Budgeting for anything fosters planning and accountability with money. The importance of budgeting is to control the flow of money in a household, project, or business. Having a budget prevents overspending, as well as unplanned liabilities and debt.
Learning with a budget
A financial budget helps you to learn your spending habits. Simply listing the incomes and expenses shows you what you spend money on.
A budget also lets you compare your income and spending over time. You can answer questions like “Is my spending on clothes increasing?” or “Do I spend too much on eating out?” With these detailed questions, you can make some corrections and reduce spending and increase savings.
You can further compare your budget to some budget rules, such as the 50/30/20 rule. With this rule, you can assess if you overcommit towards must pay expenses and have too little money you can spend on fun things.
After all, you want to be aware of the reasons why you maintain a budget.
Connect your budget with your financial goals
While budgeting is universally recommended, the goals that you are budgeting for are as different, as you and your family. But it is important to connect your goals with your budget.
Your goals are expressed in the savings portion of your budget. after all, the importance of budgeting is to save enough money to achieve financial goals, that can’t be achieved in the short term.
Goals change over time. At a young age, you might save for your first car or a vacation abroad. Later you might save for buying a house. There is one goal that should always be considered, which is retirement. Unless you are financially independent or already retired, you want to save part of your money to secure a comfortable income in retirement.
Savings for retirement should be considered as early as possible because you can invest the savings into assets that produce income of their own. This extra income can be saved again and create even more income from the wealth you accumulate. This mechanism of compounding interest is most powerful if it is allowed to continue for long periods of time. In that context, ten years is short, 20 years is better, 30 years is OK, but 40 years is great.
Making budgeting a success for you
Budgeting is a challenge for many people. If you tried and failed, you are not alone. When you start the obstacle is to collect the necessary information and to admit to bad money habits of the past. Once you have a first budget plan, it takes continued effort to collect the actual amount on income, spending, and savings. You will from time to time have to face your bad money habits again.
Here are three things that people that succeed in budgeting
- Keep it as simple as possible
- Track your budget weekly or monthly
- Redo your budget once a year or when life changes
Keep it simple
If you minimize the effort, you are more likely to stick with the process. The first thing to do is not to plan and track your expenses in too much detail. Track the big-ticket items closely, but leave things of personal enjoyment as a general bucket, such as a personal allowance. That way you don’t have to question if you buy some flowers for your coffee table to brighten up a gray week or indulge in a fancy coffee with a friend. But you need to stay within the overall allowance.
Track your budget weekly or monthly
Tracking the expenses weekly seems to be more work than doing it less often. However, at the end of the week, your memory is fresh and so you need little time to record your expenses. You may spend only 10 or 15 minutes getting everything in shape. Tracking things weekly also helps to stay reminded and motivated, that budgeting your money is a priority in your life.
If most of your money flows through accounts, such as banks and credit cards, a monthly review might be working better for you. This is especially true if your bank or credit card classifies the charges already into the categories you want to track.
Anything longer than monthly for tracking will contribute to you losing sight of the financial goals and habits that help you to stick with your budget.
Review and Plan once a year
Once a year it is time to review your budget and celebrate a plan on track. This is also a time to look if goals are still desirable or if priorities have changed. Doing this review annually will also keep you motivated to continue the weekly or monthly routines. You see the bigger picture and how it brings you closer to your goals and dreams.
While many do the annual budget review and the end of the calendar year, you don’t have to. I think it is better to choose a time of the year that suits you. It could be around your birthday, or it could be in the fall before the holiday expenses need to be planned. Or maybe during spring you are in the best mood to make new plans for a year.
Also, keep in mind, when life changes your plans just adjust. If you fall in love and want to get married, don’t wait until the annual review rolls around. Make it part of your getting to know each other, to make new plans and a joint budget. Just a word of caution, changes of plans every year are rather unusual. If you find yourself changing your budget mid-year, every year then you should ask yourself how committed are you to your long-term financial goals?
How can budgeting increase your wealth?
Only if you maintain a budget you will know with certainty where your income is spent.
If your income is spent paycheck to paycheck, then you are not increasing your financial wealth. You are actually in a rather volatile financial state because any loss of income will lead to falling behind in your obligations.
If you manage to plan your expenses in a way that you have money to save for future purchases you can at least adjust your plans when circumstances change. Ideally. you also have some money put aside for an emergency fund to give you time to react to the financial changes in your life.
Only if you have a budget that includes a long-term savings portion you are building wealth. This requires you have mastered keeping your living expenses below your income and you have mastered saving up for larger purchases, before committing to them.
When you have reached the stage where you save money for long-term wealth building, you also can invest this money to have it earn additional income on its own. This is a very powerful mechanism because not only do you have adjusted your living expenses to your income, you are generating additional income from investments. If you are smart and invest this additional income as well, this creates a powerful snowball effect, that lets you grow wealth faster and faster.
Common budget contexts
Budgeting in different life contexts is of different importance.
Living single, it is important to maintain a personal budget to achieve your financial goals.
If you live in a family, you need a family budget to communicate about financial goals.
Sometimes people live in a joint household, without being a family. A household budget can clarify joint expenses and how everyone does contribute to them.
College or university students are in a special situation with regards to budgeting. For students, a budget is essential because they may accumulate debt to finance their studies. The better you budget, the smaller you can keep your student loans. Keeping your student loans small is an important consideration. After all students loans are the largest debt burden Americans have.
Projects are an important context that should have their own budget. Whether it is that big wedding, or the renovation of the vacation home, having a budget is an important consideration, to make the project successful.
Last but not least, any business needs a budget. It is important to have a budget plan, even for a small side hustle business.
Why is budgeting important?
Budgeting is an important tool to plan and control the flow of your money. The principles are the same, whether the scope is your personal budget, a family, a project, or a business. Budgeting documents incomes, expenses, and savings as planned values and you as the actual amounts.
In the absence of a budget, you are financially adrift. The likelihood of getting financially ahead is slim in that case. The temptations of modern life to consume are enormous and they all cost money. Most people will find themselves overspending, and increasing their debt, until it becomes a real crisis. Don’t let this happen to you.