The Informed Investor

Budgeting Basics

May 1, 2023

Of all the steps you can take when managing your personal finances, budgeting may be one of the most impactful over the long term. A budget is a tool you can use to optimize your spending and assess how much money you have available to advance your larger financial goals such as saving for a home, paying off debt, or planning for retirement. In a sense, it represents the foundation on which your financial plan is built. For that reason, it’s important to understand what a budget is and how to assemble one.

Things to Consider When Budgeting

Budgeting may seem like a simple concept, but having a budget and having the discipline to stick to it are two entirely different things. Everyone has their own financial needs and tendencies when it comes to spending, so constructing a budget that accurately accounts for these details is crucial.

With this in mind, here are some of the questions you should consider asking yourself as you build out your budget.

What is your monthly income after taxes? If you have multiple sources of income – such as your regular paycheck, investment earnings, or cash from side gigs – be sure to include them all in this calculation. If you’re enrolled in automatic 401(k) contributions or have other things like insurance premiums deducted from your paycheck prior to receiving it, add these items back to your income to get a more accurate sense of how much cash you have coming in each month. You can account for these savings and expenditures elsewhere in your budget.

What is your future earning potential? Look 5, 10, or even 20 years down the line and ask yourself how much income you reasonably expect to receive. Consider your career trajectory – where do you plan to be in the future? While future earning potential won’t help you cover your needs in the short term, it may impact how you invest your money or save for your long-term goals.

What are your month-to-month expenses? This can be one of the trickier aspects of budgeting because you may have to do some digging to get all of the information you need. If some expenses are annual, semi-annual, or quarterly, figure out what they would be if quoted monthly. Think about your housing costs – property taxes or mortgage payments, utility bills, and upkeep. Then add other costs like insurance premiums, subscriptions, food, gas, and recreation costs. Reviewing bank and credit card statements may help you get a complete picture of your expenses. You could also consider using an app or online resource that consolidates all of this information for you.

What cash needs do you have on the horizon? You may have significant expenses in the near- or mid-term that you’ll need access to cash for. Examples of cash needs can include buying a home, taking a vacation with the family, or getting work done on your car. Planning for these things ahead of time and setting money aside for them can help ensure you don’t have to borrow money or draw from your savings.

What is a healthy amount of emergency savings? You never know when something might happen in your life that bears financial implications, be it the loss of a job or a busted pipe in your home. Think about keeping a few months’ worth of expenses in reserve for emergencies. Along the same lines as planning ahead for cash needs, maintaining a robust rainy-day fund can make it so that you aren’t forced to take on debt or make undesired withdrawals from your investment or savings accounts – both of which can derail your financial plan.

 What are your long-term financial goals? Consider what you’d like your future to look like. When would you like to retire and what kind of lifestyle do you hope to have in retirement? If you’ve always wanted to move somewhere, how do you plan on making that happen? Do you want to help your children or grandchildren pay for college? What kind of legacy do you aim to leave behind? These are just a handful of things you can ask yourself and each of them will factor into your planning.

Building Your Budget

Once you’ve determined your income and assessed your budget needs, it’s time to assemble your budget.

Allocate Your Budget

One popular budgeting method is called the zero-based budget and it entails making sure your net income minus your expenses equals zero each month. The goal of this method is to make sure every dollar of yours is accounted for.

When deciding what to spend on, consider using a framework as a starting point and adjust it based on your needs and cash flow. This involves spending a percentage of your net income on necessities, a percentage on wants, and 20% on saving toward long-term goals. Necessities include things like housing, food, transportation, and loan or credit card payments. Wants include things like entertainment, subscription services, and dining out. Saving toward long-term goals can mean contributing to a retirement account, paying off debt, or bolstering your emergency fund.

If the percentage  of your net income you plan to allocate is more than you need to cover necessities, you can allocate a greater portion to savings. There are countless ways to go about building a budget. The key is determining what percentages are realistic for you and then sticking to them.

Simplify and Stay Organized

Additionally, automating things like retirement account contributions, credit card payments, and monthly bills can save you time and help ensure your money goes to the right places. Using a spreadsheet or one of many available online resources can keep you organized and allow you to see where your money is going at any given time. A budget is only as good as your ability to stay on top of it, and these tools can help you keep track of each dollar that comes in and goes out.

Your Budgeting Journey

Your income, expenses, and goals are likely to change over time, so it’s important to review your budget on a regular basis and adjust it as it  becomes necessary. Once you’ve built a workable budget, the rest of your financial plan can start to fall into place.

A financial advisor can work with you to assemble a budget that enables you to meet your needs in the short term while keeping you on track to reach your goals in the long term.

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