Budget plays an important role when it comes to saving money and maintaining finances in any household. By maintaining a healthy budget, you can have a well planned financial life that makes you aware of where your money is coming from and going to.
What is the budget?
A budget is a financial plan that we design and implement in order to manage our finances in a well-defined way.
How to make a budget?
We need to follow certain steps to make and implement a budget as mentioned below
1. Know your income
In order to have an organized budget, you need to gather and keep track of all the income you get, be it in any form. Your income includes the monthly work paychecks you get, rents from own house(if you have any), part-time jobs, etc.,
2. Track your expenses and categorize the expenses
Expenses play a crucial role in making a budget. Jot down all the expenses you make on a monthly basis and keep track of the same.
Variable expenses which might include – groceries, eating out, the money you spend on gifts and luxuries, entertainment, etc.,
Fixed expenses which might include – electricity, cable bill, rent, internet service, etc.,
While jotting down the expenses, make sure that you will keep in check of the expenses that are not a necessity like expenses related to entertainment, etc.,
The income you get and the expenses you make gives you a clear picture of how to prepare your budget accordingly.
If you are not sure about the expenses you made, just go through your online financial accounts and take note of the average expenses of each category in those 1-3 months. While taking the average it’s quite important to take the exact numbers as that helps you make an accurate budget.
3. Know your financial goals and needs
When you are making a budget, you should be clear about your financial goals as well as needs. If your financial goals include your retirement plans, emergency fund, etc., you should add them to your budget. Financial goals and needs vary from person to person and you should prepare your budget based on your own financial plan or goals you have in your mind.
The main reason why setting and knowing financial goals is important is that you can prioritize your spending and the way you want to have your financial life.
- Do you want to be debt free?
- Do you want to build an emergency fund?
- Save money for other financial purposes?
Take note of all your financial goals and later add them to your expenses category so that you will get habituated to save money for the financial goals you set for yourself.
4. Subtract your expenses from your income
The next step to take in making a budget is to find out your net worth. Net worth can be calculated by subtracting all the expenses you have made from the income you have made i.e subtract the outgoing cash from the incoming one.
If the result is positive, that implies that you earn and make more money than you spend.
If you get a break even, that implies that you have exactly enough money with no breakeven.
If you get a negative result, that means that you are spending more money than you take home or earn and this can be managed by keeping in check the discretionary expenses you have each month.
Even if you go for discretionary items, make sure that you spend on them after meeting the financial goals that you have set for yourself.
Making a budget based on 50-20-30 rule
50-20-30 rule was introduced by Elizabeth Warren and the basic concept behind this rule is to divide the income and dedicating 50% on needs, 30% on your wants and allocating the remaining 20% on your savings.
This can be done as mentioned in the steps below
1. Calculate your income
This is the basic and first step involved in this 50-30-20 rule. You need to calculate the take home income you get for the profession you work for and then carry on with the division of income for necessities, wants and savings.
2. Allocation of 50% to necessities
As a part of the next step, you need to estimate how much you are spending on necessities like groceries, car insurance, etc., and you should allocate not more than 50% of your income to your most needed expenses.
To go forward with this step, you should first know what comprises your needs and wants. The payment or the expense you make with the slightest inconvenience can be added to wants like the cable bill, movie expenses, etc., and any payment or expense that should be done without fail is called need like electricity bills, medicines, etc.,
3. Limit your wants to 30%
Once you got an understanding of wants and needs, you have to take a further step of confining your wants to only 30% of your income.
This 30% that you keep aside for your wants don’t include luxuries stuff but only the things that you enjoy like movies, any small local trips that you have in mind, cable bill, dining out frequently, etc.,
4. 20% of the income to savings
Now comes the role of 20% of your income. You should allocate this 20% of your income to savings like
- Retirement account
- Emergency fund etc.,
For instance, if you have a credit card balance, the minimum payment made on the card comes under “need” which accounts for 50% of the income. Any extra payment other than this comes under the category of 20%.This part of income can also be saved for repaying debts.
Budget is one of the most necessary financial concepts to be followed in order to have your financial goals at an organized pace.