Updated: Jan 26
Earning. Spending. Saving. Investing. Protecting. All these are components of personal finance. Yes, they are components of a personal finance plan. However, while a personal finance plan may sound obscure, a budget does not. As a result, the latter tends to be more popular, especially within informal circles. However, when people talk about formulating a personal finance plan or a budget, they are saying the same thing.
So, how do you create a personal finance plan? How do you design a budget? Is there a strategy to it? Here, we provide a reasonable introduction to that.
What is Budgeting
So, you earn. But, how do you spend? That is your challenge. Of course, your spending ideally will include things like saving, investing and protecting. So, how do you dedicate your earnings to those? For that, you will need to create a spending plan. The spending plan is a budget. The act of allocating resources from your earnings to the different expenses is budgeting.
At the core of budgeting is opportunity cost. That is the theory that while your resources are limited, your needs are not. As a result, you have to prioritize expenses that are important to you.
Benefits of Budgeting
Budgeting has many benefits. Your income is limited. Correspondingly, you are limited in your expenses. Your options, therefore, are to spend less than you make or strive to make more. The former is easier: you can even begin with it right away. To do that, you can start befriending budgeting. You can make a budget for your day-to-day finances.
Budgeting helps you balance your expenses with your budget. When you budget, you become aware of your bad spending habits and your financial leakages that you need to plug. It better positions you to handle emergencies. Finally and most importantly, by holding you back from spending money that you do not have, budgeting helps to save you from debt and prepare you for a fulfilling retirement life.
There are many budgeting principles to follow. However, the most popular of them is the 50/30/20 popularized by Senator Elizabeth Warren. The rule advocates spending your earnings, your after-tax income, thus: 50% on needs, 30% on wants, and 20% on savings.
50% on Needs
Needs are those things you cannot do without. They are bills that you have to take care of. They are rent, insurance, groceries, insurance, healthcare, etc. These are obligations that you have to meet. You can die if you do not satisfy your needs.
30% on Wants
Wants are your desires. They are not essential. You can do without them. They include movies, handbags, sporting events, expensive gadgets, etc. You won’t die if you do not get your wants.
20% on Savings
You should not just be working and meeting your needs and desires. You should also save. Remember the proverb: save for the rainy day. Your savings will come in handy for emergency expenses and retirement. You can even save towards a goal. You can use an Individual Retirement Account (IRA) for this.
Another popular budgeting principle is the 70/30 rule which can be broken down as follows:
70% on Monthly Expenses
Using the 70/30 budgeting rule, you allocate 70% of your after-tax income to your monthly expenses. Those expenses include rent, shopping, utilities, groceries, and others.
30% on Savings and Retirement
The remaining 30% of your after-tax income in the 70/30 budgeting rule is allocated to savings (20%) and retirement investing (10%). If you are in debt, you should set aside a part of your allocation to savings for debt repayment.
In conclusion, the percentage number you allocate is not that important. What is most important is that you understand the principles of budgeting and apply them.
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Hope this was useful for you! If so, hit the like button to make me feel good. Please note that the above content is not investment advice and shall be considered only for informative purposes.
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