Learning Outcomes
- Describe budgeting strategies and the pros and cons of budgeting
Budget
The term budget is unpleasant to some people because it just looks like work. But who will care more about your money than you do? We all want to know if we have enough money to pay our bills, travel, get an education, buy a car, etc. Technically, a budget is a specific financial plan for a specified time. Budgets have three elements: income, saving and investing, and expenses.
A budget is a specific financial plan for a finite amount of time. For example, you can set a budget for your family for a year.
Income
Income most often comes from our jobs in the form of a paper or electronic paycheck. When listing your income for your monthly budget, you should use your net pay, also called your disposable income. It is the only money you can use to pay bills. If you currently have a job, look at the pay stub or statement. You will find gross pay, then some money deducted for a variety of taxes, leaving a smaller amount—your net pay. Sometimes you have the opportunity to have some other, optional deductions taken from your paycheck before you get your net pay. Examples of optional deductions include 401(k) or health insurance payments. You can change these amounts, but you should still use your net pay when considering your budget.
Some individuals receive disability income, social security income, investment income, alimony, child support, and other forms of payment on a regular basis. All of these go under income. During school, you may receive support from family that could be considered income. You may also receive scholarships, grants, or student loan money.
Saving and Investing
The first bill you should pay is to yourself. You owe yourself today and tomorrow. That means you should set aside a certain amount of money for savings and investments, before paying bills and making discretionary, or optional, purchases. Savings can be for an emergency fund or for short-term goals such as an education, a wedding, travel, or a car. Investing by putting your money into stocks, bonds, or real estate offers higher returns at a higher risk than money saved in a bank. Investments include retirement accounts that can be automatically funded with money deducted from your paycheck. Automatic payroll deductions are an effective way to save money before you can get your hands on it. Setting saving as a priority assures that you will work to make the payment to yourself as hard as you work to make your car or housing payment. The money you pay toward saving or investing will earn you back your money, plus some interest. Compare these investment earnings to the cost of buying an item on credit and paying your money plus interest to a creditor. Paying yourself first is a habit that pays off!
Pay yourself first! Put something in savings from every paycheck or gift.
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Categorizing Expenses
Expenses are categorized in two ways. One method separates them into fixed expenses and variable expenses. Rent, insurance costs, and utilities (power, water, gas, etc.) are fixed: they cost about the same every month and are predictable based on your arrangement with the provider. Variable expenses, on the other hand, change based on your priorities and available funds; they include groceries, restaurants, cell phone plans, gas, clothing, and so on. You have a good degree of control over your variable expenses. You can begin organizing your expenses by categorizing each one as either fixed or variable.
A second way to categorize expenses is to identify them as either needs or wants. Your needs come first: food, basic clothing, safe housing, medical care, and water. Your wants come afterward, if you can afford them while sticking to a savings plan. Wants may include meals at a restaurant, designer clothes, video games, other forms of entertainment, or a new car. After you identify an item as a need or want, you must exercise self-control to avoid caving to your desire for too many wants.
Without a personal budget, most people have a hard time gauging how much money they spend and where their money goes. If you have ever gone to an ATM to withdraw money and been surprised to discover how little you had left in your account, this section is for you. It’s also for anyone who wants to learn how to manage their money better and smarter—which is an invaluable skill to have not only during the penny-pinching years of college but also later on in life.
Categorize your Expenses
List the last ten purchases you made, and place each of them in the category you think is correct (Fixed and Variable, or Need and Want).
Even though you might find the need to cut the number of times you go to the movies each month, effective budgets still factor in leisure activities.
Budgeting Strategies
Even if you’re very conscientious about paying your bills on time and generally have frugal spending habits, creating and following a budget can put you so much further ahead. In essence, a budget is a plan for how you want to spend money. It details how much money comes in each month and how much you’ve allocated for spending on each thing. The virtue of a budget is that it puts you in control of financial decisions—so you can avoid surprises at the ATM or at the end of the month. Let’s look at some strategies for creating a budget:
- Be realistic: People are often intimidated by budgets because they’re afraid the plans will be too strict or force them to cut back too much. Though a budget may reveal that you indeed spend a lot of money on clothes, that’s okay—it may just also need to show that you spend very little on restaurants and eating out to make up for it. Again, it’s about making choices and being realistic.
- Choose a timeline: Creating a budget for a fixed period of time will help you monitor whether you’re meeting your financial goals. The timeline you choose is up to you and your goals. For example, you might create a monthly budget to monitor how you spend your paycheck every month.
- Add financial padding: Even if you feel like your list of financial obligations is already long, try to set aside a certain amount each month for a rainy day fund to pay for unforeseen expenses and emergencies, like car repair, lost textbooks, etc.
- Make adjustments as needed: While sticking to your budget is important, there’s nothing wrong with revisiting and adjusting your original targets. For example, if you find that you are actually spending $50 more per month on groceries than you intended (even after shopping for sale items), you may decide to save that money elsewhere in your budget next month—on entertainment, for example.
Pros and Cons of Budgeting
While budgeting can be a useful financial tool, it may not be for everybody. Some people may feel more confident by balancing their checkbook to see how much they have at any given time. Still, many argue that budgeting helps people stay on track and avoid overspending on wants such as restaurant food, clothes, and entertainment, so they always have enough money for needs, such as rent/mortgage, utilities, and food. The following lists summarize the advantages and disadvantages of budgeting.
Budgeting Pros
- Provides a realistic view of personal finances: A personal budget provides an honest snapshot of how much money you make and how much you can spend. It can help you avoid deceptive financial thinking, such as believing that you’re flush right after pay day when you really need to save that money for an upcoming bill.
- Helps you avoid excess spending: Because a budget gives you insight into the total picture of your income and expenses, you can make realistic decisions about spending. As above, a budget can help you avoid having a faulty sense of your financial resources and remind you that even if you just got paid, most, if not all, of your check may need to go toward fixed expenses.
- Assists in goal setting: Since you get to decide how to allocate your money, a budget can help you set goals. For example, if you create a yearly budget, you could plan and account for an upcoming family trip and start saving money for it in advance without worrying about having the money at the last minute.
Budgeting Cons
- Budgets take energy: Planning a budget takes dedication. Since most students lead busy lives and are balancing different demands like work, school, and time with family and friends, it can be easy to slip up. For example, if you have a stressful week at work or school, you might overspend while going out with friends and forget how much you budgeted for leisure activities.
- Results take time: Since most budgets cover a time period of a month, year, or even longer, people may become frustrated waiting to see if their financial situation is better than it was before. Frustration can lead people to abandon their budget and go back to overspending or neglecting to save.
- Budgets may be strict: Remember that one of the important strategies for creating a successful budget is earmarking money for treats and extras such as entertainment. However, in an effort to become more financially disciplined, some people make budgets that are too restrictive and unrealistic. Severe budgets can backfire and lead to overspending in one area or abandoning the budget altogether.
glossary
budget: a specific financial plan for a specified time, consisting of three elements: income, saving and investing, and expenses
gross pay: the larger paycheck amount that is listed on your pay stub prior to deductions for taxes
net pay: the smaller paycheck amount that remains after taxes and other deductions; this is the number you should use to plan a budget
