Who wants to be bothered with a budget? It takes time to examine what you spend, where you spend it, and how much (or how little) you bring in relative to your expenses. Plus, you could be in for some unpleasant surprises.
However, if you have dreams of buying a home, paying down debt, taking an exotic Hawaiian vacation, or having a comfortable retirement, planning is vital. And the first step to securing your future is to be aware of how you spend your money today.
Here are five reasons you need to make a budget:
1. To set and reach financial goals. Once you understand the overall picture of your finances--specifically, identifying how money flows in and out of your life--you can better see how to reach your financial goals.
Start by collecting bank, credit card, and income statements for the past six to 12 months. Determine, on average, how much you spend monthly, and break down spending into categories like food, gas, entertainment, monthly household bills, insurance, debt payments, medical expenses, and savings.
Fortunately, most credit cards and some banks will categorize expenses for you. Some credit cards, like Chase Freedom, will even give you 5 percent cash back in rotating categories like groceries, airlines, and gas stations every quarter. It also pays to calculate and record exactly how much of your debt payments are going toward interest.
Next, input all your income. Once you identify whether you have a surplus or are in the negative each month, as well as where your money is going, you can formulate ways to improve your situation. You may also wish to create a timeline for reaching goals, such as paying off debt or saving for a vacation.
2. To spend according to your priorities. If you're in the dark about how much you spend and where you spend it, changing you habits will be difficult. And even if you're financially comfortable, a budget can help you identify unnecessary expenditures and deduce ways to redirect funds towards your priorities. For example, if you don't realize you spend $80 per month on lattes, it will be much harder to break that habit and apply that money toward a priority, such as saving for retirement.
Most importantly, if you're trying to get out of debt, it's essential to budget your limited funds to make debt payoff a priority. To cut back on expenses, you need to first see where your money is going so you can then limit yourself to a specific amount per spending category and utilize a method, such as the envelope budgeting system, to be sure you don't overspend.
Additionally, research ways to save on groceries, monthly utility bills, and TV and Internet services. If at that point you still have a budget deficit, consider more aggressive cutbacks--like cutting out cable entirely--or find ways to generate extra income in your spare time.
3. To build wealth. Once you have a clear view of your overall financial picture, you can shift your focus to aggressively eliminating debts and building wealth. Once I solved my personal debt issues, I was already in the habit of putting a certain amount monthly toward debt. So rather than change that habit, I simply redirected those funds toward my savings.
As my savings and investments build, I'm able to generate a passive income from interest payments and capital gains while still using my actively generated income to budget for monthly expenses. In other words, I've been able to increase my total income simply by being smarter about how I use my regular paycheck.
4. To plan for retirement. Though technically an aspect of building wealth, retirement planning is so vital to your future that it warrants special attention. A recent Harris poll showed that 34 percent of Americans have no retirement savings, and many of those that do have a retirement fund don't contribute enough.
However, even less than $100 per month can increase your retirement nest egg by as much as tens of thousands of dollars, depending on how long you have until retirement and how well your investments perform. This is primarily because retirement funds receive tax-advantaged treatment, and gains have decades to compound. This is reason enough to aggressively pay off debt, as interest payments can easily exceed $100 per month and prohibit you from enjoying a comfortable retirement.
Also, plan to have a surplus for when you retire. Believe it or not, money will mean a lot more to you when you have less of an ability to earn it.
5. For peace of mind. If you don't have a budget, you might not know whether you can afford a new flat-screen TV, a new car, or any other major purchase. In fact, if your finances are one big mystery, your mere desire for an item might alone justify the expense.
But have you ever splurged on something, yet felt too guilty to really enjoy it? I have, and it's no fun. When you can look at actual numbers and know the truth, it's much harder to fool yourself in this way and hurt your finances. And even if the object of your desire is currently out of reach, you can budget for it. Plus, it never hurts to have a little extra money in your emergency fund, and budgeting can help you save more so you can sock away extra cash for a rainy day.
Final thoughts. Creating and following a budget involves self-discipline and sacrifice, but will help you develop wise spending habits to better manage your finances now and into the future. Keep your budget current by updating it regularly to reflect changes in your situation, such as a raise, marriage, or new home. And experiment with different applications to help you stick to budget, like the envelope budgeting methods listed above.
Lastly, don't forget to reward yourself for all your hard work. Acknowledging your accomplishments motivates you to even greater accomplishments. Just make sure to budget for your reward!
How has budgeting helped your financial situation?
Holly Mangan is a financial editor for Money Crashers Personal Finance, an online resource that seeks to educate readers about important money topics like budgeting, investing, careers, and education.