Whether you’ve just filed your bankruptcy or proposal or have completed your program, now that your debts are dealt with, your next step is to think about finding better ways to manage your money. One tool is a monthly budget.
While most people think of budgets as constraints, we like to think of a budget as nothing but a plan. We gave you a plan to be debt free; now you need a plan to stay that way.
However, budgeting can seem daunting, especially if you’re a beginner. This article will answer some key budgeting questions and will hopefully help you create your first budget. Follow these tips to create a budget and learn more about how budgeting can help you move from struggling to pay expenses to setting aside some savings.
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What is the first rule of budgeting?
A budget is a plan of how you will spend your money. It helps you identify your expenses before the month even begins so you can spend your money more responsibly.
The first rule of budgeting is to give every dollar a purpose. This isn’t the same as spending every dollar that comes in on your paycheque. It means you allocate all your income to something specific. That might be paying for living expenses, building some savings or making a debt payment.
A budget helps you avoid the temptation to overspend. It makes sure you don’t run out of money by payday, so you don’t use your credit card to pay for things. Your budget should never be balanced with debt.
Basic elements of a budget
Before creating a monthly budget, it is essential to understand the different elements of a budget, including monthly income, fixed and variable expenses, discretionary expenses, and savings.
Your monthly income is how much money you have coming in that is available to pay bills and save. When creating your budget, you want to record your net income. If you are employed, simply record your net pay from your paycheque.
If you are self-employed, you may want to create a separate business and personal budget. After deducting your business costs, move your net business income to the income line in your personal budget.
These are expenses that stay the same month after month and include mortgage, rent, and insurance. If you have a fixed phone plan, this also counts as a fixed expense. Generally, these are expenses that are easy to identify but hard to alter.
These expenses change every month depending on use. For example, your electricity bill changes from month to month. Variable expenses include utility bills, transportation, and groceries. While these are ever-changing, you can account for them in your budget through approximation. Do yourself a favour and over-estimate these expenses, so you don’t get a negative surprise at the end of the month. It’s better to over-plan than run out of money.
These are expenses that aren’t necessary – they’re wants rather than needs. While groceries are a necessary expense, entertainment is not. Examples of discretionary expenses include dining out, hair treatments, streaming services, video games, and gifts. You don’t have to give all these items up. That’s not what budgeting is about. But knowing what is discretionary spending is how you can find things to reduce if you have more money going out than coming in.
Emergencies are inevitable, and it is important to plan for them when making your budget. Unplanned expenses include replacing damaged items, unexpected healthcare needs, and emergency travel.
Saving for a rainy day is what keeps people out of debt. Even a small emergency fund is helpful. Long-term savings is what you set aside to spend in the future – a vacation fund, your retirement plan or an RESP for your children.
Organize your budget
An organized budget allows you to see everything for what it is without any clutter. Income and expenses are usually grouped together in categories.
Categories and line items
Categories and line items are useful since they group expenditures and make it easier to track. This organization clearly shows where your money is going and can be extremely helpful when trying to change spending habits.
Categories differ from person to person and depend on spending habits and lifestyle. Common budget categories include housing, food, transportation, medical costs, personal care, clothing, and entertainment. Adding a “miscellaneous” category is useful since you may have spending that isn’t budgeted for in other categories.
You can break these items down further if you want, but don’t feel pressured to have a thousand categories. Too much detail is going to frustrate you and make keeping track a chore. Budgets often fail because people get tired of maintaining them. Keep it simple, and you are more likely to continue.
Common expenses you shouldn’t forget
You can be as thorough as possible looking through bank statements and old credit card bills and still forget to budget for some expenses. Make sure not to forget these common expenses when creating your budget, which is easy to do as they often come once a year:
- Home & car maintenance costs
- Annual insurance premiums, licenses, and registrations
- Holiday and celebratory gifts
Choose a budgeting method
There is no one right budgeting method that will work for everyone. Some people will love tracking on a spreadsheet; others are comfortable with online budget apps. Others won’t want to track at all but do want to manage their money better.
Here are some budgeting methods that work well for someone just starting out with their first budget and who may be working with a limited or stretched income.
Paying yourself first
This budgeting strategy treats savings and investments as bills. By putting money for savings aside, you’re essentially paying yourself before paying any of your other bills. This prioritizes your savings goal by getting it out of the way first. This is not about paying yourself before your rent, but it is about setting aside even a small amount before spending on discretionary items.
You can start out small – $5 or $10 a week. Increase this slowly as you get comfortable with how much you can save. Set this money aside into a separate bank account to make sure you don’t tap into it except for its planned purpose.
Paying yourself first is a very good budgeting system for those who want to focus on building savings.
The modified ‘envelope’ system
Relying on credit cards to pay for things can quickly lead to overspending. That’s why a cash-only budgeting approach is popular for those starting out on a new journey of building better spending habits.
It’s true we don’t live in a world where we can pay for everything with cash today. No problem. With so many online banking options, you can use separate bank accounts as your envelopes. Just make sure these accounts have no banking fees for anything, including money transfers, debit transactions, and withdrawals at a bank machine.
Different bank accounts stand for different categories in the modified envelope system, and these accounts are each filled with specific amounts of money. The money can only be used for those specific purchases. Once the money is gone, you have to wait until the next month or paycheque (depending on what time period you choose to replenish your accounts).
The modified envelope system is a good budgeting approach for those who want to avoid overspending.
Pay your bills as you go
This is the opposite of the paying yourself first method of budgeting. With the pay your bill as you go budgeting system, you prioritize bill payments by making a small payment towards your monthly expenses every time you get paid.
If your cell phone bill is $120 and you get paid every week, you pay $30 each week. For items you can’t pay online, you can set aside money each pay period. For example, if your rent is $1,100 a month and your landlord prefers a cheque, set aside $275 each weekly pay in your ‘rent’ account so the money is there come the first of the month.
You can do the same for large annual costs, setting aside some money from every pay to cover these when they come due. Once you have your non-discretionary costs and any planned savings set aside, everything left over from your paycheque is yours to spend however you like.
The pay as you go budgeting method works well for those who do not like to do a lot of tracking but want to stay on top of their bills.
What is a realistic budget?
When budgeting, it is important to remember that this should be true-to-life. If you have student loan payments and credit card debt, it will obviously take you longer to save. If you are closer to retirement, you may need to focus harder on saving for retirement. All these factors should be taken into account when making budgeting plans and adjusting your spending.
A realistic budget is honest and considers all expenses carefully. When making your first budget, it can help to look through previous bank statements and credit card bills to learn about your spending habits. Another approach is to do a 30-day spending plan. This can be done manually or with the help of software such as Mint and GoodBudget.
Most importantly, a realistic budget is one that works for you. Only you can decide what your future financial goals are. Set a first budget that’s reasonable and creates the future you want to build. See how it goes, consider it a draft budget, adapt and change as you learn.