Make A Budget For The Right Reasons

January 12th, 2009

Ah, the New Year… And along with it the now (in)famous new year’s resolutions… Many people have probably decided that this would be the year they’d make a budget (the easy part), and stick to it (the hard part). As that last sentence suggests, making the budget is only half the battle, and the other half is the toughest. Probably one of the reasons why most budgets fail is that they’re made for all the wrong reasons. So let’s take a closer look.

Let’s say you’ve decided to make a budget, but you’re unsure where to start. First you have to figure out what problem is at the bottom of the need to make a budget.

Is it lack of discipline? Meaning that you are able to meet all your expenses, but you’re just not organized and often have to cough up late fees.
Is it overspending? Meaning that you would be able to meet your expenses if not for untimely shopping sprees.
Is it debt? Meaning that servicing your debt eats up too much of your income.
Is it cluelessness? Meaning that you just don’t “get” how to manage your money.

They’re all closely related, but identifying which one is at the root of your current problem(s) will go a long way towards setting you on the right path.

The first thing you need to know about a budget is that it’s a tool to help you control your spending, not some kind of restricting invention to keep you from buying what you want. Instead of griping about your budget, it’s more accurate to see things this way: it’s how you use your income that dictates what you can buy, not your budget. Your budget is just a reflection of how you’ve been using your money so far. It will allow you to plan your expenses according to your income so you can better achieve your financial goals. To make things easier for you, there’s even free home budget software that, you guessed it, you don’t have to pay for.

So in a nutshell, making a budget is simply planning your income vs. your expenses so you can buy what you need to. As a bonus, it’s arguably one of the very best personal finance management tools. Remember the saying that goes: it’s not how much you make, it’s how much you keep? Well it doesn’t matter what your income is, a budget will help you manage it much better.

Is making a budget really necessary?

Whether you like it or not, you’ll probably be better off with a budget. Living without a budget is like trying to drive a car without a steering wheel. Anything that goes wrong financially will hurt you badly, because you don’t have a safety net. And the reason is very simple: your expenses increase at least at the same rhythm as your income does. If you don’t think that’s true, then answer this question: what have you done with your most recent raise? More often than not, you’ve simply increased your expenses to meet your new level of income.

To know whether or not you need a budget, answer (honestly) the following questions:

What did you do with your last ATM withdrawal?
How much do you need to live on (give or take $50)?
Do you receive bills that you had totally forgotten about?
Do you have an emergency fund?
Do you always have to check your bank account balance to know how much money you have left?

The more negative answers you have, the more you need a budget.

A few reasons to make a budget

Having a budget allows you to:

know your real financial situation
reach your goals more rapidly
control your debt much more effectively
save, and ultimately, invest

(To learn more about investing, an interesting read is Valuing a Business – Seth Klarman’s 3 Methods.)

There is an abundance of software out there to help you make a good budget, some free, some you have to pay for. Now that you know the importance of making a budget, it’s time to actually sit down and get it done.