Budgeting is one of the most important activities of one’s life. Done right you can enjoy a stress-free life. Nonetheless, if you are bad with your money you could find yourself in all sorts of trouble. The typical budget is divided into 04 main blocks. They are your gross income, your net income, your total expenses, and your net balance. Each of these blocks represents a very important aspect of your financial journey.
1. Evaluate your net income
Your net income is money earned. In essence, it is your gross income minus taxes, retirements, health insurance, and other deductions that are taken out directly from your paycheck. Hence, if you are employed, it is the money that lands directly into your bank account each payday.
However, if your wages fluctuate, consider taking the past three to six months and averaging what you earned during that time. Focus on your take-home pay instead of your gross income because that’s the amount that actually ends up in your personal bank account.
If you are self-employed, for each gross income consider at least 30% for taxes and at least 40% for operational costs, and 20% for reserves. In fact, it is typically recommended to take home as personal pay 10% of your gross income. At least that is from my personal perspective.
2. Calculate Your Monthly Expenses
Once you have figured out what your net income is, you should run the numbers for your expenses. Put yourself in the right mindset by being very honest and thorough. The first step is to look at your bank and credit card statements over the past three to six months to understand your spending habits.
Then, the next step is to break down those expenses into two main categories necessary vs non-necessary. For instance, your rent, and utilities, are necessary expenses. If you don’t pay your rent you will be homeless. However, your Netflix subscription is not a non-necessary expense.
Typically, your necessary expenses are pretty straightforward, those are expenses that you must absolutely cover every circle.
Conversely, non-necessary expenses are expenses that can easily be cut out or eliminated without any harmful impact on your life. For example, eating out and entertainment.
Break down all those expenses at a granular level to have a comprehensive overview of your money flow. Your next step is to allocate a set amount for each essential category and either completely eliminate all the non-necessary expenses or find cheaper alternatives for those. Then you will have to set a budgeting plan and stick to it.
3. Net balance
Your net balance is the difference between your net income and all your expenses. This basically tells you how good or bad you are with your money. If it is negative, it simply means that you are in deficit. Hence you are funding your life with borrowed money that doesn’t belong to you. In this case, you can either downsize your lifestyle or make more money.
If it is positive this simply means that you are building up some savings.
4. Pick a Budgeting Plan
Commonly, four common budgeting methods are considered to be industry standards. Take your time and pick the plan you think will be most effective for you. If you can’t decide then try each and see which plan resonates more with you.
This is one of the most popular methods. Basically, you allocate a set amount of money for each spending category, then put that amount of cash in an envelope then label the envelope with the category name.
As a consequence, when your envelope is empty it meant you run out of money for that given category for the rest of the month. This is particularly effective for expenses that you can cover with cash.
The 50/30/20 budget strategy is the darling of financial gurus because of its simplicity. Indeed, you just have to allocate 50% of your take-home pay to necessities, such as housing, utilities, and car payments; 30% to discretionary spending; and 20% to your financial priorities, like savings and paying down debt.
The method requires discipline and flexibility at the same time.
The Two-Account Plan
Honestly, this method works well for those who do not want to see money with their eyes. Basically, you open two accounts. One account for your monthly fixed expenses and the second account for your discretionary spending. Nowadays, this is so easy to implement. Actually, your bank can help you set that up automatically, in a way that your direct deposit is automatically split with a set percentage deposited into one bank account when you get paid, and the remainder goes into a second account.