3 Easy Steps to Creating a Smart Budget
Reading time: 4 Minutes
By Frank Bass
One of the most important steps toward becoming financially secure is creating a spending plan for your money. Budgeting your finances will allow you to save money, make the most of what you earn and help you reach your goals. Don't worry! Creating a budget is easier than you might think. By sitting down and reviewing your income and expenses, and organizing them a bit, you'll be able to create a plan that puts you in control of your finances and out of debt. Just follow these three simple steps when making your ideal budget:
1. Set Realistic Goals
For some, budgeting goals are simply emotional, such as having peace of mind that you're prepared for a rainy day or that your bills can be paid. For others, goals will be tangible, such as taking a summer vacation or buying a new car. Regardless, most people can't have it all.
Think about what you want, when you want it, and how much you'll need to save. Then prioritize which goals make most sense for you.
"There is no point in setting goals that you know you'll never reach," says the non-profit National Endowment for Financial Education. "On the other hand, you want your goals to be challenging enough that you feel a sense of accomplishment when you reach them."
So what's more important to you: The vacation or the car? The new house or summer camp for the kids? The rainy-day fund or the boat? Is this the year for your dream trip to Paris, or due to added expenses like a new baby or home purchase, is it more realistic to focus on boosting savings?
Whatever it is, once you've set your goals, you'll want to set aside some money each month to get there.
2. Manage Expenses
Achieving your budgeting goals could mean cutting back on spending. But that doesn't always have to be painful.
For example, take a look at last month's grocery bill. If you don't shop with a list or look for bargains, doing so could find you an extra $50 a week. That's $200 a month that you could put toward a goal. With that $2,400 a year, how long would it take to reach the goal you set?
On the other hand, some goals feel so daunting that $50 doesn't cut it. Stefanie O'Connell, author of The Broke and Beautiful Life, advises people to “put your focus and energy into reducing your greatest costs, like housing, where a 10 or 20 percent reduction could mean hundreds of dollars in savings — as opposed to trying to scrimp and save on smaller costs, where you might save a couple of bucks here and there." For example, refinancing your mortgage at a lower interest rate can save you a substantial amount over the course of the loan.
The method you prefer often comes down to personality, personal preference and extenuating circumstances (not everyone can drop their monthly mortgage payment by 20 percent; others may see that amount as one of their goals for the year). Your local banker can be an invaluable source of assistance in figuring out how you can manage your money more wisely. They can also help you plan for a rainy day or for when you come into money. (Cha ching!)
3. Prepare for Ups and Downs
The Federal Reserve Board estimates that almost half of all Americans couldn't come up with $400 in cash for an emergency. You don't want to be one of them. One car accident or emergency room visit could tank all your hard budgeting work, and send you into debt.
The general rule of thumb is that an emergency fund should sock away nine months' worth of your expenses so if you lose your job or can't work for an extended period of time, you can still eat and pay rent. This amount should be enough to also cover a major medical emergency, assuming you also have health insurance.
Or, you can start small. Aim for a three month emergency fund, and see how long that takes to save. Or incorporate a way to save $1,000 in your initial budget, and treat yourself to a nice dinner once you hit that milestone—then set another goal.
On the flip side, coming into large sums of money, like a large tax return or bonus, is a temptation to spend. Stop and think about how you'll incorporate anticipated income into your budget this year. Will you pay off a high interest credit card debt? Will you apply it towards a savings goal for that new boat? Or should you put it away for a rainy day? Whatever you do, make a plan.
By having a forward-thinking budget that addresses the needs of the entire year, you position yourself to achieve financial success. Once you've figured out your goals, assessed your spending and made a plan, in a year, you can look back with satisfaction on how far you've come.
Frank Bass is a writer specializing in finance, business, politics, demographics and data-driven journalism.