The importance of making a budget is a financial lesson that can’t be overemphasized. When you first go on your financial journey, following a budget can help you practice basic money habits.
Still not convinced? Below are five good reasons why everyone should create and stick to a budget.
Key Takeaways
- A budget is simply a spending plan that takes into account estimated current and future income and expenses for a specified future time period, usually a year.
- Having a budget keeps your spending in check and makes sure that your savings are on track for the future.
- Budgeting can help you set long-term financial goals, keep you from overspending, help shut down risky spending habits, and more.
Helps You Work Toward Long-Term Goals
A budget helps you figure out your long-term goals and work toward them. If you just drift aimlessly through life, tossing your money at every shiny, new object that happens to catch your eye, how will you ever save up enough money to buy a car or put a down payment on a house?
A budget forces you to map out your goals, save your money, keep track of your progress, and make your dreams a reality. By seeing what money you earn and what money you have going out through a budget, you can create a map for where you need to go to get your goal, whether that is purchasing a home in a few years or going to graduate school.
Tip
Budgeting can also be used for shorter-term goals. If the brand-new Xbox game or the cashmere sweater in the store window is unattainable right now, then a budget can help you understand what you need to do to get to that goal.
Can Keep You from Overspending
Far too many consumers spend money they don’t have—and we owe it all to credit cards. The average credit card debt per borrower rose to $6,360 in Q4 of 2023, according to credit bureau TransUnion.
Before the age of plastic, people tended to know whether they were living within their means. At the end of the month, if they had enough money left to pay the bills and sock some away in savings, they were on track. These days, people who overuse and abuse credit cards don’t always realize they’re overspending until they’re drowning in debt.
However, if you create and stick to a budget, you’re more likely to not find yourself in this position. You’ll know exactly how much money you earn, how much you can afford to spend each month, and how much you need to save.
Can Make Retirement Saving Easier
Let’s say you spend your money responsibly, follow your budget to a T, and never carry credit card debt beyond monthly due dates. In addition to spending wisely, budgeting can make saving more achievable.
It’s important to build regular saving and investment contributions into your budget. If you set aside a portion of your earnings each month to contribute to your individual retirement account (IRA), 401(k), or other retirement funds, you’ll eventually build a nice nest egg. Although you may have to sacrifice a little now, it will be worth it down the road.
Here’s an example of how that could work: Let’s say Trina started a new job last year and wants to take advantage of the employer’s 401(k) plan and matching contributions. She knows that including her own monthly plan deferral from her paycheck in her budget as a recurring expense will help her be consistent in building retirement savings. She’s 36 years old, so she knows that for the 2023 tax year, people her age can contribute a maximum of $22,500 to their 401(k), before employer matching funds.
So, using a calculator provided by her 401(k)’s management firm, she figures out that she should defer $433 per week, or $1,732 per month, from her salary to max out her potential annual contribution for 2023. She adds that figure into her budget spreadsheet under expenses and makes it an automatic subtraction from her disposable income, to separate her retirement savings from her cash available for other expenses.
Note
In some cases, it may seem like a good idea to add larger amounts to your retirement account, but if it means that the reduction in disposable income will result in rising credit card and other debts incurred for everyday expenses, then boosting retirement savings could actually have a negative effect on your bottom line. Everyone’s approach will vary based on their individual financial situation.
Helps You Prepare for Emergencies
Life is filled with unexpected surprises. When you get laid off, face a costly unexpected home repair, become sick or injured, go through a divorce, or have a death in the family, those circumstances can lead to serious financial turmoil. In these situations, an emergency fund comes in handy.
An emergency fund should consist of at least three to six months’ worth of living expenses, and it should be accounted for when budgeting. This extra money will ensure that you don’t dip into other funds saved for long-term financial goals, such as paying off debt.
Of course, it will take time to save up three to six months’ worth of living expenses. Don’t try to place the majority of your paycheck into your emergency fund right away. The best strategy is to build it into your budget, set realistic goals, and start small. Even if you put just $10 to $30 aside each week, your emergency fund will slowly build up. Budgeting apps, such as Mint or YNAB, provide tools for setting up an emergency fund, depending on your chosen approach.
Can Reveal Spending Habits
Building a budget forces you to take a close look at your spending habits. When reviewing your expenses, you may notice that you’re spending money on things you don’t need, such as a cable TV subscription. Budgeting allows you to rethink your spending habits and refocus your financial goals.
Taking a look at your expenses, you may see that one month, you spent more money on eating out than cooking at home. By reviewing your budget, you can make effective changes as a result. If you see that you’re overspending target amounts set in your budget for such discretionary items, you may choose to adjust how much you commit to luxury or nonessential spending in lieu of saving for a new car or a major home improvement project that could also add to your place’s resale value.
Why is a budget important?
A budget helps create financial stability. By tracking expenses and following a plan, a budget makes it easier to pay bills on time, build an emergency fund, and save for major expenses such as a car or home. Overall, a budget puts a person on stronger financial footing for both the day-to-day and the long term.
What is an emergency fund?
An emergency fund is three to six months’ worth of living expenses set aside in case of an unexpected life event, such as employment termination, illness, or a hefty home maintenance bill.
What are some key reasons to have a budget?
There are many reasons to have a budget, depending on the individual. A budget can often help build financial independence and freedom. A budget can also set you on the right path to achieving your financial goals, spending within your means, saving for retirement, building an emergency fund, and analyzing your spending habits.
The Bottom Line
A budget is simply a spending plan that takes into account expected income and expenses for a specified period of time. It can bring you one step closer toward financial security. Having and sticking to a budget can keep your spending in check and assure that your savings for emergencies and longer-term goals, such as a comfortable retirement, stay consistent.
Read the original article on Investopedia.