Money management comes from one of the most powerful practices in finance—budgeting. Unfortunately, not many people know how to budget or what types of methods are best to achieve financial success.
This guide will discuss everything you need to know about budgeting, including popular methods to handle your spending, saving, and debt payments.
How to Start Budgeting
To begin a budget, start by gathering all of your financial data from the last 12 months:
- All of your income
- All of your expenses
- All recurring bills
- All debt owed, including loans, mortgage, credit cards
You can find a lot of this information using your bank and card statements. Print them out or download the digital versions and thoroughly examine them.
Keep in mind your income, and consider the following:
- How much do I spend monthly?
- Where do most of my money go?
- Am I saving enough?
- What percentage of my income goes towards expenses?
- How can I cut costs to improve my net income?
- How can I become more frugal?
Reducing Expenses
Now that you have the big picture of your finances, the next step is becoming more efficient by cutting costs.
Budgets reveal that little expenses add up, such as impulsive buys, leisure purchases, travel costs, and more. Three ways to assess your costs include:
- Pen and paper: Some people are comfortable jotting down their income and expenses in a notebook, keeping track every month.
- Apps: Various apps categorize and track your spending every week, creating statements every month or year, such as Mint.
- Excel: Depending on your experience level, Excel can be beneficial or tedious, although the biggest companies in the world use Excel to allocate their budgets.
After you evaluate your expenses, look for inconsistencies where you can improve. Specific events often lead to irregular costs. Plan ahead for:
- Special occasions (birthdays, baby showers, etc.)
- Holiday spending
- Annual or monthly fees
- Medical costs
- Property taxes
- Childcare costs
Once your finances are more transparent, it’s easier to tweak your spending for a better budgeting future.
Clearing Out Debt
To get a handle on your debt, continue making monthly payments in full if possible. If you miss payments, the interest rate could increase, plus the debt will just keep growing.
For severe cases with loans, consider refinancing to alleviate monthly payments. Although it may take longer to pay off, refinancing could be a smart step toward consolidating your debt and managing it.
Setting Goals
Budgeting allows you to set goals you didn’t think were possible, such as buying a home, an investment property, or heading back to college.
Think of a percentage to save that is realistic to your objectives and your expenses. For instance, saving 20% is practical for some, while others can save 50%.
Set a timeline when you would like to complete your goal, and keep depositing the money in a separate account. Most banks offer savings accounts, with others providing high-yield savings that increase the interest rate.
Budgeting Methods
Once you begin budgeting, you may want to experiment with specific budgeting methods to tackle your debt payments and start building wealth sooner.
Debt Snowball
A popular debt management method is the debt snowball strategy, which disregards interest rates and focuses on the size of each type of debt.
To begin the debt snowball method:
- Assess all of your debts balance from smallest to largest
- Begin paying off the smallest debt first
- Continue until you have a “snowball effect” by building momentum, reducing each debt one by one
For example, if you have a hospital bill of $1,000, a credit card balance of $2,000, and a loan of $5,000, you would pay off the hospital bill first, even if the interest rate wasn’t the highest. Then, you roll the payment for the smallest debt into the payment for the next largest.
Debt Avalanche
The debt avalanche method involves eliminating your largest, highest-interest rate obligations first. Begin a debt avalanche strategy by assessing your debts by largest to the lowest interest rate.
For instance, let’s say you have a $2,000 at 15.9% credit card bill, a loan of 4,000 at 8%, and a hospital bill at 1,000 at 2%. You would begin paying the credit card bill because it’s the highest interest, and the goal is to reduce “toxic debt” by eliminating high-interest obligations.
Zero-Based Budgeting
An aggressive budgeting strategy is a zero-based method, where every dollar has a job.
All of the money you make goes towards your debt, savings, and expenses. It sounds like traditional budgeting, but the goal is to have your income minus your costs equal to zero at the end of the month. Every expenditure must have a reason, making this method tougher but perhaps more effective than others.
This method is similar to accounting practices, where assets, liabilities, and equity must balance at the end of every month.
Cash Only
Also called envelope budgeting, this method involves using cash only.
The cash-only method does not use credit cards or any other debt tools for payments. Instead, you allocate your cash every month to go towards your expenditures. Once your money is gone, that’s it for spending!
The 50/20/30
The 50/20/30 rule uses after-tax income, dividing the budget by the following:
- 50% needs: Pay all of your obligations with 50% of your after-tax income
- 20% savings: Stash away 20% of your income to future endeavors or emergencies
- 30% wants: Use 30% to treat yourself, such as traveling, dining out, or any other leisure activity
If you wish, you may adjust the allocation percentages to fit your lifestyle.
Value-Based Budgeting
As the name suggests, value-based budgeting involves allocating expenses by what you value the most.
For instance, set aside more money for traveling, as opposed to dining out.
Continuous Budgeting
Continuous budgeting is a company practice that can apply to personal finances.
Begin setting budgets for future periods, such as six months from now. Depending on your current situation, you may adjust the budget. For instance, if you had an emergency expense, you may have to reduce leisure spending or save money from cutting other costs.
Final Thoughts
Reading this guide about everything to know about budgeting is the first step towards proper money management.
Once you begin your first budget, venture out to other methods to reduce costs, eliminate debt, and increase your savings for a better future.