Budgeting is an invaluable skill to maintain stable cash flow and avoid financial crises down the road. It can prevent you from incurring tons of debt and even help you amass substantial savings for your retirement or other purposes. Still, if you build your budget on sound foundations this is probably the best way to save money.
One helpful way to create a bulletproof budget is to distinguish three types of expenses. Namely, your budget should be divided into needs, wants, and debt repayments.
Needs consist of spendings like mortgage payments. For example, you should include the cost of live-in care in this category. This class of expenses includes everything you cannot avoid.
Wants, on the other hand, are things that rarely come with a set monthly fee. They can be anything from dining out to spa visits.
Lastly, debt repayments include the money you use to pay down your debts, such as 401(k) or credit card payments. In the 50/30/20 budget, debt repayments should account for 20 per cent of your income.
To save you from having to browse the best budgeting books, here is an in-depth explanation of monthly expenses you should include in your budget:
You should allocate a certain amount of money to cover your needs every month. As we already mentioned, these are expenses you cannot avoid paying. They include mortgage payments, rent, and childcare costs. If you follow the 50/30/20 method, this class of expenses should never be less than 50 per cent of your monthly income.
Here are some of the expenses you can write down in your ‘needs’ column:
- Housing costs — Housing costs are the most significant expenses in any budget. They include mortgage or rent payments, property taxes, and homeowners’ insurance.
- Groceries — Food is a non-negotiable expense that you must include in your budget. This category includes anything you spend on groceries, including toiletries and cleaning supplies. According to a 2019 report from the Bureau of Labor Statistics, the average American family spends $387 monthly on groceries.
- Healthcare — Healthcare is another essential expense you need to factor in when creating a budget. It encompasses any medical bills you have to pay, including copays, deductibles, and prescriptions.
- Transportation Costs — This category includes all the money you spend on transportation, including fuel, car maintenance, and public transport fares.
- Insurance Premiums — Insurance premiums are the monthly payments for your insurance policies, including health, life, and auto insurance. The cost of insurance premiums varies widely depending on the type and amount of coverage you choose.
- Childcare Expenses — If you have children, childcare expenses should be a top priority in your budget. They include daycare fees, after-school care costs, and babysitting bills.
If you are struggling to make ends meet and your needs are eating up more than 50 per cent of your earnings, you need to either reduce your costs or increase your income. The best way to do that is by looking for a higher-paying job or starting a side hustle to supplement your earnings.
Wants are discretionary expenses that you can live without. They can include anything from travel and entertainment to gym memberships and cable TV packages. Ideally, your wants should not exceed 30 per cent of your monthly income.
Here are a few examples of wants:
- Entertainment — Entertainment is a discretionary expense that you can include in your budget if you have room. It covers activities like going to the movies, dining out, and taking vacations. How much you spend on entertainment will depend on your lifestyle and preferences.
- Clothing — Clothing is another discretionary expense you can choose to include in your budget. It covers anything from buying new clothes to dry-cleaning bills.
If you find that you are spending more on your wants than you can afford, you will need to reduce your costs. One way to do that is by looking for cheaper alternatives for the things you love. For instance, if you enjoy going to the movies, you could consider renting movies instead.
Debt repayments include any money you use to pay down your debts, such as student loans and credit cards. Depending on your financial situation, this category can account for a significant chunk of your monthly expenditure.
To keep your finances in order, it is best to set up automatic payments. This way, you will not have to worry about forgetting to pay your bills on time. Furthermore, this way of repayment will help you avoid paying late fees and other penalties.
In general, experts advise allocating 20 per cent of your income toward debt repayments. This way, you will be able to reduce your debt faster than if you did not stick to this number. However, this rule does not apply if you are in an extreme situation where your financial obligations exceed your income.
Creating a budget is not easy. This task can be much easier if you decide to use the 50/30/20 budget rule. It offers more flexibility than other budgeting techniques and is a great way to avoid going into debt.
Still, incorporating this budget rule into your finances requires some planning and effort. While it may not be the perfect solution for everyone, it will help you save money and improve your financial situation. Consider reading some good personal finance books to get yourself back on track with regard to your own budget.
Remember that budgeting is not a one-off action; it is an ongoing process. The key to success is to create a budget that fits your personal financial situation and stick with it. If you can do that, you will notice positive changes in your financial life.