Why Budgets are Essential in Financial Planning

Hi everyone! Welcome back to Melissa Making Cents!

As both a financial coach and CERTIFIED FINANCIAL PLANNER™ my goal is to help clients get their finances in order to build healthy financial habits.  While I'm not going to ask clients to do push-ups or sit-ups, I do often run through financial exercises that cause more than a few groans and eye rolls. Know that any pain in our exercises are only temporary, after a while their benefits will start showing. 

Today I’m going to talk about one of my favorite financial topics and exercises -- budgeting! Regardless of age or income level, everyone should budget to know where their money is going. Budgeting can help to avoid debt, increase savings, and develop better financial habits overall. 

Budgets will look different for everyone depending on needs, and there is no one-size-fits-all approach. But to help you get started, I’m going to share with you some of my favorite budgeting models, tools for tracking expenses and income, and how to involve the entire family in the budgeting process. 

Everyone can benefit from a budget in their financial plan

It doesn’t matter whether you’re a college student or a working professional with a family -- budgeting is an important, lifelong skill. It helps to ensure you aren’t spending money you don’t have, enables you to reduce unnecessary expenses or poor financial habits, and prepares you for financial emergencies and retirement. 

Budgeting can help you cut out costs that are draining your bank account without providing any value to your life. Have you ever had a magazine subscription or gym membership that you bought but didn’t use? You may have forgotten all about those expenses! But creating a budget and writing everything down will help you catch those expenses and adjust your spending accordingly. 

In addition, if you have ambitious savings goals, such as buying a house within five years, budgeting can also provide a road map to get you there. If you need to save $20,000 over the course of five years to afford a down payment, that comes out to $333.33 per month in savings. The same goes for paying off debt. If you have $20,000 in debt that you want to pay off within five years, then you know you’ll need to allocate $333.33 per month toward a repayment plan. 

In short, budgeting lets you control your money so that your money doesn’t control you. 

When creating a budget, start by understanding your income.

In general, there are two main components to a budget: your income and your expenses. Before you can determine what to spend and how to spend it (your expenses), you’ll need to know how much you have to spend in the first place (your income).

For many people, income is pretty straightforward. If you are paid through an employer with a regular paycheck, the amount of that paycheck is considered your “take-home pay,” or income. That means deductions like taxes, retirement contributions, and the cost of your benefits like health insurance have already been taken out, and the full amount of the paycheck is yours to keep. You should also know how often you get paid (monthly, semi-monthly, or bi-weekly) in order to determine your income for the month. 

For other people, income can be more complicated. For example, if you are self-employed or have side hustles that bring in extra cash, then you will also need to deduct your own taxes and business expenses in order to get a fuller picture of your income. Your income also might vary from month to month, especially if you’re a freelancer, business owner, or employee who works on commission. In these cases, use a more conservative estimate of your income when determining your budget. (Spolier alert.... tune in next week to learn how to budget for variable expenses!)

Allocate your expenses based on the 50/30/20 rule.

After you understand your income, then it’s time to review your expenses. There are many different budgeting models out there for allocating spend. However, I usually recommend the 50/30/20 rule. According to this budgeting model, 50% of your after-tax pay goes toward “needs” such as housing, insurance, and food, 30% toward “wants” like travel and entertainment, and 20% toward “savings.” In general, your fixed expenses tend to be “needs” and your variable expenses tend to be “wants.”

It’s important to note that the 50/30/20 rule is based on “after-tax pay,” which means that even if your retirement contributions or insurance costs are deducted from your paycheck, these would be accounted for in the 50/30/20 rule. If you’re not sure how to find this number, look at your most recent pay stub and subtract all numbers under “taxes” from the number that says “gross pay.”

Something I tell my clients is that savings should always be included in your budget. A lot of people think of savings as “whatever’s left over at the end of the month.” But by fully integrating savings into your budget, you will better improve your financial health and provide a safety net for yourself and your family. You can count retirement contributions, college savings, debt repayment, and your emergency fund as part of your savings plan. When possible, it’s a great idea to automate your savings, such as deducting 10% of every paycheck to go into a retirement account or transferring a set amount from your checking to your savings account from each paycheck. You may also wish to put any additional compensation, such as a bonus, directly into your savings account.

Depending on your situation, there might be a bit of wiggle room with the breakdown of percentages in the 50/30/20 rule. For example, if you’ve already paid off your mortgage, you might not need to spend 50% of your income on “needs.” Or if you’re tackling a lot of student debt, you may want to cut back on “wants” in your budget in order to increase your savings. Talking with a financial coach can help you determine the best plan for your circumstances.

Find a way to track your income and expenses.

So now you have a big picture view of how budgeting works and how to allocate your money. But how do you actually track what you’re earning, saving, and spending?

It might seem overwhelming at first to think about accounting for every penny. But there are loads of budgeting software programs out there to help you out! Tax programs like Quicken offer budgeting tools, while apps like Mint let you connect your bank accounts to track cash flow in real time and create a budget right from your phone. You can also try websites like You Need a Budget (YNAB). Your bank may also have a budgeting tool to use, so it’s worth asking! If you feel intimidated by using a formal software program, paper or spreadsheets work well, too--and these are available at no cost!

As clients of Fetterman Investments, Inc. you also have access to our free client portal! This portal not only tracks your investments, but allows you to aggregate accounts and track your monthly budgets!

Let’s say you want to set your budget the old-fashioned way, by listing income(s) and then all monthly expenses on a spreadsheet. I recommend using the Plan Ahead Method from Fiscal Fitness because this allows you to track the dates and amounts of your upcoming paychecks, as well as when your bills (fixed expenses/needs) are due. I use this method with my coaching clients because it helps them to take a longer-term approach to budgeting, based on real numbers and dates, rather than estimates. It also helps to track how much money would be in your bank account at different times of the month as money flows in and out, which helps with savings. With the Plan Ahead method, you can also create “buckets” for things like savings, gifts, clothing, vacations to make these more of a fixed expense. 

As you can see, there are a lot of tools to help you budget! Feel free to test a few out and find what works best for you and your family. Speaking of which...

Include your family when creating a family budget!

Financial literacy is an important skill to develop, especially at a young age. That’s why I always recommend involving the entire family, including kids, in the budgeting process. You don’t have to discuss every penny, but involving kids helps them to become more financially aware early in life. Maybe you start off by working on a vacation budget together and then branch into more advanced types of budgeting over time. If your children earn an allowance or have a part-time job, then you can also teach them budgeting with their own money.

It’s also important for partners to be on the same page about budgeting. I’ve had clients before where one partner is a “saver” and the other is a “spender,” which can lead to conflict down the road. Having open and honest conversations about money--and creating a budget together--can alleviate some of these financial and relationship stresses. A financial coach can also be helpful in working with multiple people to create a family budget.

Remember that your specifics within your budget may vary from month to month--and that’s okay!

It would be nice if life were simple enough that you could always allocate the same amount each month for each category of your spending. But that’s not always the case! For example, you may increase the shopping category of your budget during the holidays, or decrease your restaurant spending during winter. Similarly, you may only need a haircut every three months, or you may take a vacation only once every two years. Anticipating the fluctuations in your spending ahead of time can help you adjust your budget accordingly. Ideally you have saved ahead for some of these expenses using the savings buckets I mentioned above!

Unexpected expenses may also arise--such as a car repair--so add a little extra cushion so you aren’t scrambling to pay a surprise bill. Aside from these unexpected circumstances, try to stick to the budget you created at the beginning of the month. 

When setting a budget, be realistic about how much you need to spend. 

Budgets are meant to help you take control of your finances, not to promote a scarcity mindset. That means you should be realistic about the amount of money you need to spend, especially on...well, your needs! For example, if you know from past experience that groceries for your family usually cost between $300 and $400 per month, don’t allocate only $150 for groceries in your budget! If anything, estimate the cost of your “needs” just a little higher so you have some peace of mind that you aren’t overspending.

If anything needs to be trimmed from your budget, it’s usually under the “wants” category--thinks like dining out, going on vacation, and buying new clothes. But at the same time, try not to keep your “wants” spending so low that it makes you feel guilty if you want to indulge in an occasional treat, like taking your family to the zoo. When done properly, budgets should reduce stress and make you feel more empowered about your finances, not like you’re pinching pennies.

Your budget is likely to change over time, especially during major life events.

Budgeting is never a one-and-done. The budget you set today may not be the same as the budget you set next year, five years from now, or ten years from now. Life changes such as getting a new job, moving to a new city, earning a promotion, getting married, having children, or taking care of an elderly family member can affect how much you earn and how much you need to spend each month. It’s always a good idea to review your budget after a major life change, and at a minimum of once per year. And the good news is that once you’ve gotten in the habit of budgeting and tracking income and expenses, it gets easier over time!

A financial coach or a financial planner can help you learn how to set a budget.

Budgeting may seem scary if you’ve never done it before. Sometimes, enlisting the help of a professional can give you the confidence you need. As a certified financial planner and a financial coach, I’ve helped my clients create budgets tailored to their specific situation. Budgeting is also one of the cornerstones of my financial coaching program Making Cents of Your Money. If you want assistance in learning how to create a budget, please call or email to schedule an appointment with me. 

Until next time...this is Melissa Making Cents!

Melissa Anne Cox CERTIFIED FINANCIAL PLANNER™ is also a College Planning and Student Loan Advisor in Dallas, Texas.