by Maurie Backman | April 11, 2019
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Following a budget is a smart move -- but be sure to incorporate one key line item.
Many people reject the idea of budgeting because they find it tedious or assume it'll be time-consuming. In reality, budgeting is one of the most effective money management tools out there.
With a budget, you can track your spending so that you're able to see what each individual expense you incur costs you. You can also identify ways to reduce your spending if you find that you're overdoing it. And while creating a budget does take some time, it's not something you need to devote an entire weekend to. Chances are, a few hours is all it will take to get your budget set up.
To create your budget, review your bank and credit card statements from the past year to see how much you spend, on average, on your recurring monthly expenses. These might include things like housing, transportation, food, utilities, healthcare, clothing, and leisure. Next, factor in once-a-year expenses, like your annual warehouse club renewal fee, and make sure you're allocating money for them month after month. For example, if you have an annual license renewal fee that costs $600, set aside $50 a month for it. Finally, compare your total spending to your total earnings and see how the numbers align.
Now you might go through those motions and find that you're breaking even at the end of each month. And as long as you're not spending more than what you earn, you're in decent shape, right?
Spending down your entire paycheck regularly means you're neglecting one key component of your budget -- your savings category. If you don't incorporate savings into your budget, you're doing yourself a major disservice.
Many people forget to include a line item for savings in their budgets, and as such, don't contribute any money toward their emergency funds or retirement plans month after month. That's a dangerous pattern to uphold. Without emergency savings, you risk going into debt the moment an unplanned bill lands in your lap, which is why you should always aim to have a minimum of three months' worth of living expenses in your bank account.
Once you have a fully loaded emergency fund, your next focus should be retirement savings. If you're contributing to a 401(k) through work, it means that money is getting deducted from your paychecks automatically. If that's the case, and you're basing your budget off your take-home pay, then you're fine to not include an actual line item for savings unless you have another goal you're supposed to be socking money away for (like buying a home, for example). But if you're saving for retirement in an IRA that isn't set up for automatic transfers, then you'll need to allocate money in your budget each month for that purpose.
How much money should you be saving? If we're talking about retirement, your goal should really be at least 15% of your income. If you can't swing that right now, save something and work your way up from there as your earnings increase or you find ways to cut back on other expenses. Just don't forget to include a place for savings in that budget. Otherwise, you might forget it -- and regret it later on.
Automating your savings is the best way to ensure that you stay on target. If you arrange for a portion of each paycheck to land in a savings or retirement account, you won't have to worry about factoring it into your budget because your take-home pay will be reflective of those automatic contributions. If you're saving manually, you must make sure there's room in your budget for it, and start cutting back immediately if that isn't the case.
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