The Beauty of Budgeting

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By 

THE INVESTOPEDIA TEAM

 Reviewed by 

THOMAS J. CATALANO

on January 02, 2021

Can you name a Fortune 500 company that doesn't have a budget? Don't spend too much time thinking about it—because there aren't any. Successful businesses around the world have one thing in common: they budget their money. And they do it because it works.

But although making money and making a budget appear to go hand-in-hand, a 2013 Gallup poll found that only one in three Americans prepared a detailed written or computerized household budget.1Things may be improving somewhat: A Bankrate.com survey in 2015 found a much higher number said they budgeted. On the other hand, another 18% didn't budget, and a number of respondents answered "yes" to keeping the information "all in your head."2

If you're one of the non-budgeters (or sketchy budgeters), we'll show you how to get a better idea of how you spend your money by putting together—and sticking to—a personal budget.

Get Over the Terminology

Part of America's aversion to budgeting may be rooted in language. The word "budget"—much like the word "diet"—has negative connotations. Budgets and diets are viewed as restrictive reminders of things we cannot have. This is linguistic nonsense. A budget and a diet are both tools. If the tools are used properly, they lead to the desired outcome. Nobody dislikes the word "shovel," even though the use of the shovel requires effort. People use a shovel to dig a hole; they use a diet to develop a healthy body, and they use a budget to develop a fiscally responsible lifestyle. If it makes you feel better about the process, drop the word "budget" and call it a "spending plan." Instead of viewing the plan as restrictive, think about the things it allows you to buy. After all, a budget is nothing more than a plan for how you will spend your money.

Start with Your Bills

Many people complain that they can't create a budget because they don't know exactly how much money they will earn in a given week. While it is true that workers earning an hourly wage or working on commission might not get the exact same dollar figure in each paycheck, the amount that you earn has much less to do with the basics of budgeting than the amount you spend. Instead of focusing on whether you earn enough each month, focus on your monthly spending. The question is simple: where does your money go?

Regardless of how much you earn or when you earn it, everybody has fixed expenses, such as the following:

• If your recurring expenses don't add up to the amount of your monthly income (and one would hope that they don't), your next step should be to save the receipts from every purchase that you make next month and use them as the basis for creating additional categories or adjusting the numbers in the existing categories. Mortgage payments or rent
• Transportation (car payment, gasoline, train or bus pass, etc.)
• Utilities
• Food
• Insurance
• Healthcare

Beyond the Basics

Once you have the fixed expenses covered, it's time to plan for the variables, such as the following:

• Birthdays/holidays
• Gym membership
• Pet care
• Haircut
• Clothes
• Vacation
• Entertainment

These items are listed as variables for two reasons. The first reason is that these expenses vary from month to month. The second is that if you don't have the money to cover these expenses, the expenses can be reduced or eliminated without too much difficulty. For example, if you're out of money, the entertainment budget takes a hit, and you stay home on Friday night, or you don't buy those new shoes that you've been considering. Part of taking control of your money is learning how to exercise some discipline in your spending habits.

Look at Your Income

Now it's time to take the theoretical aspects of budgeting and apply them to your life. Take a look at your monthly income. How much are you bringing in on your worst month? Compare that number to the amount that you are spending. Ideally, the income is larger than the output. If so, it's time for a personal savings plan. In other words, don't spend everything you earn—save some for yourself. If you are spending more than you are earning, it's time to review your spending habits. When the expenditures are larger than the income, you have two choices: increase your income or cut expenses.

Strategies to increase your income include getting a new higher paying job, getting a second job, or finding a roommate to help you with expenses. Strategies to cut your expenses include eliminating impulse buys, which are a major expense for most people, and cutting out planned but unnecessary expenses. Keep in mind that simply cutting out that $3.00 cappuccino every morning can save you around $90 a month. The concept is quite simple—if it's not in your spending plan, don't buy it.

Create Your Spending Plan

Nearly everyone wishes for more money at some point. That said, all but the wealthiest among us are essentially living on a fixed income. In other words, you bring in a certain amount of money each month, and when it's gone, it's gone. Accepting that reality is the key to living a happier, wealthier life. Keep in mind that your creditors don't work for free, so spending money that you don't have is also incredibly expensive. Fortunately, getting your finances on track isn't that difficult. While there are spreadsheets and software programs designed to make the budgeting process faster and easier, all you really need is a piece of paper, a pencil, and the desire to live within (or even below) your means. The example below will help you get started:

Monthly ExpensesCostRent?Insurance?Transportation?Utilities?Food?Entertainment?Clothes?Emergency Fund?

As a general rule, you should also plan to set aside enough money to cover at least three months' worth of your expenses in case of an emergency. Once that money is put away, you won't need to rely on your credit cards should you lose your job or experience unforeseen expenses. Like every other recurring item in your budget, the emergency fund is something you fund one month at a time until you reach your goal.

The Bottom Line

Despite its negative connotations, a budget is really just a tool that can work to put your personal finances on the right track. If the most successful multi-million dollar companies must budget their spending, it makes sense that a typical household should have to control its expenses in a similar way. Budgeting your money need not be seen as a chore. After all, accepting the limits of your income is the best way to take control of your spending, live within your means, and, ultimately, reach your financial goals.