Budgeting is one of the most important financial habits you can adopt. But if you’ve never lived on a budget, or haven’t experienced the all the benefits that budgeting has to offer, it’s easy to wonder why it’s such a prominent aspect of personal finance. So, why is budgeting important?
In short, budgeting is important because it helps you control your spending, track your expenses, and save more money. Additionally, budgeting can help you make better financial decisions, prepare for emergencies, get out of debt, and stay focused on your long-term financial goals.
Put simply, living on a budget is a fundamental component of proper financial management.
In fact, for the rest of this post, I am going to take a much deeper dive into the importance of budgeting, and why it is such a vital part of your financial well-being.
Let’s get started!
Table Of Content
- Importance Of Having Systematic Budgeting Plans.
- How To Budget Your Money?
- Understand the budgeting process
- Try a simple budgeting plan
- Allow up to 50% of your income for needs
- Leave 30% of your income for wants
- Commit 20% of your income to savings and debt repayment
- Evaluate, Monitor, Adjust And Practice Your Planned Budget
Importance Of Having Systematic Budgeting Plans.
- 1. Budgeting Helps You Avoid Or Get Out Of Debt
We talk a lot about the negative effects of debt on this website, and I’m not going to stop now. It’s really this simple: if you want to have money (i.e. build wealth), then you need to stop spending it on things you can’t afford. In particular, you need to stop hindering your monthly income by using a large portion of it to pay somebody back (with or without interest) for things you couldn’t afford in the past.
That’s why budgeting is so important. It can help you get out of debt, or plan your finances so that you can save and pay cash for big purchases and avoid debt in the first place.
- 2. Budgeting Helps You Control Your Spending
Let’s be honest, when you operate your finances without a budget, you don’t really have anything holding you back from spending beyond your means. Sure, you might have a general idea about how much money you can spend each month, but without hard, accurate numbers, it’s easy to lose control of your spending habits.
I would know. Before my wife and I started budgeting, we spent money like it wasn’t a big issue. From going out to eat, to taking trips to the mountains, without a budget it was hard to correlate our daily spending to our less than optimal financial situation. I mean, sure, buying one lunch out to eat at a time doesn’t feel like a big deal in the moment. However, when you sit down with a budget and add up the cost of 30 Chipotle burritos each month (yeah, I said 30), those seemingly insignificant lunch bills add up to way too much spending.
- 3. Budgeting Keeps You On Track For Your Financial Goals
Along the same lines of controlling your spending, budgeting is important because it keeps you on track when you are trying to achieve your financial goals.
Let’s be honest, setting goals is pretty easy. Anybody can do it. You just think of something you want to achieve, and then set a defined timeline to achieve it. But here’s the thing, setting goals and actually achieving your goals are two very different things.
In order to achieve a goal, you need to stick to a plan, and stay focused on a clearly defined process; and that’s where having a budget is so important.
Through a budget you can reverse engineer your goals, and develop a clearly defined process to achieve them. In essence, when you create a budget, you are setting boundaries on your financial behavior so that you can stay on track and achieve every goal you set for your life.
- 4. Budgeting Helps You Find Financial Contentment
Financial contentment is one of the foundational elements of good financial behavior. It keeps you from spending money that you don’t have, and helps you to enjoy your financial journey.
But here’s the thing, if you spend all your time focusing on the finances of other people, you will never find contentment. You’ve probably heard this referred to as “keeping up with the Jones’”, and it’s a bad (and financially dangerous) way to live.
Instead, you need to focus on your own life, your own money, and your own decisions. And that’s why a budget is so important.
How To Budget Your Money?
Divide your income among needs, wants, savings and debt repayment, using the 50/30/20 budget.
If I have take-home pay of, say, $2,000 a month, how can I pay for housing, food, insurance, health care, debt repayment and fun without running out of money? That’s a lot to cover with a limited amount, and this is a zero-sum game.
The answer is to make a budget.
Calculate your monthly income, pick a budgeting method and monitor your progress.
- Try the 50/30/20 rule as a simple budgeting framework
- Allow up to 50% of your income for needs.
- Leave 30% of your income for wants.
- Commit 20% of your income to savings and debt repayment.
- Track and manage your budget through regular check-ins.
Understand the budgeting process
- Figure out your after-tax income: If you get a regular paycheck, the amount you receive is probably it, but if you have automatic deductions for a 401(k), savings, and health and life insurance, add those back in to give yourself a true picture of your savings and expenditures. If you have other types of income perhaps you make money from side gigs subtract anything that reduces it, such as taxes and business expenses.
- Choose a budgeting plan: Any budget must cover all of your needs, some of your wants and this is key savings for emergencies and the future. Budgeting plan examples include the envelope system and the zero based budget.
- Track your progress: Record your spending or use online budgeting and savings tools.
- Automate your savings: Automate as much as possible so the money you’ve allocated for a specific purpose gets there with minimal effort on your part. An accountability partner or online support group can help, so that you're held accountable for choices that blow the budget.
- Practice budget management: Your income, expenses and priorities will change over time, so actively manage your budget by revisiting it regularly, perhaps once a quarter. If you're struggling to stick with your plan, try these budgeting tips.
Try a simple budgeting plan
We recommend the popular 50/30/20 budget to maximize your money. In it, you spend roughly 50% of your after-tax dollars on necessities, no more than 30% on wants, and at least 20% on savings and debt repayment.
We like the simplicity of this plan. Over the long term, someone who follows these guidelines will have manageable debt, room to indulge occasionally, and savings to pay irregular or unexpected expenses and retire comfortably.
Allow up to 50% of your income for needs
Your needs about 50% of your after-tax income should include
- Groceries.
- Housing.
- Basic utilities.
- Transportation.
- Insurance.
Minimum loan payments. Anything beyond the minimum goes into the savings and debt repayment category.
Child care or other expenses you need so you can work.
If your absolute essentials overshoot the 50% mark, you may need to dip into the “wants” portion of your budget for a while. It’s not the end of the world, but you'll have to adjust your spending.
Even if your necessities fall under the 50% cap, revisiting these fixed expenses occasionally is smart. You may find a better cell phone plan, an opportunity to refinance your mortgage or less expensive car insurance. That leaves you more to work with elsewhere.
Leave 30% of your income for wants
Separating wants from needs can be difficult. In general, though, needs are essential for you to live and work. Typical wants include dinners out, gifts, travel and entertainment.
It’s not always easy to decide. Are restorative spa visits (including tips for a massage) a want or a need? How about organic groceries? Decisions vary from person to person.
If you're eager to get out of debt as fast as you can, you may decide your wants can wait until you have some savings or your debts are under control. But your budget shouldn't be so austere that you can never buy anything just for fun.
Every budget needs both wiggle room maybe you forgot about an expense or one was bigger than you anticipated and some money you're entitled to spend as you wish.
Your budget is a tool to help you, not a straitjacket to keep you from enjoying life, ever. If there's no money for fun, you'll be less likely to stick with your budget and a good budget is one you’ll stick with.
Commit 20% of your income to savings and debt repayment
Use 20% of your after-tax income to put something away for the unexpected, save for the future and pay off debt. Make sure you think of the bigger financial picture; that may mean two-stepping between savings and debt repayment to accomplish your most pressing goals.
- Priority No. 1 is a starter emergency fund.
- Priority No. 2 is getting the employer match on your 401(k).
- Priority No. 3 is toxic debt.
- Priority No. 4 is, again, saving for retirement.
- Priority No. 5 is, again, your emergency fund.
- Priority No. 6 is debt repayment.
- Priority No. 7 is you.
Evaluate, Monitor, Adjust And Practice
- Professional financial planners recommend sticking to budget benchmarks for each category in your budget. These benchmarks are designed to help individuals from over or under spending in a category. For example, if a person was spending 20% on food a month, that would be over the recommended amount to spend for food. Likewise, if you are spending 15% of your income on housing, you are under the benchmark! This means that you could be spending more on housing and therefore own a better or bigger house that fits your needs.
- Read through the benchmark percentages for each category and evaluate your current written budget. What places are you over or under spending? Adjust as you need to better fit within the recommendations. Also, monitor your actual spending during the month compared to your projected amounts. Adjust as needed here too. It is important to be realistic with yourself and understand that you may need to make changes that best match your lifestyle. That does not mean you make poor financial decisions though, it just means maybe you do not have a house payment so you can afford to save or give more as one example.
- You may be new to budgeting or you may be looking to try a new way to budget. Either way, remember that it takes practice and self-control to make a budget work properly. In this case, practice does not make perfect. With practice, your budget will get better and better each time you write and follow one, but it will never be “perfect” per say. That is because life throws you surprises and sometimes it is not easy to face these surprises even with all the planning in the world.
- Experts state that it takes 3 months to become use to a budget (Dalton et al). This means that if you are rocking with your budget and you get a raise, it will likely take you 3 months to get use to your new budget. Same with if you buy a car and now have a car loan payment, it will take you about 3 months to get use to making those payments and making it a part of your budget. Practice, practice, practice, and do not give up! The results are well worth the time you put in to planning your money.
Special Considerations
- Determine Saving: By including a section to save a portion of your money, you are able to visually and physically allocate funds for the future. Savings can be on a pre tax basis from your payroll deductions like retirement. It can also be a post-tax basis from your net income by putting it aside for an emergency fund, your next car, your next house, or a vacation. These post-tax savings goals are known and unknown upcoming expenses. Known expenses such as a house down payment are simple to save for as you know how much money will be needed for the expenses. It is crucial to prepare for the unknown through an emergency fund although it is slightly more difficult to plan for emergencies that may occur. An emergency fund is meant to cover unforeseen financial expenses such as medical bills, plumbing problems, a car breakdown, and so forth. Financial planners recommend creating an emergency fund that covers at least 3 months of month non-discretionary expenses. Read emergency funds for more information.
- Debt Payments: Debt payments include mortgage payments, auto loans, student loans, credit cards, and any other outstanding account balances. For more information check out debt management for strategies and tips on how to control debt instead of letting it control you.
- Insurance: After debt payments, you’ll list out all of the insurance payments you have for one month. Insurance payments typically include renter’s or homeowner’s insurance (unless it’s added in to the monthly cost), auto insurance, life insurance, and health insurance. There may be more in your life, so if there are be sure to add them to your budget!
- Bills: Bills and living expenses can often be the main focus of a budget as they consist of the primary expenses that individuals (young and old) experience. Some financial planners do not separate bills from expenses, however for the purpose of this article they have been separated. The distinguished items allow individuals to prioritize their expenses and clearly see what expenses are discretionary (non-essential) and non-discretionary (essential). All bills are non-discretionary which basically means they are nonnegotiable. No matter what, these expenses must be paid each month.
- Living Expenses: These expenses are purchases you make in relation to your lifestyle. How many times you eat out and what grocery stores you shop at determine the amount of money you spend on food. Same with the type of car you drive and the commute to work also contributes to how much you spend on gasoline in a month. Food and transportation specifically are month non-discretionary expenses while the rest shown are discretionary. This means that other than food and transportation the remaining items could be eliminated from the budget because they are not essential.
- Food (smart to separate groceries from eating out)
- Transportation (gasoline and maintenance for vehicles)
- Clothes
- Subscriptions
- Gym memberships
- Entertainment
- Miscellaneous
- Understanding the difference between essential (non-discretionary) and nonessential (discretionary) expenses will help you in the event of loss of income when you no longer can afford all the usual items in your budget. Read emergency funds for more information.
- Establish Goals: Before you write out your budget you need to write down your goals. Short term and long term goals are important and will play a part in how you create your budget. Think about the goals you have. Common goals include purchasing a home and/or car, earning a degree, owning a business, writing a book, vacationing, traveling the world, and many more. Some of these goals should be saved for (education and travel) while others need to be paid for (home and cars). If you implement your goals into your budget, you maximize the potential of accomplishing them when and how you want. That’s really what budgeting is all about; creating a plan to accomplish your goals, hopes, and dreams.
- Determine Income: A key element to preparing a budget is to do so before you actually receive any income, so before your next paycheck and before the month begins. This is crucial because you are not tempted to spend your earnings before creating a plan for how you really want to spend them. Determine all types of income you will receive such as wages, gifts, refunds, etc. (Dalton et al). All that money that comes to you should be considered income. This includes $5 you find on the sidewalk. This should be treated as income, not random money that comes into your wallet and right back out. A common technical issue is that some individuals do not know what their income will be before they receive it. This can occur when a person is paid by the hour, by the contract, or by commission.
- Tithes And Gifts: Once you have determined your budgeted income, you can move on to tithes and giving. Tithing is a command brought to us in the Old Testament and mentioned again as a something Christians should do in the New Testament. Deuteronomy 14:22 states: “Be sure to set aside a tenth of all that your fields produce each year.” Again in Proverbs 3:9 it says: “Honor the Lord with your wealth, with the first fruits of all your crops.” While Christians no longer set aside produce anymore as an offering to the Lord, we set aside the first 10% of our income to give back to the Lord through our local church as a tithe. This is why tithes are recorded just below income on the budget. Additional gifts after tithes such as donations, sponsorship, etc. can be recorded below the tithes.