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Budgeting is the foundation of a long-term wealth-building plan.
Today, just about anyone can build wealth. But if you don’t have a budget for your money, you can be financially broke even when you’re earning more than the average person.
Nearly 70% of lottery winners end up broke after three to five years and a third of them even go on to declare bankruptcy later on.
But with smart budgeting, you can build just as much wealth as those lottery winners even when you don’t make above $100k.
In fact, when you budget your money, you can anticipate wealth in a much safer and persistent way.
In this article, we’ll show you what a budget is, what a budget consists of, how you can track your expenses, and common mistakes that people make when they first try to budget.
What Is A Budget?
When most people think of a budget, they think of sacrifice, deprivation, and restriction.
But having a budget doesn’t mean you can’t spend money on the things you like or enjoy.
In fact, having a budget means knowing how much money you have, where it goes, and how to best allocate those funds to work for you.
The more you understand how to handle your money, the harder your money will work and the more wealth it will generate – even when you think you’re broke or don’t think you make enough to start budgeting.
This is due to the fact that wealth doesn’t come from how much money you make, but how you handle the cash you keep after all the taxes and deductions.
When you budget your money, it’s like getting a physical exam, but for your money – it tells you whether or not you’re financially healthy by comparing your income with your expenses.
What is income? Income is how much money you receive every month from your job or side-hustle.
Let’s say you make $2,200 from your main job and $750 from your side-hustle. Then $2,950 would be your monthly income and all your expenses should not add up to more than this number.
Expenses are everything from your rent to your monthly Netflix subscription.
Some other common expenses you might have:
- Utilities such as gas, electric, water, and internet.
- Groceries and household items
- Fitness memberships
- Vocation and travel
- Services such as landscaping, snow removal, and housekeeping
If your income is greater than your expenses, then you’re in good shape; if your income is smaller than your expenses, then you need to make some adjustments to lower your expenses, such as brewing your own coffee at home and bringing homemade meals with you to work.
Higher expenses can signal danger; anything out of the ordinary can push you into financial trouble and leave you in a pile of debt.
When you’re financially healthy, you can start accumulating wealth and securing your financial future, which is done through building an emergency fund and an investment strategy that helps grow your money over time.
This is how some people like Janitor Ronald Read, who, through smart budgeting, amassed millions of dollars without ever making more than $100k or winning a lottery – and while 80% of NFL players who earn a minimum of $480,000 – $915,000 per year experience financial trouble, or even go bankrupt, within the first two years of retirement.
So it’s not how much money you make that matters, but how you budget your money and handle your personal finances because both will determine how much money and financial security you get to enjoy.
In the next section, we’re going to talk about one of two components within a budget – your income. This is one major factor that determines how much you can save, spend, and invest.
Income – How To Determine Your Income?
Before you create a budget for your money, you first need to know how much money you make.
This is important because if you don’t know how much you make, how else would you know how much money you can save, spend, and invest?
When we say how much money you make, we’re not talking about annual income.
The annual income can also be referred to as your “gross income”.
Gross income is your income on paper. It’s money before tax and deductions such as social security, retirement account contributions such as 401(k), and health/life insurances.
401(k) is an employer-sponsored retirement account in which you take a portion of your salary (before tax) and earmark it in a retirement account to invest in securities like ETFs and index funds.
- ETF is a basket of various different companies’ stocks that you can own.
- Index funds are a low-risk investment that exposes you to a wide range of markets.
Both of them are great ways for beginners to invest in stocks without depending on the performance of one individual company.
But without knowing how much you make from your job, you can hardly start investing.
When it comes to building a budget, we’re talking about how much money you actually keep, aka your “net income”.
This is your income after all the tax and deductions.
Let’s say you make $3,000 a month. But you pay $500 in tax, contribute $500 into your retirement account, and spend $200 on health/life insurances. Then what you make every month isn’t $3,000, but $1,800 instead, because $1,800 is what reaches your account every month for you to work with.
This means your income on paper doesn’t equal what you have in your bank account.
So, when you create a budget, make sure you use the income you have in your bank account instead.
This way, you know exactly how much money you need to distribute to different expense categories.
You can also add additional income from your part-time job or side hustle if you have one.
In this case, if you receive $2,500 every month from your main job and $700 from your side hustle, then you should use $3,200 as your income when you create a budget.
Your take-home pay can be found on a pay-stub. A pay-stub contains information including gross income, social security, 401(k) contributions, insurances, and your net income.
You can request one from your manager if you work for an employer.
In the event you can’t obtain a pay-stub from your employer, you can check your bank statement and find how much money is wired into your account on payday.
But what if you’re a freelancer or self-employed and don’t have a set income? Then you should take an average of three months’ worth of earnings and use that as your monthly income.
For example, you made $2,240 in April, $1,780 in May, and $2,080 in June. Then, you take an average of the total amount, which is $2,033 a month. You should use this number as your income when you create a budget.
Here are a few tips for you if you’re new to irregular income.
- Budget your income conservatively.
- Create an income backup plan which should consist of three to six months worth of expenses; this is different from an emergency fund.
- Once you’ve created your income backup plan, then start building an emergency fund. (We have a section dedicated to cover the emergency funds.)
- If you’re a seasonal worker or weather-dependent worker, then take an average of earnings you made during the same month in the previous three years, then dividing that by three to create a projected income.
With irregular income, try to budget more conservatively so you can build a more predictable income which will allow you to better form a reliable plan.
Once you know how much income you have accurately, get a piece of paper and write it down. In the next section, we’re going to do a deep dive into your expenses and how you should budget your income.
Expenses – How To Budget Your Income
Budgeting requires you to allocate or distribute your income. There are three major expenses in a budget: spending, savings, and investing.
When it comes to the spending money category, we’re referring to all of your regular living expenses that include things like:
- Utilities such as gas, water, and electric
- Home/car/health insurances
- Gas and transportation
- Entertainment subscriptions such as Amazon Prime and Netflix
This portion tends to be the part where most people don’t have the easiest time to master because it requires a certain level of self-discipline.
But just like anything else, you need to practice financial discipline every day. Then over time, it will improve as you keep trying again and again.
In addition, during the early month of budgeting, you might feel like your budget is a failure, but know that it’s going to take some time and effort to estimate all your expenses accurately, so keep making adjustments until you have a firm grasp on your spending.
If you don’t have a savings fund equals to a minimum of three months’ expenses, you need to add that to the list and start building your own savings funds.
A savings fund will protect you from relying on credit cards and retirement funds in the event of a job loss and a leaky roof.
For example, you need $4,500 every month to pay for your overheads, then you need at least $13,500, or three months’ worth of expenses in the savings account to protect you in case of emergency.
You can also build a separate, $2,000 short-term emergency fund on the side in your checking account for smaller accidents like broken car tires and medical copay.
This way, you can leave the complete emergency fund in a savings account to accumulate interest until you’re in serious financial trouble.
However, you should stop putting more money into your savings account once you have a minimum of six to twelve months worth of expenses saved up due to the rising cost of goods and services – or commonly referred to as inflation.
Inflation means the dollars you’re holding are losing purchasing power. In other words, you can’t buy as many goods and services as before because the prices of goods have gone up.
For example, a big Mac at Mcdonalds used to cost you five dollars, now it costs you seven dollars. A big mac is a big mac; the ingredients haven’t changed one bit, but now it costs more money to afford one.
In the U.S., the average savings account pays 0.04% per year, but inflation drives up prices by 1-3% (2.60% in 2021) each year.
This means if you have $10,000 in savings account for one year, you’d be earning a total of 4 dollars all year (assuming 0.04% interest rate)
On the flip side, the average stock market return is about 7%-10% per year, which is more than enough to cover the cost of inflation.
So, a bank is a good place to keep your emergency funds, but it’s not so good if you’re looking to build long-term wealth.
Therefore, after accumulating a complete savings account, you should invest the extra money into your investments and allow them to grow over time.
But for the sake of your financial security, make sure you build an emergency savings fund to protect you and your family.
Just as an emergency fund can protect you during critical times, an investment portfolio can protect you from the rising cost of living due to inflation.
The historical average of inflation in the United States is 3%.
That means if your budget for your family’s grocery was $5,000 a month last year, then this year, your family grocery budget needs to be $5150 a month in order to afford the same quality of food.
Fortunately, investments like stocks and real estate can help you keep up with inflation and build a better retirement strategy for you.
If you’re into stocks but unsure of what to pick, you can invest in index funds and ETFs that give you a wide exposure to the market.
You can buy stocks, bonds, and ETFs when you open a brokerage account online, which allows you to invest in the market anywhere in the world and it often comes in lower fees.
On the other hand, if you’re into real estate but you’re a bit scared of putting so much money into one deal, then you can invest in Real Estate Investment Trusts (REITs) and Crowdfunding.
- Real Estate Investment Trusts (REITs) – publicly-traded stock companies that own commercial real estate.
REITs are a way for investors to pool their money together to invest in real estate that they couldn’t afford to buy outright on their own.
REITs provide diversification, liquidity, and high dividend yield to investors who want to diversify their stock portfolio with commercial real estate.
- Crowdfunding – a platform for investors to access a collection of real estate, and in exchange, you’ll get your share of rental income, interest, and appreciation.
One example of this kind of platform is Fundrise.
At Fundrise, you can become a real estate investor without the hassle of owning physical real estate.
More importantly, you can even begin investing in real estate with as little as $500. This is perfect for those who just started budgeting, unsure of how much money to allocate to the investment category but don’t want to miss the chance to begin investing.
This is a great way to dip your toes in the real estate market without putting your life savings on the line.
In the end, it doesn’t matter which one you decide to invest your money in, both REITs and Crowdfunding give you exposure to the real estate market without putting your life savings down in one single deal.
You can find more details here on how you can begin investing with as little as $100.
Tracking Your Monthly Expenses
Tracking where your money goes once it reaches your bank account allows you to not only understand what you spend money on but also help you re-evaluate your financial decisions and make adjustments according to them.
There are two ways you can track your expenses.
- Use a notebook or a spreadsheet – The most hands-on approach that’s very easy to start.
Whenever you make a purchase, write it down in a notebook or enter it into a spreadsheet.
This approach is a little time-consuming but it can give you a clear understanding of exactly where your money goes every month, whether it’s going towards your monthly entertainment subscriptions or the extra side of guacamole in your food order.
This will also help you re-evaluate all your financial choices and learn to discipline a lot quicker.
You can keep all your receipts to help you keep track if you don’t want to write everything down right away.
But if you don’t like to keep receipts with you, make sure you have a written record every time you make a purchase because you might forget the expenditure later.
- Use an app – Apps like Mint can help you track your income and expenditures through your bank accounts, credit cards, and retirement accounts.
If you’re not a big fan of writing everything down, you can utilize apps like Mint to help you keep track of all your expenditures.
Mint links your credit cards and bank accounts to track your income, spending, and savings.
Every purchase is labeled and automatically categorized for you so you have an accurate and organized record that can be easily referenced if you need to make a change to your budget.
However, unlike manual transcribing your expenditure, you might not get the chance to re-evaluate your choices right at the moment you make a purchase. That means you need even more discipline to help you make better financial decisions whenever you shop.
Both ways have their own pros and cons. But at the end of the day, it doesn’t matter which approach you choose to track your income and your expenditures because what we want is to organize and record your budget. So as long as you can track it effectively, you can pick the one that works best for you.
Determine What Kind Of Budget You Want To Make
There are tons of budgeting plans out there that you can try, but try to stick with one consistently once you find the plan that can budget more effectively for your money.
A zero-based budget is a financial plan in which every dollar you receive from your work matches every dollar that’s going out to individual expenses.
That means every dollar you have has a job that it’s responsible for, whether it’s paying for your rent, student loans, or credit cards.
Suppose you make $3,000 every month. This might be what your budget would look like with a zero-based plan. The total expenses come out to be exactly $3,000.
- Rent – $1,000
- Groceries – $375
- Insurance – $100
- Gas – $200
- Entertainment – $100
- Emergency funds – $300
- Student loan – $200
- Utilities such as gas, electric, water – $150
- Internet – $100
- Cell phone – $70
- Retirement – $250
- Vocation and travel – $155
When you have a zero-based budget, you can spend your money with less stress and guilt because each category has a predetermined amount that you can spend every month, or at least until the next paycheck.
But a zero-based budget might not be a friendly choice for a new budgeter because you have to do a lot of estimation in the early month of budgeting which can lead you to overestimate one thing and underestimate the other.
Plus, it won’t stop you from taking out your credit card on a shopping spree – you have to rely on your own discipline during those unexpected events.
Fortunately, we can solve the credit card issue with the next budget plan; It removes the use of credit cards so you can learn to discipline yourself more when it comes to spending.
Just like its name, an envelope budget involves the usage of envelopes; you first establish your spending categories and set spending limits for those expenditures, then you match each one of the categories with one envelope, cash your paycheck, and put the allocated amount for each category into the respective envelope.
Essentially, it’s a zero-based budget but with cash only.
Let’s say you have a paycheck for $300. Then your budget may look like this.
- $150 in the rent budget envelope
- $75 in the grocery budget envelope
- $30 in utility budget envelope
- $15 in savings budget envelope
- $30 in investment budget envelope
This is particularly helpful for those who have overspending issues when it comes to credit cards.
Every month, you can only spend the amount of money inside the envelope. This way, you won’t run into the problem of overspending because once the envelope is empty, you can’t spend from the specific category until the next paycheck replenishes the envelope.
If you have money left over in any of the envelopes at the end of the month, you can either keep the cash in that envelope for the next month’s spending, or you can remove it from the envelope and add it into your emergency funds.
If you’re unsure about how much money you should assign for each category, you can use the 75/15/10 method to allocate your money.
- 75% of every dollar will go towards expenses like rent, groceries, and insurance.
- 15% of every dollar will go towards savings like your $2,000 emergency fund and a complete emergency fun equals six months of expenses
- 10% of every dollar will go towards investments like index funds and ETFs.
With this method, you need to make sure all your regular expenses don’t go over 75% of your take-home income so you can have the rest dedicated to your financial future.
There is one major benefit to using the 75/15/10 method – you’ll always have a portion of your income that will go towards your financial future.
If you find 75% of your income can not cover all the expenses besides savings and investment, then you need to take a hard look at everything you’re spending and evaluate the importance of each one; If you’re not using it, cancel or remove it so you can use that money towards your savings or investments.
Investing is something you want to start as early as possible because the younger you are when you begin investing, the more wealth you can build over your lifetime.
Let’s say you decide to invest $360 every month into the stock market at the age of 20. Then by the time you retire, you’ll most likely amass millions of dollars even if you never make above-average earnings.
But if you decide to wait until you’re 40 to begin investing, you’d have to allocate $2,000 a month to have the same earnings.
Therefore, once you have a complete savings account, you should use that money towards your investments so more money can work sooner to generate more income.
If you’re single and don’t have a lot of responsibilities, we recommend you to use a similar, but much more aggressive method, 50/20/30.
- 50% of every dollar will go towards your expenses
- 20% of every dollar will go towards savings
- 30% of every dollar will go towards your investments.
This will not only help you save faster, but it will also help you invest more aggressively and generate more money.
In addition, the faster you can build up a complete savings fund, the more security you will have when things don’t go your way.
4 Common Mistakes New Budgeters Encounter
There are four common mistakes that people often make in the early months of budgeting.
Not Having A Budget At All
It’s hard for wealth to come by if you don’t know where your money goes once it reaches your bank account.
Small expenses like a quick run to a convenience store can be easily forgotten, but when they’re added up, can become a big financial hole that you can’t climb out of, which could be both financially and mentally draining for you and your family for a long period of time.
So, save yourself from that kind of situation and start budgeting today.
Not Having An Emergency Fund
When you don’t have some extra cash prepared before a crisis, you might find yourself in more trouble than you can handle.
Little things such as a broken tire or a visit to the doctor’s office can put you in difficult situations if you don’t have the funds to cover those unexpected expenses.
If you can’t fix a broken tire, then you might not be able to get to work.
If you can’t go see a doctor when you’re sick, then a small sickness might keep you from earning a salary for a month (or even longer) than a few days.
You can save yourself from a lot of financial trouble when you include an emergency fund in your budget.
This is why you should begin building an emergency savings fund – even just a $2,000 short-term savings fund would be able to save you from tons of financial crises.
Forget About Semi-Regular Expenses
These are expenses that include birthdays, holidays, and annual premiums that many people tend to forget since these kinds of expenses don’t happen as often.
In 2017, Americans who borrowed over $1,000 to cover holiday costs, more than half of those were still repaying the holiday debt even three months later.
Debts like these can be a huge burden on your finances for a long time and they will require you to sacrifice many opportunities and experiences such as a nice home, a reliable car, and a family vacation.
Make sure you keep a list of all the semi-regular expenses and set aside some money every month beforehand so you dig yourself into a huge financial hole.
For example, you typically spend $55 on Thanksgiving dinner, $175 on Christmas presents, $250 on your birthday, and $1500 on a family vacation. Then, you need to set aside $165 every month beforehand so you don’t end up with debts that you can’t handle.
Think You Can Live Without Fun
Thinking you can live without fun when you make a budget is like thinking you can begin exercising for three hours every day for a whole year – it’s impossible.
There will be times that you’ll be tempted and give in to seeing that movie, hanging out with your friends, or buying that extra scoop of ice cream.
So, instead of waiting for that incident to come and rely on your credit card, set aside a small portion of your income specifically for you to enjoy all the things you like.
For example, if you make $3,000 a month, you can choose to set aside 5% of your income, or $150, and designate it as your “fun money”. This is the money you can spend on whatever you like, whether it’s getting new clothes or dining out at your favorite restaurant.
This way, not only are you financially stable and organized, but you can also enjoy the fruit of your work.
Budgeting Is The Foundation Of Wealth Building
Any financial plan begins with a budget for your money.
Knowing how much money you have and how to best allocate your money are the two best steps you can take to secure your financial future.
It doesn’t matter if you’re making a six-figure salary or living paycheck to paycheck, your financial future depends solely on how you budget your money today.
Every budget starts with knowing how much money you keep after taxes and deduction and ends with allocating your money into spending, savings, and investing.
Building an emergency savings account will protect you in times of crisis, while your investments will protect you against the rising cost of living due to inflation.
However, you should stop distributing a portion of your money into a savings account once you’ve set aside six months of living expenses and funnel that money into investments that make your money grow over time.
For the sake of your financial security, learn to budget your money today so you can take charge of your personal finances and head toward a promising financial future for you and your family.