Welcome back to Macro Mondays! For the next eight weeks, we will be taking a look at the process of budgeting: a topic in high demand yet is a subject of soreness for a lot of people who have tried and failed at budgeting in the past.
I'll be sharing some invaluable knowledge from the university section of Investopedia, to help you through the process of budgeting in the New Year (2018) and hopefully beyond.
Today we are taking a look at the basics of budgeting, and why it is a concept that can be used for everyone, no matter your level of wealth.
To learn more and read the original piece on Investopedia, CLICK HERE.
What is budgeting?
Many people think of budgeting as something to do when they’re short on cash. College students might budget to figure out how to make do with their high expenses and limited incomes and minimize how much they need to borrow. Young adults who are supporting themselves for the first time create budgets to make sure they’re properly allocating their paychecks among emergency savings, retirement savings, student loan repayments, rent and utilities, and rewards for their hard work like new gadgets and concerts. Young couples trying to figure out how to afford a wedding, or newlyweds wondering how to fit the expense of buying a house or having a child into their monthly cash flow, are also likely to make budgets. Empty-nesters budget to accelerate their retirement savings once the kids are self-sufficient. Retirees budget to make sure they don’t outlive their savings and to stretch their Social Security checks further.
Maybe you associate budgets with people who can’t make ends meet, or think that if you start budgeting, you’re going to live a life of deprivation where you eat nothing but rice and beans. The truth is that budgeting isn’t just for times when your money is tight or your life is undergoing a major transition. Budgeting is for everyone, rich and poor, young and old. In fact, budgeting will be that much easier in times of change or financial stress if you already do it all the time.
Where do you think a Fortune 500 company like Amazon would be today without proper budgeting? What about wealthy people like Warren Buffett? There’s no way that he or his holding company, Berkshire Hathaway, could have achieved such success without paying attention to their monthly, quarterly and annual cash inflow and outflow. Budgeting won’t just get you out of a rut — it can also help you get rich. And yes, it can help you do that even if you have a modest income.
Let’s look at some ways budgeting can help you achieve your goals.
1 ) Make Long- and Short-Term Projections About Your Personal Finances
A budget will help you plan for short-term expenses such as your monthly bills; mid-term expenses such as vacations; and long-term expenses such as buying a house, paying for a child’s college education or putting away money for retirement. When you have an app, spreadsheet or notebook in front of you showing how much money you expect to make over the one month, six months, one year or five years — and how much of that money will be flowing out and how much you will have left to save each month — you’ll always know when you need to cut back on spending, when you can afford to loosen the reins and how long it will take to save for major goals or pay off debts.
If you’re not happy with the numbers, knowing what they are will help you take steps to improve your situation. These steps might include paying off credit cards to increase your monthly cash flow; reducing your food expenses; or getting a promotion, switching companies, starting a side hustle or founding your own full-time business to make more money.
2) Prevent a Crisis
Let’s say a significant expense pops up: Maybe you develop a serious toothache and your dentist informs you that you’ll need a root canal and a crown. While you may have dental insurance through work, you’re still going to have to fork over at least $500 out-of-pocket to get the work done and end your misery. How can a budget help you handle an expense like this?
If you’re new to budgeting and don’t have any emergency savings yet — or if your savings has already been depleted by another recent emergency — your budget will help you determine which expenses you might be able to postpone or shift to help you pay the unexpected bill. For example, maybe you normally pay your car insurance once a year and it’s due next month, but you can opt to pay half now and half in six months instead to free up the cash to pay your dental bill. Or maybe your situation is tighter than that, but examining your budget shows that if you cut next month’s grocery bill from $300 to $200 and go out to eat once instead of twice, you’ll be able to start making a dent in your dental bill. You might then be able to propose a payment plan of four, $125 payments to your dentist to cover your $500 coinsurance.
Payment of almost any emergency expense can be postponed by at least a couple of weeks by putting it on a credit card or asking the service provider to let you make payments over several weeks or months. Of course, if you put the expense on your credit card, you should pay it in full when the bill is due to avoid paying interest. If paying it in full is not possible, pay as much as you can; try to go beyond the minimum payment.
Your budget will also give you an idea of how long it will take you to replenish your depleted savings once you’ve paid for your dental care. How much can you set aside per month to restore your emergency fund?
3) Get the Most Out of Your Money
Chances are you spend at least 40 hours working each week, and that doesn’t include the time you spend getting ready, the time you’re forced to be away from home because of commuting, or the hours of free time that get lost because you’re too tired from working all day to fully enjoy them. If you’re going to dedicate that much of your life to earning a living, you owe it to yourself to make sure your money is going to the things that are most important to you.
A budget helps you track all your expenses, large and small. It lets you find out how much you spend on everything from coffee breaks to gasoline to clothes. If you discover that you’re spending $500 a month on clothes and that horrifies you because you haven’t been able to afford a vacation in three years and don’t have an emergency fund, you’ll know what to do. And because you know where your money’s going and you’ll continue to track it, you’ll finally be able to save up for both the vacation and the unexpected expenses life will inevitably throw at you.
4) Manage an Irregular Income
Budgeting is different if you have an irregular income instead of a steady one. If you’re paid hourly or on commission, are self-employed, work seasonally or are a student, you probably won’t know how much you’re going to make until the month is over. Irregular pay makes budgeting a little trickier, but it’s still feasible.
You know you will still have to cover certain expenses no matter what, and if you’ve been in the same line of work for a while, you probably have a good idea of the minimum amount of money you’re likely to make each month. Budget around that minimum and you might be pleasantly surprised at the end of the month if you make more. It’s important to save extra in the months when you make more to account for the months when you make less and/or have higher expenses.
5) Plan for Major Changes
As mentioned earlier, a budget lets you model in advance how a major purchase or life change will affect your finances. Instead of wondering if you can afford a house or panicking about whether you and your spouse can afford to live on one income while the other is laid off or staying home to raise a child, you’ll have the data you need to crunch the numbers.
Figuring out ahead of time whether you can afford a major life change and what sacrifices you might need to make will help you plan. You can start saving for a down payment, plan for one partner to get a second job, research whether child care would be less expensive than continuing to work, and so on, with solid numbers to back your decisions.
6) Experience the Freedom of Having Money in the Bank
By helping you sock away money each month, budgeting is an important tool for achieving financial freedom. The ultimate freedom, of course, is being able to retire, but along that winding road are opportunities for many rest stops if you have money in the bank.
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