A recent survey found that only 63% of American adults are able to pay for an unexpected $500 bill with savings. In such a scenario, the remaining 37% would have no choice but to cover the expense by other means such as a credit card, a personal loan, or cutting their spending in other areas. Unexpected costs are inevitable, no matter how much you plan to avoid them. Relying on a loan or credit card in these scenarios will set you back further financially. If you want to set yourself up for success when these unexpected costs come your way, then it is time to learn the art of personal budgeting.
What exactly do we mean by personal budgeting? It simply refers to coordinating income and expenditures. Income refers to any and all money that you acquire. Expenditures refer to the places in which you will devote that money, regardless of if it’s out of necessity or preference. When all of the numbers are properly accounted for, a finalized budget comes in three variations: deficit, balanced, and surplus.
A budgetary deficit is when the expenditures exceed the income. Someone who earns $40,000 a year but has expenses totaling more than $45,000 in that same year is an example of this. Unless budgeting is performed intentionally, most people will continue to run a deficit. When prolonged, such a state leads a majority of Americans to being unable to afford a $500 emergency expense.
So, how do you start? There are many different methods for setting up a personal budget. Below, we will go through the process of the “zero-dollar” method. This is designed to ensure a balanced budget by pairing every dollar of income with a dollar of expenditure. Let’s get into some raw numbers so that you can see what this looks like.
“Zero-Dollar” Example
Like many Americans, Roy gets paid bi-weekly from his full-time job. Fortunately for him, he receives the same amount of money per paycheck throughout the year. After all his deductions, such as taxes and his retirement account contributions, he earns $1,150 per paycheck. Multiply this by 2 and he earns $2,300 per month. As his sole source of income, this is all of the revenue Roy needs to account for in his budget.
Now, let’s take a look at all of his recurring monthly expenses:
- Rent: $1,200
- Utilities: $110
- Car Insurance: $130
- Car Payments: $160
- Subscriptions: $30
Our total here adds up to $1,630. Of course, these are only the expenses Roy has that are fixed at the same cost month over month. (In real life, utilities bills do tend to fluctuate throughout the year depending on seasonal usage, but the difference month-by-month is rarely extreme). There are still additional expenses Roy needs to calculate that tend to be trickier to narrow down.
Expenses such as food and gas are far more likely to fluctuate month-over-month, especially during a time such as of the past few years, when inflation on consumer goods is soaring well above a historical rate. Even when high inflation is not a factor, food is one expense where most people vastly underestimate how much they spend, especially when it comes to eating out. If you tend to go out for food and drinks a lot and that involves swiping your card or phone without keeping a running tally of the totals, I encourage you to go over your last month’s credit card statement and add up exactly how much you spent in that area. The answer may surprise you. (Don’t worry, I’m often in the same boat as well).
Let’s say that Roy spent $285 on food and drinks last month. Unless he has reason to believe it will alter significantly, he should use the same number as a projection in the upcoming month that he is budgeting for. (Don’t worry, we’ll discuss reducing expenses later on).
Roy also drives to work and to visit his family on most weekends. He spent $250 on gas last month. As he did with the food, he will use the same number to estimate his gas expense for the upcoming month.
Combined, Roy spent $535 on food and gas in the last month. If he adds that to his current budget, the new total arrives at $2,165. When we subtract this total from his monthly income of $2,300, there is now only $135 remaining that is unassigned.
Even though all of the major expenses are now accounted for, Roy is likely to end up spending some of that remaining money in the upcoming month in an additional area. Perhaps he ends up receiving a parking ticket for $30. Perhaps he forgets until the last minute to buy a birthday gift for his mother that costs $45. Regardless of how thoroughly he plans for it, Roy will be faced with at least one expense he did not forecast. The same is likely to be true for you as well. Because he knows this, Roy decides to devote his remaining money as follows:
- $50 – savings
- $85 – miscellaneous
Now that he has done all the work in calculating his expenses, Roy’s final budget looks like this:
Expenditure Type | Cost | Revenue Remaining |
Rent | $1,200 | $1,100 |
Utilities | $110 | $990 |
Car Insurance | $130 | $860 |
Car Payment | $160 | $700 |
Subscriptions | $30 | $670 |
Food | $285 | $385 |
Gas | $250 | $135 |
Savings | $50 | $85 |
Miscellaneous | $85 | $0 |
Roy’s budget is now balanced. Every dollar he receives is assigned to a particular area. There are now zero dollars remaining to be accounted for. Nothing slips through the cracks. Many of you will likely sit down after this and discover that your budget is not balanced. That’s normal, especially if you’ve never committed to this before. It’s far better to discover that now than to continue on in your life oblivious to that fact. The first step to solving any problem is acknowledging that there is one and acknowledging that you need to reorganize your finances in order to set yourself on the right track is a major step forward. If you make this routine the norm, you will finally feel in control of your money. Knowing where and when your money is being spent is essential to achieving financial independence. Great work!
[…] discussed in the first post on how to budget, there are three different budgetary states you can find yourself in. The one you […]