocated to pay off debt (credit cards, vehicle loans, etc.)

Examples of types of budget, called the budgeting plan, are the zero-based budget, the envelope system, and the 50/30/20.

Track your progress

Keeping track of how you are doing on your budget is a key factor in your success. There are several things you can do to simplify the process.

Automate your savings

Setting up an automatic deposit to your savings account ensures you will grow your money without having to think about it every month.

If you struggle with following a savings plan, grab a friend to be an accountability partner or join an online group focused on budgeting to help keep you on track.

Revisit your budget as needed

As your daily life changes, you need to change your budget along with it to continue meeting your personal finance goals.

Adjust your budget when your wages or expenses change. Also, it is likely your priorities or what you need to spend each month will change over time, making it necessary to adjust your budget to match.

If sticking to your plan is a challenge, try these budgeting tips to keep you on track.

Frequently asked questions about budgeting

How do you make a budget spreadsheet?

The 50/30/20 budgeting strategy divides your expenses the following way:

• Necessities – 50% of income
• Wants – 30% of income
• Savings and debt payment – 20% of income

How do you keep a budget?

Keeping track of your spending on a regular basis is the key to maintaining a budget. This will give you an accurate picture of where your money is going and help you make a plan where you want it to go.

It’s simple to get started. Here are the steps you need to follow:

1. Use your account statements to pull your expenses and other expenditures

2. Create a category for your expenses

3. Track your spending consistently (daily or weekly at the least)

4. Monitor your budget consistently to be sure it is balanced and you are not spending more than you make

5. Make changes as needed to fit your current situation

How do you figure out a budget?

Look at your overall situation and assess how healthy it is and what changes need to be made to get you to your financial goals.

Pick the budgeting system you want to follow.

The 50/30/20 system is a great place to start because it divides your salary across three major categories:

• 50% – Needs/Necessities
• 30% – Wants/Fun
• 20% – Savings/Debts

Start with a simple budgeting plan

A big reason to follow a budget is that it will provide a path to get the most out of your money. Maximizing your money will allow you to reach financial independence quicker.

The 50/30/20 budget method is popular because it divides your money in a doable and logical way so your money is working for you.

With this plan, approximately 50% of your income is spent on necessities you need to live, 30% is spent on non-necessities, and 20% on savings and lowering your debts owed.

This approach to spending money is simple and straightforward.

Following these principles help to avoid debt, allow room to splurge every now and then, and build savings to pay unanticipated or irregular expenses when they arise, as well as the opportunity to create a happier retirement.

Allow up to 50% of your money for necessities, for example:

• Housing
• Groceries
• Utilities
• Transportation
• Insurance
• Loan payment minimum amount due
• Child care if applicable
• Other expenses required for work or living that are not flexible

What if your essential living expenses are more than 50% of what you earn?

Pull money from the 30% category of fun things until you can fit your necessities into the 50% category without going over.

Leave 30% of your income for wants

Don’t get confused with the difference between wants and needs. It can be a challenge to separate the two!

The best way to understand the difference is that needs are essential for you to live and work. They are not an option.

Wants are not required to live, such as going out to eat, buying gifts, traveling, going to concerts, or other entertainment and activities.

You are the only one that can decide if an expense is a need or a want.

Is a gym membership a need or a want? Do you really need organic food? Personal preferences vary.

If you want to get out of debt as soon as possible, you may choose to put off your wants until you have some savings built up or your bills are easily paid in full each month.

Just keep in mind your budget should not be so tight that you can’t enjoy yourself once in a while.

Allowing a little wiggle room will also keep you on track with your budget if you forget about a bill or a special event comes up you really want to attend.

The purpose of following a budget is to help you, not hinder you or make you feel trapped that you can’t spend money on fun things. Without doing activities you enjoy it is more likely you won’t stay on the plan, so don’t get stuck in this trap!

Set aside 20 percent of your income for savings and debt repayment

Put 20% of your after-tax wages toward unexpected expenses, retirement savings, and debt reduction.

Make sure you look at your entire financial picture, which might need switching back and forth between savings and debt repayment to achieve your most important objectives.

Set your budget priorities

Priority #1: Prepare for emergencies

An emergency can arise at any time and without an emergency fund, it will leave you stressed and in a panic about how to pay it. For example, unexpected vehicle repairs, medical expenses not planned for, house repairs, etc.

Build your emergency fund to $500 as quickly as possible, then continue to grow it to at least $1,000.

It is also important to understand what a true emergency is, and if the situation is not a true emergency, this money should not be touched.

If you accrue more debt every time something happens you didn’t expect, you will never get out of debt. Your emergency fund will help you to avoid more debt, and it will also give you peace of mind knowing there is a small cushion of money if you need it.

Priority #2: Get your employer to match 401(k) contributions (or look for one that will)

Check with your employer and ask if they offer a 401(k) match. What this means is the amount of money you put in your 401(k) your employer puts that much into it as well.

Employers that offer this option typically have a maximum of around 3-5% they will contribute. Whatever the amount, it is free money so don’t pass it up! Contribute the amount up to their match.

Why does capturing an employer match take precedence over paying off debts?

Because you won’t get opportunities like this every day to earn free money, tax advantages, and compounding interest. Also, establishing this savings habit will help you establish the importance of saving to build wealth faster.

Priority #3: Get rid of toxic debt

Your next focus is to eliminate the toxic debt that hangs over you and holds you back from reaching financial goals. Examples:

• High-interest credit cards
• Personal loans
• Title loans (vehicles, boats, etc.)
• Payday loans
• Rent-to-own payments

Getting rid of these debts will make a significant positive impact on your financial situation because these types of debt charge high interest rates. In fact, typically you will end up paying two or three times the amount of money you borrowed if they are not paid off early.

If you struggle to make the minimum payment requirements on your unsecured debts such as credit cards, personal loans, or medical bills and don’t see your income increasing, investigate options of debt relief such as enrolling in a debt management plan or filing for bankruptcy.

Another reason to seek debt assistance is if the total amount of your unsecured debt is equal to half or more than half of your gross income.

Priority #4: Save money for retirement

After you have eliminated the toxic debt, the next priority is to create a plan to save money for retirement.

Getting on track for a solid financial future is an exciting endeavor that shows you are working hard on getting your financial life in order!

The goal to shoot for is to save 15% of your gross income, including your employer match (if it is available – see priority #1).

Once you are adding the necessary amount in your 401(k) to meet your company match, consider adding money to a Roth individual retirement account. When you reach the maximum limit on the IRA, start adding additional funds to your 401(k).

Priority #5: Build your emergency fund

Earlier we recommended you get $500 in your emergency fund as quickly as possible, then build it to $1,000.

This is a small amount that can only handle a small emergency. However, in the event of something unexpected happening that is more impactful in your life, such as losing a job or needing to provide constant care for an ill family member, you need to be prepared.

The goal is to build this account to six months of living expenses so you are prepared if the worst were to happen and would be able to carry on with your life until you could get back to a steady income.

Priority #6: Pay off other debt

You tackled your toxic debt in priority #3, but what about your other debt, such as a mortgage or government-issued student loan?

Debts that have lower interest rates and are often tax-deductible belong at this priority level.

You have done an excellent job managing your money and getting your financial state in tip-top shape by meeting the other priorities. Now you’re ready to take on the last of your debt obligations.

This money needs to come from your wants budget category or possibly from the general savings budget category. You should never use your emergency fund or retirement savings to pay off debt.

You did it!

Awesome job! You have built an emergency fund, eliminated your toxic debt and bad spending habits, and you are consistently saving 15% of your income building a nest egg for the retirement years.

You’ve formed a consistent habit of saving, which provides you with significant financial freedom.

How does it feel?

Do you feel ready to keep going?

The next step is to put cash aside for items like a new roof or your next automobile.

Those costs are pretty much guaranteed to come up at some point, and it’s better to save for them and pay with cash than to borrow money that will have interest attached.

Make sure you look at your entire financial picture, which might need switching back and forth between savings and debt repayment to achieve your most important objectives.

5. Go one step further and use cash only

If overspending your money is a constant mental fight with yourself, a cash-only system of spending may be the answer to get over the hump.

Parting with cash as you place your hands on it and pass it to someone else creates emotional feelings that do not happen when we hand over a piece of plastic.

If you make the switch to a cash-only system, remember this also includes your debit card. Leave it at home with your credit cards.

Solution:

• Set up a system to monitor your cash, the envelope system works well
  • Create a way to track receipts
  • Set up the time you will get your cash, weekly or monthly
  • Plan before you go shopping so you know how much cash to take

6. Don’t try to keep up with your friends

For many people, one of the hardest challenges in sticking to a budget is telling their friends or family they can’t join them for a night out at the movies or to turn down an invitation at a new restaurant in town.

If might be your friends don’t follow a budget and don’t see why it is important, or they can have a higher income or fewer expenses than you.

Solution:

• Let your friends know you are following a budget right away, so they know before they ever ask you to join them
• Plan activities that cost little and invite them so you can still spend time together, such as a picnic at the park or backyard bbq

7. Delay purchases outside of general living expenses

This is typically known as impulse buying, one of the biggest enemies of budgeting.

An impulse purchase can be something small like stopping at the coffee shop on the first floor of your office building or a much larger purchase.

Either way, impulse buying can throw your budget out of whack very quickly.

Solution:

• Allocate a set amount of money each week or month for your typical impulse purchases, such as coffee or donuts in the morning, and when the money is gone there are no exceptions to adding to the amount
• For larger purchases, set a time limit for making the purchase, such as a few days or a week.

8. Take your budget seriously

If you are serious about getting your finances in control, you must be serious about following a budget plan.

If you don’t have a reason to start and follow a budget, you likely won’t be motivated to stay on track.

Solution:

• Define your financial goals before you start
  • You are more likely to reach your goals when you take small steps at a time and track each step as a milestone
• Pick goals that inspire you so you want to achieve them

9. Don’t create an unrealistic budget

If your budget is not realistic, you are setting yourself up for failure before you even get started.

Don’t let this happen to you.

I get it. It is hard to look at your income, then compare it with the money you are spending each month.

But you have to be realistic with your spending to move forward.

Otherwise, you will continue to overspend your budget and in one, two, three years and later, you will be in the same situation you’re in now.

Solution:

• Don’t stop with your budget, take it a step farther and track your spending every single day for as many weeks or months as necessary to see where your money is really going
• Face the truth and if you are spending more money than you make, adjust your expenses or get a side hustle for more income

10. Your budget is too restricting

Accuracy is important for a budget to work, especially if overspending is a challenge.

However, if your budget doesn’t include any wiggle room for fun and activities you enjoy, it is highly unlikely you will be willing to stick to it.

Solution:

• Without overdoing it, set aside money for activities you enjoy

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