Quote of the Week: “A budget is telling your money where to go instead of wondering where it went.” ― Dave Ramsey.
No matter how much we earn, our income does not seem enough to pay for all routine expenses. As our income increases, our needs seem to increase as well. This is because of lifestyle changes, as well as inflation. Our needs will always be unlimited while our resources are always limited. Any attempt to satisfy all our needs will almost always lead us to accumulate debt. That’s why we all need a budget.
Governments, businesses and other institutions use a budget because it is a powerful tool that helps you properly manage and account for your money. You should too. A budget will keep you on the straight and narrow when it comes to personal finance. It will help you manage your money better, avoid getting into debt, help you get out of debt, and help you save more.
But enough of the benefits of having a budget. How do you create one? The basic rule of any personal budget is that the expenses should not exceed income. But beyond that there are no other general rules on how you should apportion your budget. It all depends on your goals. However, there are 2 very popular budgeting styles which we will discuss below.
The 50/20/30 Budget
The 50/20/30 budget divides your budget into three main categories: essential expenses (needs), financial priorities, personal expenses (wants).
- Essential Expenses
This budget calls you to spend 50% of your net income on your essential expenses. These are your needs. Things you can’t live without. They include food, rent, clothing, transport expenses, among others.
- Financial Priorities
This helps you build a strong financial foundation. If you are following this budget, these payments should be made after the essential expenses but before the personal expenses.
- Personal Expenses
These can also be defined as personal expenses. They should be the last items on your list and you shouldn’t spend more than 30% on them. These expenses include holiday expenses, dining out, shopping, hobbies, entertainment and other miscellaneous expenses.
As long as you have taken care of your essential expenses and financial priorities first, there are no limits here.
The 70-20-10 Budget
This type of budget was popularized in George S. Clason’s brilliant book, “The Richest Man in Babylon”.
In the book, readers are advised to save 10% of all their income, spend 70% and use the remaining 20% to pay up debt. This budget is popular because it does not restrict your spending that much. You can spend on anything you want whether it’s a need or a want as long as you don’t spend more than 70%.
There is only one limitation to this budget, it was designed for people who are in debt and are looking to get out of it. However, not everyone is in debt. And even those who have debt tend to pay it off if they follow this budget. What happens when you don’t have debt then? This question has led to a variation of this budget.
The variation calls for 70% to be spent on living expenses; 20% for savings (10% for retirement, 5% for emergencies, and 5% for specific goals); 10% for investing.
Ultimately, budgets are only effective when you follow them, they are just a tool to guide your finances. If you implement budgeting in a disciplined way, you will reap the rewards of financial well-being.