In the previous section we discussed How Saving Money Works and What it Will Afford You. If you have done this and have established a habit of saving you have begun the process of creating a personal budget that will give you freedom, flexibility, and peace of mind.
Having a plan is essential and establishing/sticking to a budget is nothing more than following your plan. This becomes much easier when you know why you are going through the trouble.
What Is the End Goal of Following a Budget?
A budget does nothing more than allocate funds for specific purposes. They can be granular and strict, or they can be vague and loose. Circumstance and your end goal will determine how deep you need to define your spending. Someone in retirement is dealing with a much different reality than a student that just started college. Here we have someone with likely a fixed income and a short time horizon vs. someone with no income and an entire career ahead of them. Both can benefit greatly from a budget.
Many government agencies in the US operate off of a budget and work to spend every last cent so they don’t lose funding whereas a bootstrapping startup works from a position of stretching every single penny they can drum up.
The tool of a budget communicates the paths that the moneys will go in order to achieve your financial end goal.
Curiously enough the less money you have the more likely you are to achieve your goal. This is because your “why” and desire is much more focused than someone who doesn’t have to worry about where their next dollar is coming from. In our piece Key Small Business Success Factors we explore this a bit further.
Goal setting for your budget can consist of short-term and long-term Goals. In the case of a startup the goal is to make money, in the case of an individual it could be retirement. It could be as simple as a goal to pay for a family vacation, braces, or a new vehicle. You will likely have a large overarching end game goal and then many subsequent milestone goals along the way.
Why Many People Don’t Follow a Budget
Many people don’t establish or follow a budget for the following reasons:
- They don’t know how to write a budget.
- They don’t see a benefit in a budget.
- A budget feels like a restraint.
For those that don’t know where to start with a budget I can sympathize. It can be daunting to lay out all the transactions and decisions that need to be made around setting up a budget. The front-end effort of this can seem laborious and overwhelming. I have a harder time however with the people that don’t see the benefits of budgeting or who feel like a budget will hurt them. These people simply have not lived on a budget and are allowing fear of an unknown hold them back.
How Do You Write a Personal Budget?
As mentioned earlier, if you have put the effort in establishing a savings you have already taken the first step. Next, we want to outline the other main elements of common personal financial situations. A great place to start is with the 50/30/20 rule.
The 50/30/20 rule simply allocates funds to three main areas. 50 is for 50% or half of your income to go towards your needs. 30 is for 30% of roughly one third of your income to go towards your wants. 20 is for 20% or just under a quarter of your income to go towards savings. Needs would be shelter, food, transportation. Wants would be entertainment. Savings we discussed previously.
So, with a $1,000.00 dollar income we would see the following:
- $500.00 for Needs
- $300.00 for Wants
- $200.00 for Savings
This spread won’t work for every situation but is a great place to start. It allows for a person to take care of their fundamental needs, have some fun, and put money aside for the future.
Benefits Of a Budget
Getting a budget set up will allow you to know in advance if you have the money you need or not. How much can you spend on rent? Well, what do you have available in your budget? Can you afford that nice car? Well, do you have room in your budget? Is the trip you want to take a need or a want? Do you have room in your budget?
A budget will change your spending behavior to align with your end goal. It will bring to light where you historically have been spending money that you didn’t need to spend. It can be quite liberating to find these areas and adjust them to see your financial situation improve. This will have its own effect of encouraging you to stick with your budget further.
How a Budget Frees You
Any time you address change one must address the risk associated with that change. It’s on this principle that I believe people allow their fear to keep them from budgeting. They falsely believe that introducing a budget will hold them back or make them feel stuck. This risk of being held back or feeling stuck is a false assumption.
The truth is failing to plan is planning to fail. Cliché I know but it’s true.
When you start dialing in your spending you begin to find more and more ways to save. By virtue of this you plug the holes in your bucket creating more available funding for any purpose.
A purpose such as that trip you wanted to take but just didn’t have the money for. Or, that purse that was so cute you almost couldn’t say no to. You now have a road map to get to these things without compromising your financial situation. You can make those previously “emotional” buys and feel good about it.
There is much more out there on the theories and practices of budgets, and I would hope you get those questions answered but, in the meantime, do yourself a favor and get a budget started.
Wherever you are on your income journey be sure to check out The Four Stages Of Wealth Creation; From Clueless To Capitalist. We put this together as a guide for those looking to grow their financial acumen and take their next step towards financial independence.