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How Budgeting Works

How Budgeting Works

The word “budget” has many meanings.  For some, it means controlling their spending.  For others, it means planning their monetary expenditures.  And yet, for others, it can be a way to make sure that they don’t run out of money each month.  All of these meanings make sense, but for a budget to be effective, you must really understand how the whole budget process works.  Here are some guidelines and takeaways that can hopefully help you create and manage your own personal budget.  Perhaps the most important factor is to get in the right mindset before you begin the process.

Budgeting is a Process

First of all, budgeting is a process.  A budget is not something you turn on and off, or decide to do for one month at a time.  Rather, a budget is something that requries a lot of tracking, analysis and planning.  You need to start by tracking your spending on a daily and even hourly basis so that you can gather all of the information you need to be able to get to the next How a Budget Worksstep, which is analyzing your budget.  In the analysis stage, you must add up, categorize and calculate how much money you are spending on each type of expense each month.  By doing so, you can get a feel for where you need to reduce spending.  Planning is the final step.  During the planning stage, you make a long term plan as to how to lower your expenses and hopefully maximize your income.  This can involve voluntary cutbacks or even major lifestyle changes.  Because a budget plan focuses on the long term, it is a process that must be repeated.  While you don’t need to precisely track every expense each day for a budget to work, you must stick to the process of optimizing and maximizing your personal finances in order to make your plan work.

A Budget Is Worthless If You Don’t Learn From It

Many people go through the painstaking work of collecting, classifying and adding up all of their monthly expenses to make a budget.  While this is the typical first step in creating a budget, many people neglect to take full advantage of this information.  Gathering this information and failing to analyze it or act on it can render your attempt to budget useless.  For example, if you create a budget and it shows all of your monthly expenses listed out, what does it really tell you?  For most people, looking at these numbers is confusing and often the end of their budget attempt.  In order to learn from your work, you need to analyze each expense.  Do your research and find out what other people in your situation spend on these expenses.  Look at each expense critically and see if it can be lowered, eliminated or improved.  Calculate ratios of your fixed versus discretionary spending, as well as your savings rate.  Then, understand what those ratios mean and set goals so that you can try to improve your budget going forward.

Changes in Lifestyle are Often Necessary to Improve Your Budget

For many, getting a budget to work means making lifestyle changes.  A case in point, there are many people that bought houses and cars that they really couldn’t afford.  When housing costs are the majority of your monthly income, there is just no room to fix your finances unless you remedy the situation.  For some, this could mean moving to a less expensive apartment, getting a roommate, refinancing their home, or even selling your home and moving to a rented house or townhome.  Besides housing costs, many people just plain live beyond their means.  There’s a reason that the United States’ average credit card debt per household is almost $16,000!  It’s because people spend more money than they make.  If you’re serious about improving your financesa and getting your budget to work, then you may need to make minor or even serious lifestyle changes.  Whether its your dining out habits, expensive clothing, or car fetish; most people already know what is costing them the most money each month, but somehow find a way to justify it instead of reducing it.

It’s All About Your Frame of Mind

While budgeting does require a lot of tracking, categorizing and planning, you won’t get results unless you have the right frame of mind.  Many people realize their spending is out of control and make a rash decision to make a budget as a quick fix.  Unless you have an open mind about evaluating your financial position, you are likely going to fail.  That’s because, without the right mindset, you will have pre-conceived notions about how to fix your spending.  Instead of looking at what the numbers say, many people have a propensity to justify their spending mentally.  For example, that mocha at Starbucks is “only five dollars”.  It’s pretty easy to mentally justify small and even large expenses, but make sure you have the right mindset when you add these expenses up and realize the damage to your finances.  After all, that five dollars a day adds up to $150 per month and $1,800 per year.  If that money were invested at 8% for the next thirty years instead of spent on coffee, you would have over $200,000 in your savings account.  Indeed, the small things do add up and do make a difference.

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