Budgeting

A budget is a tool that allows you to take control of your personal finances and to make the best use of your income in order to meet your needs, according to your values and preferences. It also helps you to plan and to ensure that you reach your objectives. When we realize where our money is going, some options may become more apparent. Budgeting can help you reach a savings target, or repaying debt.

This article first adresses who needs a budget, and why making a budget can be a good idea. The article then deals with the various steps involved: define your goals; track your spending for a while; prepare a balanced budget; track your progress.

Who needs a budget?
More than 60% of US households currently engage in budgeting (formally or informally), and of those who currently don't, more than 40% have done so in the past. Budgeting is "highly prevalent across the income distribution", so it is not restricted to people who are under financial strain. There is a positive correlation (not to be confused with causation) between budgeting and percieved financial wellbeing: "the propensity to budget increases signicantly from 41.8 percent to 71.1 percent when moving from the lowest to highest index score for perceived financial wellbeing".

However, if (1) you've calculated a savings rate that will allow you to reach your goals, including retirement, (2) you are easily saving that amount or more every year, perhaps with the help of automated contributions to your investment accounts, and (3) you have no consumer debts, then you probably don't really need a budget. In other words, if you're already saving enough, who cares where the rest of the money goes in detail? Everybody else, read on...

Why budgeting can help
In preparing your budget, generally your goal is to balance your income with your regular expenses, savings for your financial goals and repaying your debts.

Specific reasons for budgeting include:
 * Figuring out where your money is going
 * Making sure that you spend less then you earn, to repay debt and save for the future
 * Reducing stress
 * Gaining more control over your finances, and feel in control
 * Helping you to reach your goals

Thaler describes bugeting as self-control procedure. A person can be thought to contains two entities, a planner and a doer. The planner is concerned with lifetime well-being, which requires saving for the future. The doer is selfish and wants to spend now. Therefore, "the planner requires some psychic technology capable of affecting the doer's behavior", such as rules of thumb or budgeting.

A large Dutch study shows a statistical correlation between mental budgeting (mentally assigning expenses to categories or 'accounts') and having savings goals. A correlation was also seen between mental budgeting and knowledge of financial products. In the authors' words, "mental budgeting is not a naive type of financial management".

A US study found that the most common reason given by people who budget is the desire to avoid overspending. Other popular reasons include saving for short term or long term goals, avoiding future debt, and repaying existing debt.

Goals
Budgeting typically starts with some thoughts on what are your financial goals, both short term and long term? Write them down. This may include paying back debt, reducing your weekly expenses, saving for a big expense, saving for retirement, etc.

Tracking expenses
It is worthwhile to consider past spending when formulating a budget. So the next step is keep track of your money for a month or two. This will help you understand spending habits and expenses. Consumer advocates generally recommend tracking everything on a daily basis during this time.

Some expenses might only occur once a year, such as purchasing certain gifts, some insurance payments, renewing your driving licence, property taxes, etc. Go through your files (paper or online) to find out the relevant yearly amounts and divide them by 12 to arrive at the monthly figure.

Needs versus wants
Knowing the difference between your needs and your wants is an important budgeting consideration. Things you need are essential expenses such as appropriate shelter, food, basic transportation, basic clothing, etc. People's needs change over time, depending on where they live, if they have children, etc. Things you may want are everything else, and wants are influenced by factors such as advertizing, emotions, habits and peer pressure.

A commonly cited guideline on personal finance websites (e.g., ), probably aimed at middle income families, is 50-30-20: you could spend 50% of take-home pay on needs (necessities), 30% on wants, and 20% on savings and debt repayment. The specific numbers are not important here, but rather the basic message is that a significant portion of income should go to savings, and most of the remaining portion should be spent on needs rather than wants, otherwise the budget will typically not balance.

Preparing your balanced budget
Now that you know what you've been spending for the last month (or year), you can prepare a balanced budget for the future. This means that revenues (income) and expenses (including savings) must balance. In terms of spending categories, keep it simple; the more complicated the budgeting process is, the less likely a person is to keep up with it.

Shortfalls
After preparing your budget, if it indicates that you have a shortfall, review your budget to see where you could reduce spending. You could also consider whether there are ways to increase your income.

Surpluses
If you have money left after you have completed the budget, consider using it to repay debt, particularly non-deductible debt, faster or to increase savings for an important financial goal.

Flexibility
Depending on your circumstances, you might want to have some flexibility in your budget. Preparing a budget when you have irregular income or a number of "one-time" expenses can be tricky. To avoid running out of money because expenses occur before the money actually arrives you should establish an emergency fund.

Budgeting tools
There are a number of tools available to help in the creation of a budget, such as spreadsheets, personal financial software and online budgeting tools (including apps). For example:
 * The Financial Consumer Agency of Canada has developed an online tool that does the math for you
 * The Credit Counselling Society has a free Interactive Budget Calculator Spreadsheet for Canadians
 * See the sample budget worksheet below.

Such tools generally provide a good starting point for preparing a budget, but remember simplicity will typically increase your chances of successfully following your budget.

Tracking your budget
Once a personal budget has been created does not mean the effort is done. You should track your monthly income and expenses against your budget. If you find that your actual amounts are not matching up to your plan, then adjustments should be made, either in budget amounts or spending habits.