Americans, as a whole, have some unhealthy spending habits. 65% of Americans don’t know how much they spent last month, according to a Mint study. Another study discovered Americans overspend by $7,400 per year.
A good way to get a handle on your personal finances is by setting a budget. A budget is essentially a blueprint that lays out how much you plan to spend over a certain period of time. That time period could be a day, a week, a month, a year — you get the picture.
Two-thirds of those surveyed indicated that they would feel much more confident about their financial health and security if they had a budget. Today, we’ll walk you through everything you need to know about budgets, including what they are and how they work. We’ll also cover the different types of budgets, and what you can do if you happen to overspend the budget you set for yourself.
A budget is essentially a spending plan used for financial forecasting. It estimates how much you intend to spend over a certain period of time. Budgets are based on your income and expenses.
Often, people view budgets in a negative light. They think of them as constricting and a way to deprive themselves. However, this is not the case. Budgets can be a positive tool. They allow you to take control of your finances and make changes for the better.
Many institute a budget because they have an end goal in mind. Perhaps that goal is to stay out of credit card debt. Maybe it’s to start saving for retirement, or else it’s to reach a savings goal, like building an emergency or rainy day fund. Whatever the case may be, the short-term downsides you feel from budgeting can result in long-term positive results.
Budgets work primarily by accounting for three things:
- Your income (positive cash inflow)
- Fixed costs (negative cash outflow)
- Variable costs (negative cash outflow)
Of these, your income and fixed costs are most predictable. For example, let’s say your budget period is going to be one month. You can look at your paystub or bank account to figure out how much you are paid each month, assuming you consistently work the same number of hours.
You also know what your fixed costs will be. These are costs that are uniform each month and can include things like:
- Car payments
- Student loan payments
- Personal loan payments
- Minimum monthly payments on a credit card
There are also variable costs, and some are harder to predict than others. For instance, if you have a car, it may be easy to estimate that you will spend $25 a week on gas. Perhaps you know that you spend roughly $150 per week on groceries. These types of variable costs may fluctuate, but many of us can at least roughly estimate these expenses.
On the other hand, it’s a bit more challenging to budget for unexpected variable costs. These can include things like replacing a flat tire on your car or paying for an emergency medical procedure.
The more personal line items or buckets you have in your budget, the easier it is to craft your financial plan. Meaning, the more you can predict in your budget, the less likely you are to throw off your budget with unexpected expenses. Using your expenses from last year can be a great starting point.
However, not everyone wants to track and categorize every single purchase they make. Luckily, there are different budgets to fit different lifestyles and personalities.
Although you should have structure to your budget, it should also be flexible. Your budget isn’t something that will stay the same over time. A flexible budget is necessary because life circumstances change. This includes both good and bad life events.
For example, if you are laid off from your job and begin collecting unemployment, your cash flow may not be what it was when you were employed. You may have to tighten the purse strings and adjust your budget to reflect these circumstances.
On the other hand, if you receive a promotion and raise at work, you can adjust your budget the other way. Perhaps you can add a few more dollars per month to discretionary spending.
The most important thing to remember is that the budgeting process should be completely personalized. While we’ll give blueprints and outlines of different types of budgeting options below, remember that the budget you choose should fit your lifestyle and finances. The more you tailor your financial budget to your unique situation, the more likely you are to adhere to it.
There are different types of budgets — too many to count, in fact. Small business budgets may include things like operating budgets, master budgets, cash flow budgets, sales budgets, and capital budgets.
Fortunately, setting a personal budget doesn’t involve you predicting sales volume, anticipating capital expenditures, or analyzing cash flow statements and balance sheets.
Personal budgets are much more straightforward. Below are three types that you can consider.
The traditional budget is, well, traditional. With this budget, you take your income and expenses and find the difference. From there, you can set goals for how much you wish to spend in different categories, such as food, entertainment, and clothing.
If you are a detail-oriented person or have time to come up with something extensive, then this budget may be right for you. It does require you to track all of your expenses though, so it may not be ideal for busy people or those who are “big picture” thinkers.
The 80/20 budget is excellent for those who are looking to jump-start their savings. It calls for you to take your income and then skim 20% off the top. This 20% is immediately transferred to savings.
The remaining 80% is for you to spend as you please. However, you still need to be mindful of the fact that you have fixed expenses — like rent or a mortgage — that you can’t afford to miss.
This is also known as the “Pay Yourself First” budgeting method. It is better suited for “big picture” thinkers, as their finances are broadly sorted into two categories: savings and other.
The 50/30/20 budget is similar to the 80/20 budget, except it breaks it down even further. With this budget, you divide your expenses into three categories:
- Needs = 50% of spending
- Wants = 30% of spending
- Savings = 20% of spending
Needs can include both fixed and variable expenses. As we mentioned, gas can technically be a variable expense since it can range from one week to the other. But gas could also be a necessity for you to get to work each week.
Another example would be grocery store spending and knowing how to eat on a budget. Whole foods like fruits and vegetables that you use for meals could be considered “needs,” while junk-food snacks might be”wants.”
This budget is a hybrid of the two models above. It’s a good fit for someone who needs a bit of structure in their budget but isn’t looking to track every detail.
Budgeting takes patience, and there are bound to be some hiccups along the way. Perhaps a few unexpected costs arise that you did not account for.
If you happen to use a credit card to pay for these expenses, you are using borrowed money that you will have to repay. Credit cards, however, can have high APRs and compounding interest. And if you happen to miss a minimum monthly payment, your lender will charge you penalties and even higher APRs.
In these circumstances, you might want to look into a credit card payoff app like Tally. Tally automatically pays your credit cards in the most efficient way possible, helping you get out of debt faster.
Establishing a budget is an excellent way to grab ahold of your financial situation. Budgets lay out a blueprint for how you will spend your money over a certain period of time. It accounts for not only your income but both variable and fixed costs as well.
The most important thing to remember when establishing a new budget is that it won’t be perfect. You should try your best to build your budget to meet your financial goals. But even then, there are bound to be road bumps. In cases where you overspend, a credit card payoff app like Tally can help you quickly get out of debt and back on track.