Budgeting 101: A Beginner's Guide to Creating a Financial Budget that Works
Updated: May 7
A key component of personal finance is budgeting, which enables people to manage their income and expenses efficiently. Yet, despite how crucial budgeting is, many people need help to develop a personal budget that works for them. The good news is that there are several tried-and-true strategies that you can use to take charge of your finances, and they might be easier to implement than you think!
The 50/30/20 rule, the envelope approach, and the Zero-Based Budgeting method are three widely used and practical budgeting techniques we'll examine in this beginner's guide. After reading this guide, you will have the information to select the best approach for your lifestyle. And with some work and dedication, you can develop a personal budget to reach your personal finance goals. So now, let’s dive in and start your journey to financial understanding and freedom.
The 50/30/20 Rule:
A simple-to-use budgeting strategy is the 50/30/20 rule, which indicates you should allocate your income to three categories: needs, wants, and savings. The costs necessary for surviving, such as shelter, food, transportation, and healthcare, are needs. Wants include eating out, entertainment and travel, as these costs are not required for survival but bring pleasure or delight. Savings are the funds you set away for long-term financial objectives, such as retirement, unexpected expenses, and other goals.
First, determine your after-tax income before applying the 50/30/20 rule. Next, divide your money into three sections: needs (50%), wants (30%), and savings (20%). If one category's costs exceed the suggested proportion, you should tweak your spending in other areas. You may have to minimize your entertainment spending or look for ways to lower your housing costs, for instance, if your housing expenditures account for more than 50% of your income.
As you can tell, the 50/30/20 rule provides several benefits. First, it provides a framework for balancing spending and ranking savings goals. Secondly, by devoting a percentage of your income to the wants category, the 50/30/20 rule enables you to enjoy life while being financially responsible. Lastly, it assists in controlling expenditures and assures you set aside enough cash for emergencies and long-term objectives.
The 50/30/20 guideline, however, assumes that your earnings and living expenses are steady and predictable, which may only be the case for some. For many people, earnings are irregular, and outgoings fluctuate. Also, it might not consider unique circumstances, such as heavy debt or extensive medical expenses. If the 50/30/20 rule doesn't work for you, you can also try the envelope technique or the cash-only method, which we will discuss next.
The Envelope Method:
The envelope technique is a form of budgeting that entails physically putting cash in envelopes with labels corresponding to specific expense groups. Limiting your spending to the amount of money in each envelope allows you to keep track of your expenditures and prevents overspending.
To envelope method requires you to make a budget for your monthly expenses. First, determine your fixed costs, such as your rent or mortgage, utilities, and transportation expenses. Next, set aside money for each group of fixed expenses. The next step is to allocate a particular amount of money to your variable costs, such as groceries, entertainment, and eating out.
Next, please write the name of the spending category and the amount of money you have designated for it on the front of each envelope. Then, as you make purchases, take the money from the proper envelope. To take it further, you can place the receipt for what you purchased in the envelope. Once the envelope is empty, that category is off-limits until the following month.
The envelope approach offers several advantages. Restricting your spending to the amount of money in each envelope helps you stay within your spending limit. In addition, you’ll be able to identify if you are consistently emptying the same envelope halfway through the month and can make spending cuts accordingly. This method can also assist you in avoiding excessive credit card spending, which can result in high-interest debt.
Nevertheless, the envelope approach might not be practical for everyone. It requires carrying cash, which in some circumstances can be inconvenient. Also, unexpected expenses or internet purchases might not be as practical. Consider the 50/30/20 rule if you prefer to utilize a credit card or debit card for your transactions.
The Zero-Based Budgeting Method:
The last budgeting technique is zero-based budgeting (ZBB), which allocates every dollar of your income to a predetermined purpose, leaving no money unaccounted for. If you use this technique, you should make a budget for all your income, including what you spend on fixed costs, savings, and discretionary items. The goal is to have a zero balance at the end of each month, indicating that you have assigned each dollar to a particular category or use.
Determining your monthly spending is the first step in developing a zero-based budget. Your monthly income includes all your revenue sources, including your job, side hustles, and investment income. You then divide your income among various expenses, starting with your fixed costs, which are the non-negotiable expenses that occur every month, so you must allocate these dollars first.
The next step is to set aside money for your investments and savings. This includes retirement plans, emergency reserves, and other long-term savings goals. Again, budgeting for savings is crucial, and you should commit a monthly portion of your income to these accounts.
You can devote the remaining funds to discretionary expenses after you've set aside money for savings and fixed expenses. This encompasses spending on groceries, entertainment, eating out, and other discretionary costs. However, as ZBB requires you to track every dollar spent in these categories, you should keep your discretionary spending to a minimum.
The Zero-Based Budgeting approach forces you to concentrate on your financial priorities while encouraging you to be deliberate with your spending. As a result, you will better understand your spending and be able to contribute more money toward your financial objectives by developing a precise strategy for every dollar of your income. This technique also helps prevent excessive discretionary expenditures, which can result in high-interest debt.
Zero-Based Budgeting requires more work than the previously described methods because you must have a plan for each dollar. Also, adhering to a zero-based budget could be challenging if you don't clearly grasp your spending patterns.
Creating and sticking to a personal budget can be daunting, but it is necessary for financial stability and success. By understanding your spending (income and expenses) and identifying a budgeting method that works for you, you can take control of your finances and achieve your financial goals.
The 50/30/20 rule is a simple and effective way to allocate your income, while the envelope method and the Zero-Based Budgeting method can help you to track your spending and avoid overspending. However, it's essential to understand that every individual has a different financial situation, and there is no one-size-fits-all approach to budgeting.
The goal is to find a budgeting method that suits your lifestyle and meets your personal goals. Be realistic with your expenses, track your spending, and adjust when necessary. Then, with consistency and discipline, you can create a personal budget that works and paves the way for a secure financial future.
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