Guide to budgeting

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Budgeting is a cornerstone of financial wellness. It benefits everyone from the finance veteran who has their eyes set on retirement to the college student trying to figure out how to stretch a dollar.

Simply put, it gives you a plan for your hard-earned money.

So, let our guide lead the way for you to update your reliable budget or establish one for the first time:

What is budgeting?

Budgeting is like an itinerary for a road trip. It’s like a playbook for a coach. It’s a plan for your money that allows you to plan, track, and achieve your goals.

Simply put, budgeting is a plan for your money.

It can be as basic as a few categories that your money flows into or as detailed as a color-coded spreadsheet where you meticulously track each purchase.

Why is budgeting important?

There’s a long list of reasons why budgeting is an important part of a healthy financial life. However, most of them fall under one of two categories:

Eyes on the prize

Budgeting helps you stay focused and on track towards your financial goals.

Say your goal is to maximize your retirement savings, you’ll be able to accurately project how much you’ll save since it’s the same amount every month.

The same is true with saving for college, eliminating debt, building an emergency fund, and most other financial goals.

On top of all of that, it helps you to avoid feeling overwhelmed. Having a clear map of where your money goes allows you to have peace of mind. Having peace of mind helps you think clearly about your financial goals and eliminates distractions.

Identify bad habits

A budget forces you to look at where your money went at the end of every month and have honest conversations about your habits. This can help identify bad habits including overspending, not saving enough, or not having the correct allocations for each section of your budget.

Budgeting myths

Though this guide will primarily focus on the many benefits and aspects of budgeting, it’s just as important to address the reasons that people avoid budgeting. Here’s a list of common myths we’ve heard surrounding budgeting and why they aren’t true.

1. “Budgeting is too much work”

Saying budgeting is too much work is akin to saying exercise is too much work or that eating nutritious foods is too much work. The work put into budgeting leads to a better understanding of your money and habits.

Plus, with a wide variety of budgeting apps and websites, it’s easier than ever to keep track of your budget with minimal work.

2. “I don’t need to because I’m in good shape financially”

If you’re in good financial shape, wouldn’t you want to take every step possible to keep it that way? On top of that, budgeting can be vital to help understand what habits you have that are allowing you to be in good shape financially.

3. “I barely have enough money to cover my necessities”

Budgeting can eliminate lots of financial stress by showing you where all your income is going. It can also help you stay on top of due dates for bills and start building an emergency fund.

Also, it’s important to do things that you find joy in even when things are tight financially. When you know you’re staying inside of each category in your budget, the guilt of spending money on yourself is removed.

4. “I don’t have the discipline”

Stop shortchanging yourself in 2022. You can do it!

5. “I don’t know where to start”

Read the rest of this guide for tips on first-time budgeting.

Different approaches to budgeting

Budgets are not one-size-fits-all. The approach you take to your budget depends on many factors including income, savings, debt, and much more.

Even though there is a long list of ways that people budget, we’ll focus on a few popular budgeting frameworks. These ways of thinking about budgeting have kept many people motivated to track their finances. As you read about some of these, look for the ones that would motivate you personally, because the most important factor in choosing a budget is choosing one that you’ll actually stick to.

Zero-based budgeting

Zero-based budgeting, also known as zero-sum budgeting, is a method where every single dollar of your income is assigned to a category.

This is a wonderful method if you’re hoping to get a better sense of how you use your money each month. It keeps you cognizant of both your income and expenses and with every dollar accounted for, you’ll be less likely to spend what you don’t have.

Zero-based budgeting is also entirely customizable, so it can be less overwhelming for first-time budgeters.

50/30/20 budget

One of the most popular budgeting methods around is the 50/30/20 budget. This has you break your monthly post-tax income into three categories: 50% of your income is dedicated to needs, 30% is dedicated to wants, and 20% is dedicated to savings.

Many enjoy this method because it sets frameworks for necessities, while still dedicating a major percentage of your income to things you enjoy doing and savings for your future. In that way, many people find it less restrictive than traditional budgeting.

Needs – 50%

These are the things that you can’t do without: food, housing, utilities, transportation, insurance, and anything else you need to live your life. These are expenses that you will have to pay regardless of how your finances fluctuate.

Wants – 30%

This is where you can have some fun with your hard-earned dollars. Whether you’re spending on a winter vacation to escape the cold, checking out a new restaurant, or on ten different streaming platforms, it’s important to do things you enjoy. This prevents budgeting burnout.

Even though your Netflix or Peloton subscriptions seem like a need at this point, be sure to budget all non-essential expenses under your wants. Learn more about distinguishing between wants and needs.

Savings and debt – 20%

The average American saves less than 5% of their income, and a major reason why is a lack of budgeting.

Even though it can be enticing to put a higher percentage into wants, future you will be very excited that you set aside 20% of your income for savings.

This starts with setting up an emergency fund. Financial experts say that you should multiply your expenses by at least three months and save that amount as emergency funds. This will protect you against unexpected expenses such as medical bills or home repairs.

After that is set up, your focus can shift to retirement savings. Be sure to take advantage of any employer 401k match, and look into if opening an IRA is right for you.

However, this 20% of your budget isn’t just for savings, it’s for paying off debt too. This is a necessary part of many budgets when you consider the average American has over $90,000 in debt. Prioritize paying off high-interest debt, such as credit card or personal loan debt.

Envelope system

Traditionally, users of the envelope system have put cash in physical envelopes that represent each category of their budget. For example, you would have envelopes labeled “mortgage” and “electricity bill” and fill them with the cash needed for that payment each month. Many proponents of this system now use online tools to simulate this experience.

Fans of this system swear by its ability to keep them from overspending and irresponsibly swiping their cards. If you’re not using a budget, it can be easy to overspend because nothing is telling you to stop or that you’re financially overextending yourself. If you’re using the envelope system, when the money in one category is gone, you know your spending in that category is done for the month.

On the other hand, if there’s money left over at the end of the month, you can either choose to roll it into the next month’s budget for that envelope, move it to another envelope, or use it for wants. This can be a great system for anyone with credit card debt or anyone who is looking to curb impulsive spending.

Pay yourself first

If you’re looking to give a gift to the 2040 version of yourself by prioritizing savings, this is the budget for you.

Where most budgets see savings as the last step, it’s the first step here. Called a “reverse budget” by some, this method shifts the focus of traditional budgeting by “paying yourself first” in the form of retirement savings or investments.

If this method sounds right for you, be sure that there are goals tied to the savings such as retirement, a college fund, or hitting a certain number. This will allow you to stay motivated since you’ll be on a savings journey that has a destination.

Automation can also be a great tool when paying yourself first. For example, if you want to allocate 25% of your income to “paying yourself” you can set up rules in your bank account to automatically allocate 15% of that to savings. You can then set up a rule in your brokerage account to take out that additional 10% you’re allocating towards investing. Learn more about using automation with your M1 Finance account.

Static vs. flexible budgets

Another consideration when building a budget is deciding between a static and flexible budget.

Static budget

A static budget is what many people traditionally think a budget is. There are set expenses and a set level of income to pay for those expenses. Once these numbers and categories are set, all you have to do is follow them. However, this creates a drawback for some due to the lack of flexibility.

Flexible budget

Many businesses use flexible budgets because of the changing nature of both the revenue they bring in and the expenses they encounter. You can change things on the fly which is great for small business owners, freelancers, or people with a side hustle. The downside of a flexible budget is that it takes much more time and work to upkeep.

Learn more about static vs. flexible budgets, and which one is right for you.

How to build your budget

Now that you have the framework for some popular budgeting methods, let’s go over how to build a budget.

1. Find your net income

The easiest way to find your net income is by looking at tax forms. If your job or income has changed, you can multiply your most recent check by the number of times you receive it per year.

Example: Your take-home pay was $2,000 last check. You get paid on the 1st and 15th of every month, which means you get paid 24 times a year.

$2,000 x 24 paychecks = $48,000 in net income

2. List your expenses

Your expenses will fall in one of three buckets: fixed expenses, dynamic expenses, and discretionary expenses.

  • Fixed expenses: Bills that stay the same each month, usually housing and some utilities.
    • Examples: rent, internet, and insurance
  • Dynamic expenses: Bills that change from month to month.
    • Examples: Gas, electricity, and groceries.
  • Discretionary expenses: Anything that is optional or for fun.
    • Examples: Spotify, vacations, and going out to eat.

3. Set SMART goals

SMART is an acronym that lays out important guidelines for the financial goals you set. It stands for specific, measurable, achievable, realistic, and time-bound. People use this framework of goalsetting because it provides clarity around goals, so they can be achieved. Let’s look at an example below.

Mary’s New Year’s resolution is to save more money this year. Rather than just intending to save up more money, Mary uses SMART goals to save up.

I want to save $6,000 by the end of the year.

  • Specific – $6,000
  • Measurable – She can measure the goal each month to see if she is on track.
  • Achievable – Mary has 12 months to complete this goal.
  • Realistic – Mary has budgeted and found that she can allocate $500 a month in savings.
  • Time-bound – She has until December 31 to hit her goal.

4. Pick a budgeting method

  • Use a popular method: You can use one of the methods we laid out above such as the 50/30/20 budget, zero-based budgeting, the envelope system, or pay yourself first.
  • Tried and true spreadsheet: The simplicity and flexibility of old-school spreadsheets work best for some people. You can customize percentages and create your columns by opening Excel or Sheets.
  • Use a budgeting app or website: Some people love the tools that budgeting apps offer and use them to track all their spending. Many budgeting tools require a subscription but offer great ease of use. These apps connect to your bank account and track your spending for you. Read Investopedia or Nerdwallet’s guides to find the platform that works best for you.

How to stick to your budget

1. Find your why

Why are you budgeting? Is it to build up a college fund for your kids? Is it to erase credit card debt? Is it to take control of your finances? Whatever the reason may be, identify it and remember that is the reason you’re budgeting. If you’re budgeting with a partner, be sure to communicate these reasons and make sure you share the purpose for budgeting.

2. Re-evaluate your budget quarterly (or more often)

There are a lot of things that change during a year. Maybe your income has changed, you leased a new vehicle, or you have a new hobby. Whatever the circumstance is, your budget should be adjusted accordingly. A scheduled check-in can help you identify where changes need to be made. Don’t be afraid to make changes that will help you adjust and ultimately reach your goals.

3. Automation is your friend

Like we touched on earlier, automating your finances can help in a wide range of ways. It can help you prioritize savings, it can help you be disciplined and consistent in your investing, and it can help you avoid missing utility or credit card payments. Automation can help you lower your financial stress and increase your financial efficiency.

4. Don’t be afraid to try different budgeting methods

This could be advice for any major overhaul in your life. Whether it’s budgeting, exercising, or finding the right foods to eat, there’s no harm in trying different programs until you find the one that suits you best.

Think of it like you’re test driving a car at the dealership. If the first car isn’t right for you, you wouldn’t give up on getting a car. In the same way, don’t give up on budgeting just because the first attempt wasn’t perfect.

Time to budget!

Whether this is your first-ever budget, or you’re a seasoned budgeting veteran who is looking to refresh their methods, consider this a victory. You’re taking an important step on the journey towards financial wellness by budgeting.

No matter what budgeting method works best for you, keeping track of your income and expenses will empower you to have a greater degree of financial control and stability.

M1 and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.

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