However, this human tendency could lead to financial problems if not kept in check; this is where a personal budget comes into play. A personal budget allows you plan for how you will spend and/or save your money and also keep track of your spending patterns. By tracking your spending, your budget will provide a clear picture of the difference between what you think your priorities are and what they actually are in reality.
Although the term “budget” has come to have negative connotations, having a personal budget provides a lot of insight into the things that you prioritize and whether those things align with the goals you have in life. So, how do we use this budget to ensure that we achieve our financial goals? In article, I will be sharing 6 steps to help you design your very own personal budget.
The overarching goal of a personal budget is to maximize savings by minimizing expenses. In order to achieve this, you’ll need to - Figure out exactly how much money you earn, how you are spending that money, then make adjustments to maximize savings. The following is a step-by-step guide to making an accurate and helpful personal budget:
Step 1: Clarify your goals
The first step in creating a personal budget is to clarify why you want a budget in the first place. What are your financial goals? Do you have debts you need to pay off? Are you trying to save for a car, a vacation, or your future? Budgeting involves tough choices, but having a goal will make budgeting a little less painful and allows you to start planning for the future you want.
Every financial goal you set should be a SMART goal: Specific, Measurable, Achievable, Relevant, and Time-Framed. Your goals can be defined using these three categories:
- Short Term: less than one year
- Mid-Term: one to five years
- Long Term: more than five years
For example, let's say that you want to go on a vacation to Hawaii for your honeymoon, and you plan to get married in three years. So, you have 36 months to save for your vacation. You did your research and found that you will need to save at least ₦1 million for the trip you plan to take; that means you will need to set aside roughly ₦28,000 each month until your wedding day. Guess what? You just created a SMART goal! Your goal is:
Specific: You plan to go to Hawaii when you get married
Measurable: You know that you will need to save ₦1,000,000 to take your trip
Achievable: You will need to save ₦28,000 a month to meet your goal
Relevant: Your goal is relevant to you - you plan to take a trip to celebrate a major milestone in your life
Time-Framed: You plan to reach your goal in 3 years
Step 2: Record all of your sources of income
The next step is to record all your sources of income in order to a clear idea of your current financial status. If your income is in the form of a regular salary where taxes are automatically deducted, then using the net income (or take-home pay) amount is fine. Record this total income as a monthly amount.
If you have irregular sources of income, I would advise that you base your income on your lowest-paid month from the previous year (or your lowest paid month to date, if you have not been working for up to a year).
Step 3: Create a list of monthly expenses
This step in the budget-making process involves creating a monthly expense average; the most effective way to do this is to refer to previous financial statements (e.g. bank statements, investment accounts). The key here is to get a realistic view of how you spend your money, so the more factual the more information you can dig up, the better.
It's useful to separate your expenses into three categories:
- Fixed Needs – Necessary expenses that stay the same from month to month e.g. rent.
- Variable Needs – Necessary expenses that may vary from month to month e.g. fuel, groceries.
- Wants – Nonessential expenses, e.g. movies, eating out, night-outs.
Categorizing your expenses in this manner will help you balance your budget by identifying which expenses should be cut back on first. Apps like Fudget can help you document and categorize your expenses effectively; Apple users can click here to check it out, while Android users can click here.
Step 4: Total your monthly income and monthly expenses
This step involves adding up your monthly income, then adding up your monthly expenses and identifying what number is higher. If your end result shows more income than expenses, you are off to a good start. This means you can prioritize this excess to particular areas of your finances such as saving for a financial goal or paying off debt faster. If you have a higher expense column than income, then some changes will have to be made.
Step 5: Make adjustments to expenses
If you have a higher expense column than income, here is a strategy you can use to control costs. For each type of "want" expense identified in Step 3, decide on a reasonable monthly limit that you think you can stick to consistently. This may require you to shop and eat-out less often than you might like but it is an effective way to balance your budget.
If you can't trim enough from your "wants" in order to balance your budget, you will need to reduce your "variable needs" expenses in the short term and perhaps your "fixed needs" expenses in the long term. However, it's important that whatever limits you set are reasonable for your adjustments to be sustainable long-term.
I would highly recommend the use of the 50/20/30 rule when making adjustments to your expenses. The 50/30/20 rule states that:
- 50% of your income should go to necessities (fixed and variable needs) like rent, bills and groceries.
- 30% of your income should go to non-essentials (wants), things you want but don’t necessarily need like going for dinner or watching a movie.
- 20% of your income should go to savings and debt, this includes emergency fund savings or any debt you owe.
By using the 50/30/20 rule, you will be able to realistically budget and save money without constantly penny-pinching or having to make drastic lifestyle changes.
Related: How to get a grip on your savings.
Step 6: Review your budget monthly
It is important to review your budget on a regular basis to make sure you are staying on track. After the first month of budgeting, take a minute to sit down and compare your actual expenses versus what you had created in the budget. This will show you where you did well and where you may need to improve.
I would advise making a habit of reviewing your budget by choosing a particular day each month to do it, for instance you could choose to review your budget at the beginning of every month or a day before you get paid. This way you will be on top of your finances with a plan in place before money even comes into your account.
Learning to live within your means is an important component of financial success, and is a simple matter of spending less than you earn. For most people, this means cutting back on their current expenses, which is possible but requires some degree of discipline. Designing your personal budget is the first step to ensuring that you live well within your means and with practice and discipline, it will surely help you achieve the financial results that you want.
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