Budgeting 101: How to Plan for Financial Success

Budgeting is an important skill to develop for anyone looking to have a better handle on their financial success. Put yourself on the path towards smarter money management.

Why Budget?  

One of the most crucial components to successfully planning for your finances is having a budget, no matter how small or large your paycheck is. A budget can be really helpful if you need to save some money to pay down a debt, plan to own a house, or want to go on a vacation, as it helps us understand how much to spend and save based on your own goals and income. 

While many see budgeting as living frugally and restricting spending, it is really more focused on knowing how much money you have coming in and going out, so you can optimally live off of your means and even plan for the future. Even better, budgeting can be simple by following three basic steps. 

Keep Track of Your Money 

It’s important to be aware of money you are making (i.e. positive cash flow), and money you are spending (i.e. negative cash flow) within a certain time frame. This could be weekly, or biweekly, but the easiest and most often used time-frame is monthly, as most large expenses (i.e. rent, utilities) occur on this basis.  

First, let’s focus on money coming in - this step is pretty simple. What is the actual dollar amount you are getting in your paycheck after taxes? Next, think about any other streams of money. Birthday money or other cash gifts this month? End of year bonus? Add any extra cash coming in to the positive side of your budget. 

Fixed Costs vs Variable Costs 

Now, let’s focus on money going out, or total expenses. This step can often be more complicated because of how many different expenses we can have on a daily basis! To break it down into simpler bits, let’s think about expenses month to month as either fixed or variable costs, and essential vs nonessential costs. To get an idea of what may count as a fixed vs variable cost, as well as what items may be essential vs non-essential, see the chart below. 

To put it briefly, fixed costs are expenses that do not change month to month, while variable costs are expenses that may. Essential expenses are necessary to your life, while nonessential expenses are "wants" that you could live without. It's important to distinguish between expenses in this way because it will help us understand where we can reduce or increase spending if the need arises while devising a budget.  

Take Account of Your Expenses 

Now that you have a better sense of fixed vs variable expenses, how can we account for these in our budget?  

Below, we’ve provided a sample table to do just that. To keep track of your total expenses, add up your fixed and variable costs to figure out your total expenses, or "Money Out." 

To reflect fixed costs, like mortgages, rent, subscriptions, car payments or public transit expenses, insurance (if paid monthly), etc., in your budget, simply add up the expected payment on each fixed expense you have. 

Reflecting variable costs, like groceries, utilities, clothing, etc., is more complicated as the dynamic nature of these costs means they are harder to expect and budget for. Take a look into your past activity (~6 months) to see what recurring variable expenses you have and what the average expense of each is. If you do not use cash and don’t have this information on hand, start keeping track of your spending in a notepad or spreadsheet over the next 2-3 months to give yourself a better estimate of spending. Use those estimates to make realistic assumptions of what you would like to spend on each category in the upcoming month. 

Income vs Expenses 

Next, add up your total income and total expenses, keeping in mind that your expenses are negative.  

After you have your income and expenses added up, there are some key things you may want to consider. First, do you have enough total income to cover your total expenses? If not, it may be time to prioritize essential over nonessentials. 

That is, what money are you spending on things you do not absolutely need? Are you overspending on clothing, takeout, or entertainment on a regular basis? If you are, it may be good to rethink your spending habits. Addressing overspending does not mean you need to cut out wants from your life, just that it may serve you to cut down. On the other hand, even if you are not overspending, there may be changes you could make to aid in creating a short- or long-term savings plan. 

Devise a Budget Plan 

When setting a budget, think thoroughly about your priorities and goals when figuring out how much you would like to spend. Even if you are not spending in excess of your income, cutting down on impulsive or excessive spending may help you grow your savings, an important part of financial planning. For example, you might find yourself wanting to save up to go on a $1000 vacation. If you saved $25 a month, it would take you 40 months to save enough money to go. Instead, if you saved $250 a month, it would only take 4 months. Therefore, if you are dreaming on going on your vacation now, or have plans to save up little by little long term, your financial goals month to month may look really different. 

Below is an example of how you can allocate money in your budget: 

Overall, no one plan will work for everyone, but a good general rule of thumb is to allocate 50% of income to living essentials like rent and groceries, 30% to personal expenses like shopping and eating out, and 20% to savings. Of course, what is essential vs non-essential may vary person to person, but the previous chart may be used as a general guide.  

Common Budget Mistakes 

Some mistakes people often make when it comes to a budget are actually easily avoidable.  

Underestimating 

People often underestimate their spending when devising a budget. This may lead to lower amounts of money left to be saved, or even spending in excess of income, causing debt in the long term. To avoid this, be more realistic about your spending habits. Don’t underestimate your spending when devising a budgeting plan, and make feasible month-to-month goals to reduce spending if needed, instead of ignoring the problem. 

Not Expecting the Unexpected 

Most people know how to plan for the expected, but what about unexpected life events and emergencies? To avoid going into financial trouble for things you can't plan for, make an effort to allocate money to a savings account on a regular basis. 

Impulsive Spending 

If you are prone to impulse shopping, try to shop with a friend to keep you accountable, stay away from online sites where you often find yourself making spur-of-the-moment purchases, and think about how you can use a product in the long run. (Hint: If you cannot come up with a long term use for an impulse purchase, don’t buy it!) 

Forgetting the Long-Term 

Budgeting is a lifetime practice that will put you in better shape financially in the short term and long term. Over time, your budget will change as you encounter life changes related to your job, family, and investments. This is why it’s important to track your progress, revisit your budget plan, and make necessary adjustments to reflect your present-day circumstances.