Contributing Writer at Tally
January 12, 2022
When creating a monthly budget, you‘ll likely divide your expenses into a few different categories. While these categories can range from person to person depending on their financial situation, they generally cover three primary areas:
Your "needs" are rather straightforward. These are expenses you don't have a choice in paying, like your rent, mortgage payment or groceries. Paying off debt and setting aside money in a savings account are also pretty self-explanatory. Putting money into the “needs” category is not going to harm you financially.
The one area that can serve to derail your budget is "wants." But by creating a monthly expenses list and identifying wasteful purchases, you can cut unnecessary spending to help you stick to your budget and reach your financial goals.
Wasteful spending is a pretty big problem across the country. One recent study found that the average adult in the U.S. spends $1,497 a month on non-essential items, adding up to roughly $18,000 per year. This has a ripple effect that can impact your personal finances.
If you lower your discretionary spending, you may be able to pay off debt more quickly. This, in turn, will reduce how much you pay in interest and allow you to focus on other financial goals, like saving for retirement.
Furthermore, cutting back on discretionary spending could potentially prevent you from having to take on debt in the first place. For instance, let's say that, instead of buying nonessentials, you put money in a bank account for a rainy day or emergency fund. This money is then available when an unexpected expense arises, like a medical bill.
If you don't have cash on hand, you may need to pay these expenses using a credit card or personal loan, thus entering a cycle of debt repayment. When you consider that the average American has roughly $90,000 in debt, it's easy to deduce that cutting back on wasteful spending can improve your personal finances.
When you create a budget, you’re implementing a tool that you hope will hold you accountable. Your budget is representative of cash flow — money in vs. money out.
Identifying your monthly income is pretty straightforward. You probably know your gross pay, as this is your salary or hourly wage. To identify your net income, you simply need to look at your paystub or bank account to see how much you receive each pay period, whether that be weekly, bi-weekly or monthly.
Once you know your take-home pay, you need to figure out where your money is going.
As mentioned earlier, there are three high-level budget categories you'll likely lump your expenses into:
Debt payments or savings
As a rule of thumb, it’s smart to stick to the 50/30/20 budget rule. This means you’ll allocate 50% of your take-home pay to needs, 30% to wants and 20% toward your efforts to pay off debt or save money.
Within these categories, however, it’s wise to hone in on precisely what your expenses are. The more accurate your monthly expenses list is, the greater the chance that you'll stick to your budget. That's because you’re reducing the likelihood of surprise spending.
Though unexpected expenses are ultimately unavoidable, they can derail your budget — especially if you don’t have cash on hand in an emergency fund to cover the cost. The more you can predict your expenses, the greater the likelihood of success you'll have when budgeting.
To create your monthly expenses list, start by identifying — off the top of your head — the things you pay for each month. You'll likely find that a lot of these expenses are "necessities." You know you have to make these payments for you and your family. They may even be the expenses that stress you out or keep you up at night.
Rent and mortgage payments
Student loan payments
Child care or daycare
Transportation costs for work, like gas and tolls
Alimony and child support
Personal loan payments
Minimum monthly credit card payments
Cell phone bill
Some of these expenses are fixed expenses set by lenders. Your interest rates and payment terms are predefined by your lender, and there’s not much you can do to change them from month to month.
Sure, you may be able to refinance your loan. Perhaps you move into a home with a cheaper mortgage. Maybe you sell your car and take public transportation instead. But these decisions are major life decisions compared to, say, skipping a meal out with your friends.
There are also other fixed expenses on the list that cannot be changed, though they aren’t necessarily tied to lenders. Child support and alimony payments, for instance, are pre-determined and set by the courts.
Lastly, some of these expenses are variable even though they are a part of your “needs.” For example, you need to purchase groceries each week. But you can make choices at the grocery store that will directly influence the size of your bill.
Once you've identified your necessities, it's time to identify your discretionary expenditures. Again, you can start by making a list off the top of your head. But you may need to go through your bank or credit card statements for a refresher as well.
These discretionary expenditures can include:
Subscription services like Spotify, Apple Music, Netflix and Hulu
Nights out and meals at restaurants
Movies and concerts
If you’re going to stick to your budget, you may need to cut back in some of these areas. You have much more flexibility to cut spending in these categories than you do in others.
Life is about balance. Cutting discretionary spending out of your household budget altogether is rather unrealistic. Instead, try sticking to the 50/30/20 rule, and allocate no more than 30% of your take-home pay to discretionary expenses. How you choose to spend this money is completely up to you, as long as you’re paying all of your "needs" and putting money toward debt payoff or savings.
While the 50/30/20 rule is a great guideline, it may require some tweaking to meet your needs. You may decide to spend less than 30% of your net income on discretionary expenses in order to spend more on needs, debt payoff or savings.
So, what are some ways you can cut back in this category? Try focusing on compromise:
Instead of buying coffee from your local cafe every weekday, perhaps you only do so once or twice per week. If each cup of coffee from the cafe normally costs you $5, this change alone could save you around $800 or more per year.
Instead of going out to eat every weekend, perhaps you only go out to celebrate someone's birthday. On a normal weekend, you may stay in and play games or watch movies.
Focus on your subscription services. Do you really need to have Netflix, Hulu and HBO streaming services? Try picking one of them. If you cut two subscriptions, you could save $20 or more per month.
When it comes to budgeting, it's important to remember the big picture. You may not need to make drastic changes to your financial management structure. Instead, focus on making smaller changes.
Over time, these changes will become habits. They’re more manageable, which means there’s a greater chance you'll stick to them. And, more importantly, a bunch of small changes can add up over time.
Creating and holding yourself to a budget can be challenging. An accurate monthly expenses list can go a long way toward increasing the likelihood that your budget really works. The more accurately you can predict your monthly cash flow, the more likely you are to stay on track with your budget.
Your monthly expenses list will broadly cover three categories: needs, wants and debt repayment or savings. You'll want to divide your actual monthly expenses into these categories. You have less flexibility with needs and debt repayment than you do with your wants, otherwise known as your discretionary spending.
One long-term strategy to free up cash flow is to pay down debt. Doing so will ultimately save you money on interest and free up cash for other expenses.
If you're looking to pay down credit card debt, consider Tally†. Tally is a credit card payoff app designed to help you pay down debt quickly and efficiently, putting you on the path to financial freedom.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.