Creating a Budget
Big Idea
Building wealth starts with a plan that serves as a guide to income, spending, saving, and investing with the end goal of comfortable living and wealth creation.
Members of a household share living quarters, food, and responsibilities. They help each other meet needs and satisfy wants. They all want to get the most of what they value at the lowest possible opportunity cost to maximize their individual and shared satisfaction and standard of living.
Sometimes members of a household are not satisfied with their standard of living. Sometimes, people are stressed. Many things can add stress to a household, for example, unexpected life events such as an illness. A common stress point is financial insecurity. Sometimes financial stress is caused by job loss, economic problems, and other forces not under the household’s control. Often, though, it is caused by or worsened by unwise financial choices. These include:
Spending more than earned.
High debt.
Not using a budget.
Not saving money.
Money problems can weigh heavily on all members of the household, taking time and energy away from productive activities. Budgeting can help address this problem and help keep finances on track.
What’s a Budget?
A budget is a tool used to build economic stability. A great way to start a budget is to map out your consumption. How much do you earn? How do you spend that money? What do you buy? How much do you save? Are you spending your money wisely? Use the answers to these questions to create a budget. It can help you plan to spend in a way that is consistent with healthy financial living.
Try it
Select the circles to to explore Sam's budget.
People, like businesses and nations, build wealth primarily through saving and investing a good chunk of their income. Setting aside money now enables more options for future consumption. Set a goal to begin saving as soon as possible.
An architect designs a house by crafting a blueprint. A heating engineer follows the design plans to repair a customer’s furnace. An athlete arrives at the Olympic games only after following a routine of practice, exercise, and nutrition long before the competition. Developing a detailed plan of action to achieve a goal, sticking to it, evaluating it, and updating it when necessary are critical steps toward succeeding in life.
Whether for an individual or a household, that plan of action is a budget. A budget helps direct funds toward purposeful spending and saving. A budget will help you:
Prevent excessive spending.
Recognize “bad” debt.
Determine if you are saving too little.
Set funds aside for an emergency.
Save for investing.
Determine if you need more income.
Big Idea
Spending today costs you saving and investing for tomorrow. Look for ways to spend less on your wants so you can save and invest.
How to Budget
The first step in budgeting for purposeful consumption over unwise consumption is to separate needs from wants.
After you separate your needs from your wants, reduce your wants for today to make way for saving and investing. For example, a budget can help you save money now to cover an expense later. It could be an unexpected expense or an expected expense like your college education, a down payment on a house, or even retirement. Both saving and investing can help you use a budget to meet your short-, medium-, and long-term goals.
In other words, saving and investing help you spend in the future. However, if you spend today by borrowing or using credit cards, that spending can cost you future resources. Find creative ways to reduce spending today so you can increase your saving and investing.
Another way to save or invest more is to find ways to bring in more income. Some people choose to work more hours or even take on a second job. Consider earning income by helping others in your neighborhood. Do these things if and only if they are the lowest-opportunity-cost activities. Make sure that increasing your income is a sound choice given whatever your second-best alternative to working happens to be.
Planning for Emergencies
A budget includes an allocation for savings because everyone needs to be prepared for emergencies. A good rule of thumb is to have savings that can cover three to six months of expenses.
An emergency can be personal, such as an illness or accident, or it can be large-scale, such as the COVID-19 crisis that increased the unemployment rolls by millions of people. While the federal government moved quickly to give citizens subsidies, the money received can never replace full incomes or consistent savings.
Emergencies put a budget into perspective quickly. Research done by the New York Times after stay-at-home orders were issued in March 2020 saw a drop in household credit and debit card expenditures on travel of more than 75 percent as vacations were canceled. Spending on dining out, entertainment, and shopping all dropped by double-digit percentages. The only category that saw an increase was groceries, and by April 1, 2020, even that spike in spending had returned almost to normal as panic buying subsided.
Summary
Developing and sticking to a budget can help in tracking income and expenditures and help improve a household’s financial picture. When you have a clear picture of where your money goes, you have the information you need to look for ways to:
Increase income.
Cut back on wants-based expenditures.
Pay down “bad debt.”
Save more.