Budgeting Basics - What Is Budgeting?
Many people think of budgeting as something to do when they're short on cash. College students might turn to a budget to figure out how to make due with their high expenses and limited incomes. Wise new grads create budgets to make sure they're properly allocating their first paychecks among emergency savings, retirement savings, student loan repayments, rent and utilities, and rewards for their hard work like new gadgets and nights on the town. 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. Of course, budgets are commonly associated with people of all ages who are barely able to make ends meet.
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 alike. In fact, budgeting will be that much easier in times of change if you 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.
Let's look at some ways budgeting can help you achieve your goals. A good budget will help you do all of the following:
Make Long- and Short-Term Projections
A budget will help you plan for short-term expenses, like your monthly bills, and mid-term expenses, like vacations, as well as long-term expenses, like buying a house, paying for a child's college education and putting money away for retirement. When you have a spreadsheet or notebook in front of you showing how much money you expect to make over the next few months (or years), how much of that money goes out every month and how much you 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. And if you're not happy with the numbers, knowing what they are will help you take steps to improve your situation, whether that means focusing on paying off credit cards to increase your monthly cash flow, or getting a promotion or switching companies so you can make enough money to afford everything you need and want. (For more, read Increase Your Disposable Income.)
Prevent a Crisis
Let's say a significant expense arises unexpectedly: 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 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. 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 have already been depleted by another recent emergency, your budget will help you determine what expenses you might be able to postpone or shift around 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 you can see 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. Also, you may not have to pay the bill immediately. 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 two or three 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 if at all possible to avoid paying interest.
Your budget will also give you an idea of how long it will take you to replenish your depleted savings once you pay off your dental care. (For more insight, read Build Yourself An Emergency Fund.)
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 and lunch time, or the hours of free time that get lost because you're too tired from working all day to 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 MP3 downloads 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, 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 that vacation.
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 stays home to raise a child, you'll have the data you need to crunch the numbers. You'll find out before you make any change whether you can afford it and what sacrifices you might need to make. (For more on finances, read Get Your Finances In Order.)
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.
Those stops might include:
- having a child
- starting your own business
- going back to school
- taking an extended vacation
Now that you know why you need a budget, let's talk about how to set one up. We even give you a downloadable spreadsheet to get started.
Budgeting Basics - Setting Up A Budget
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