A budget is telling your money where to go instead of wondering where it went. —Dave Ramsey, financial author
By the end of this section, you will be able to:
Define budget strategies
Explore the pros and cons of budgeting
Create a personal budget
Without a personal budget, most people have a hard time gauging how much money they spend and where their money goes. If you have ever gone to an ATM to withdraw money and been surprised to discover how little you had left in your account, this section is for you. It's also for anyone who wants to learn how to manage their money better and smarter—which is an invaluable skill to have during the penny-pinching years of college but also later on in life.
Even if you're very conscientious about paying your bills on time and generally have frugal spending habits, creating and following a budget can put so much further ahead. In essence, a budget is a plan for how you want to spend money. It details how much money comes in each month and how much you've allocated for spending on each thing. The virtue of a budget is that it puts you in control of financial decisions—so you can avoid surprises at the ATM machine or at the end of the month. Let’s look at some strategies for creating a budget:
Be realistic: People are often intimidated by budgets because they’re afraid the plans will be too strict or force them to cut back too much. Though a budget may reveal that you indeed spend a lot of money on clothes, that's okay—it may just also need to show that you spend very little on restaurants and eating out to make up for it. Again, it's about making choices and being realistic.
Choose a time line: Creating a budget for a fixed period of time will help you monitor whether you’re meeting your financial goals. The time line you choose is up to you and your goals. For example, you might create a monthly budget to monitor how you spend your paycheck every month.
Add financial padding: Even if you feel like your list of financial obligations is already long, try to set aside a certain amount each month for a "rainy day" fund—to pay for unforeseen expenses and emergencies, like car repair, lost textbooks, etc.
Make adjustments as needed: While sticking to your budget is important, there’s nothing wrong with revisiting and adjusting your original targets. For example, if you find that you are actually spending $50 more per month on groceries than you intended (even after shopping for sale items), you may decide to save that money elsewhere in your budget next month—on entertainment, for example.
Even though you may not be able to afford "unlimited" trips to the movies each month, an effective budget can still account for leisure and entertainment activities.
Pros and Cons of Budgeting
While budgeting can be a useful financial tool, it may not be for everybody. Some people may feel more confident by balancing their checkbook to see how much they have at any given time. Still, many argue that budgeting helps people stay on track and avoid overspending on "wants" such as restaurant food, clothes, and entertainment, so they always have enough money for "needs," such as rent/mortgage, utilities, and food. The following lists summarize the advantages and disadvantages of budgeting:
Provides a realistic view of personal finances: A personal budget provides an honest snapshot of how much money you make and how much you can spend. It can help you avoid deceptive financial thinking, such as believing that you're "flush" right after pay day, when you really need to save that money for an upcoming bill.
Helps you avoid excess spending: Because a budget gives you insight into the total picture of your income and expenses, you can make realistic decisions about spending. As above, a budget can help you avoid a having faulty sense of your financial resources and remind you that even if you just got paid, most, if not all, of your check may need to go toward fixed expenses.
Assists in goal setting: Since you get to decide how to allocate your money, a budget can help you set goals. For example, if you create a yearly budget, you could plan and acccount for an upcoming family trip and start saving money for it in advance without worrying about having the money at the last minute.
Budgets take energy: Planning a budget takes dedication. Since most students lead busy lives and are balancing different demands like work, school, and time with family and friends, it can be easy to slip up. For example, if you have a stressful week at work or school, you might overspend while going out with friends and forget how much you budgeted for leisure activities.
Results take time: Since most budgets cover a time period of a month, year, or even longer, people may become frustrated waiting to see if their financial situation is better than it was before. Frustration can lead people to abandon their budget and go back to overspending or neglecting to save.
Budgets may be strict: Remember that one of the important strategies for creating a successful budget is earmarking money for "treats" and extras such as entertainment. However, in an effort to become more financially disciplined, some people make budgets that are too restrictive and unrealistic. This can backfire and lead to overspending in one area or abandoning the budget altogether.
Creating a Personal Budget
Even though you may be persuaded by the downsides of budgeting and think, "It's not for me!" don't give up until you've tried it. Tracking one's income and spending is a good exercise for anyone, and if you follow the basic steps, below, it's easier than you think:
Calculate regular expenses: Using your bills, receipts, checkbook, and any other financial records you have, make a list of your regular expenses and record how much you typically pay each month or year. Since some expenses like grocery bills may vary from month to month, you’ll want to examine several months' worth of receipts to come up with an average.
Record your income: Identify all income sources and add up how much you receive during a given period of time. This amount should include all sources of money—from regular full- or part-time work and from intermittent sources, such as freelance jobs, babysitting, etc.
Adjust your expense percentages, and set goals: After you outline your financial obligations and income, you can start deciding how much money you’d like to allocate for each expense. Start with fixed expenses such as rent, car payments, etc. Next, decide how much you want to devote to each of the remaining categories, such as food and entertainment. At this point you can also set specific financial goals. For example, you may decide to lower the amount you spend on clothes in order to pay off outstanding credit-card debt or save for a trip.
Identify a method for tracking your budget: Develop a plan for monitoring your budget. You might decide to use an Excel or Google spreadsheet, a budgeting app, or a budget tracking tool provided by your bank. You can also write things down in a notebook. The method doesn't matter, so long as it's easy for you to access, use, and interpret.
Still not convinced that making and following a budget is doable? The following video describes a budgeting technique that's very easy and straightforward to follow: the "Envelope Budget." Simply placing cash in labeled envelopes (one for each category or purpose) each month can be a very effective means of building healthy spending habits.
Activity: Creating a Personal Budget
Create a personal budget
Review the How to Budget Using the Envelope Method video above, or watch the How to Set Up a Budget video, below.
Select one of the types of budgets suggested in these videos. Write down each step for the type of budget you selected.
Complete each step using your own financial information.
Do you think this process for creating a personal budget was helpful? Is there anything you’d change?