We have all lived paycheck-to-paycheck once in our lifetime. A personal budget can help you keep track of your income and expenses, and that can make a lot of difference. You can find plenty of apps on how to make a budget with tags like expense tracker, money manager, expense management, daily budget, money goals, etc. It all boils down to balancing expenses against your income.
Most importantly, personal budgeting should be personal. It can be as simple as an excel worksheet, a budget planner calendar, or a simple budget journal as long as you personalize it with your goals and circumstances. Here's how to make a personal budget and bring your finances back on track.
Why Do You Need to Prepare a Budget?
Personal budgeting is necessary to realize your financial goals and set priorities one step at a time. The end goal of a personal budget is not to set ambitious goals but to break your goals into achievable tasks. The ultimate goal is to make better money habits and achieve financial freedom early in life.
- Keep Your Eye on the Prize - You can set financial goals in your budget and break them down into small actionable milestones. This can actively remind you of the rewards so you can make mindful financial decisions. Keeping the bigger picture in mind may help you focus on ways to increase income or decrease expenses to achieve your bigger goals.
- Don't Spend Money You Don't Have - An average American spends $314 monthly on impulse purchases. Living in a consumer economy can strain our savings and push us closer to expensive debt like credit cards and personal loans. You can better understand your income potential and the limits of your expenses by preparing a personal budget.
- Bad Habits Spending - You get a bird's eye view of your spending behavior while maintaining a personal budget. It can help you draw the line between your needs and wants. You can constantly remind yourself of long-term goals to avoid impulse purchases.
Saving an extra $10 daily may not seem like much, but it can add up to $3,650 in a year. You can earn this additional $10 by working an extra hour, planning errands together to cut down on gas bills, separating bank accounts based on needs and wants expenses, renewing unnecessary subscriptions, or even packing your lunch to work.
Think about your end goal every time you refuse to spend and save instead. Sometimes the anticipation of a reward is more pleasurable than the reward itself. As each day takes you closer to your end goal, take the liberty to feel good and proud of your daily achievements. These positive reinforcements can help you develop a priceless habit of savings.
How to Make a Budget in 4 Simple Steps
You can create an effortless budget in just four simple steps. Don't get too bogged down by details. Instead, try to create a financial roadmap. You might not know the exact figures, so take the average of the last three months or start with pragmatic guesstimates. You can always put in actual figures as your budget evolves over time.
1. Calculate Your Income
The first step is to determine how much money you earn each year. Most people make money through two income streams; active and passive. Income generated through active work like salaried jobs, business profits, freelancing, etc., is known as active income.
You can also earn passively by investing in stocks/bonds, opening fixed deposits, renting out a property, or gains from asset appreciation. At this stage, subtract the income tax from your gross income to figure out how much you make each year.
2. Determine Fixed and Variable Expenses
The first step in controlling your expenses is understanding the different types of expenses. You can classify your everyday expenditures into four types
- Fixed: Expenses like rent, insurance premiums, loan payments, etc. that remain the same every month are called fixed expenses.
- Variable: Expenses that keep changing every month like utility bills, clothing, entertainment, hobbies, holiday gifts, etc., can be grouped as variable expenses.
- Non-recurring: These are one-time payments that you won't have to repeat in the foreseeable future. Some common examples are property tax, home upgrades, vacations, etc.
- Whammies: These are the saddest expenses that we must deal with from time to time. Some common examples of whammy expenses are home repairs, car breakdowns, uninsured medical emergencies, legal troubles, penalties/fines, etc. Allocate an extra 10% to your total annual expenses as whammies.
3. Create a List of Monthly Expenses
Spend some time each day going over your expenses and income. Simply being more aware of your spending can lead to a higher degree of control over your expenses. You can juggle alternatives and reduce unnecessary spending habits by listing all your expenses. You may also divide your expenses according to frequency, priority, and type for easier management and self-analysis. Here is a list of 30 common monthly expenses-
- Loan Payments
- Uninsured Medical
- Utility Bills
- Home Repairs
- Car/Bike Maintenance
- Public Transportation
- Property Tax
Insurance/Warranty Services Expenses
- Home Insurance
- Auto Insurance
- Life Insurance
- Health Insurance
- Home Warranties
- Child Support
- Pet Care
- Eating Out
- Entertainment Subscriptions
- Internet/Cell phone charges
- Luxury Purchases
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4. Make a Plan, and Set a Goal
You can start budgeting with the 50/30/20 rule that you can always tweak according to your circumstances. You may begin by dividing your after-tax income into three buckets; Needs, Wants, and Savings.
- Needs represent essential expenses like rent, groceries, maintenance/repairs, minimum loan payments, insurance premiums, medical costs, etc., that you require to maintain a certain standard of life. You may spend 50% of your income on these necessities.
- Wants are personal. It can be anything from buying that new sneaker you have been eyeing for a long time, indulging yourself in a spa, going out for movies, or chugging beer with your best friend. These expenses can be harder to budget as we naturally tend to overspend on things that give us joy. Set a strict target of spending a maximum of 30% of your monthly income on your wants.
- Savings: The remaining 20% of your income can be used to build an emergency fund, open fixed deposits, invest in stocks/bonds, or repay your loans early.
Money comes into our lives as income and leaves as expenses. Another way of looking at it is you generate income by producing goods/services and incur expenses by consuming goods/services.
Mike Tyson declared a $30 million bankruptcy in 2003 despite earning more than $300 million throughout his boxing career. No matter how much you earn, your consumption should be rooted within your income. Based on this simple idea, create a personal budget that remains true to your needs.