Budgeting

A budget is a tool that allows you to take control of your personal finances and to make the best use of your income in order to meet your needs, according to your values and preferences. It also helps you to plan and to ensure that you reach your objectives. When we realize where our money is going, some options may become more apparent. Budgeting can help you reach a savings target, or repaying debt.

This article first adresses who needs a budget, and why making a budget can be a good idea. The article then deals with the various steps involved: define your goals; track your spending for a while; prepare a balanced budget; track your progress.

Who needs a budget?

More than 60% of US households currently engage in budgeting (formally or informally), and of those who currently don't, more than 40% have done so in the past. Budgeting is "highly prevalent across the income distribution", so it is not restricted to people who are under financial strain. There is a positive correlation (not to be confused with causation) between budgeting and percieved financial wellbeing: "the propensity to budget increases signicantly from 41.8 percent to 71.1 percent when moving from the lowest to highest index score for perceived financial wellbeing".

One US study found a correlation between some of the "Big-5" personality traits and money management practices (defined as “budgeting, saving, investing, spending, and otherwise overseeing the use of money”). In other words, some people seem psychologically better predisposed at managing money carefully than others. The two relevant personality traits in the US study are conscientiousness (positively correlated) and neuroticism (negatively correlated). A small Dutch study found a negative relationship between "mental budgeting" (the tendency to assign expenses to mental accounts) and neuroticism. People who score high on neuroticism tend to show more compulsive buying behaviour. Therefore, somebody who scores low on conscientiousness and/or high on neuroticism would probably be more likely to benefit from developing an explicit budgeting strategy/system to increase self-control and good financial outcomes. People with such personality traits might also benefit from consulting with a financial advisor.

Who does not?

However, if (1) you've calculated a savings rate that will allow you to reach your goals, including retirement, (2) you are easily saving that amount or more every year, perhaps with the help of automated contributions to your investment accounts, and (3) you have no consumer debts, then you probably don't really need a budget. In other words, if you're already saving enough, who cares where the rest of the money goes in detail? Everybody else, read on...

Why budgeting can help

In preparing your budget, generally your goal is to balance your income with your regular expenses, savings for your financial goals and repaying your debts.

Specific reasons for budgeting include:

• Figuring out where your money is going
• Making sure that you spend less then you earn, to repay debt and save for the future
• Reducing stress
• Gaining more control over your finances, and feel in control
• Helping you to reach your goals

Thaler describes bugeting as self-control procedure. A person can be thought to contains two entities, a planner and a doer. The planner is concerned with lifetime well-being, which requires saving for the future. The doer is selfish and wants to spend now. Therefore, "the planner requires some psychic technology capable of affecting the doer's behavior", such as rules of thumb or budgeting.

A large Dutch study shows a statistical correlation between mental budgeting (mentally assigning expenses to categories or 'accounts') and having savings goals. A correlation was also seen between mental budgeting and knowledge of financial products. In the authors' words, "mental budgeting is not a naive type of financial management".

A US study found that the most common reason given by people who budget is the desire to avoid overspending. Other popular reasons include saving for short term or long term goals, avoiding future debt, and repaying existing debt.

Before you start

Goals

Budgeting typically starts with some thoughts on what are your financial goals, both short term and long term? Write them down. This may include paying back debt, reducing your weekly expenses, saving for a big expense, saving for retirement, etc.

Tracking expenses

It is worthwhile to consider past spending when formulating a budget. So the next step is keep track of your money for a month or two. This will help you understand spending habits and expenses. Consumer advocates generally recommend tracking everything on a daily basis during this time.

Some expenses might only occur once a year, such as purchasing certain gifts, some insurance payments, renewing your driving licence, property taxes, etc. Go through your files (paper or online) to find out the relevant yearly amounts and divide them by 12 to arrive at the monthly figure.

Needs versus wants

Knowing the difference between your needs and your wants is an important budgeting consideration. Things you need are essential expenses such as appropriate shelter, food, basic transportation, basic clothing, etc. People's needs change over time, depending on where they live, if they have children, etc. Things you may want are everything else, and wants are influenced by factors such as advertizing, emotions, habits and peer pressure.

A commonly cited guideline on personal finance websites (e.g., ), probably aimed at middle income families, is 50-30-20: you could spend 50% of take-home pay on needs (necessities), 30% on wants, and 20% on savings and debt repayment. The specific numbers are not important here, but rather the basic message is that a significant portion of income should go to savings, and most of the remaining portion should be spent on needs rather than wants, otherwise the budget will typically not balance.

Preparing your balanced budget

Now that you know what you've been spending for the last month (or year), you can prepare a balanced budget for the future. This means that revenues (income) and expenses (including savings) must balance. In terms of spending categories, keep it simple; the more complicated the budgeting process is, the less likely a person is to keep up with it.

Shortfalls

After preparing your budget, if it indicates that you have a shortfall, review your budget to see where you could reduce spending. You could also consider whether there are ways to increase your income.

Surpluses

If you have money left after you have completed the budget, consider using it to repay debt, particularly non-deductible debt, faster or to increase savings for an important financial goal.

Flexibility

Depending on your circumstances, you might want to have some flexibility in your budget. Preparing a budget when you have irregular income or a number of "one-time" expenses can be tricky. To avoid running out of money because expenses occur before the money actually arrives you should establish an emergency fund.

Budgeting tools

There are a number of tools available to help in the creation of a budget, such as spreadsheets, personal financial software and online budgeting tools (including apps). For example:

• The Financial Consumer Agency of Canada has developed an online tool that does the math for you
• The Credit Counselling Society has a free Interactive Budget Calculator Spreadsheet for Canadians
• See the sample budget worksheet below.

Such tools generally provide a good starting point for preparing a budget, but remember simplicity will typically increase your chances of successfully following your budget.

Tracking your budget

Once a personal budget has been created does not mean the effort is done. You should track your monthly income and expenses against your budget.

If you find that your actual amounts are not matching up to your plan, then adjustments should be made, either in budget amounts or spending habits.

As Heath and Soll (1996) write, "for a budget to be an effective self-control mechanism, it must be at least somewhat inflexible", since you don't want to spend your rent money on a frivolous expense. On the other hand, as noted above, some flexibility between budget categories (especially the non-essential categories) can be a good thing, as long as you can still reach your savings goal at the end of the month or at the end of the year.

Sample budget worksheet

Sample Budget Worksheet

	Previous Month ($)	Budget ($)	Actual Spending ($)	Difference ($)
INCOME
Salary or benefits
Canada Child Tax Benefit (CCTB)
Other
Total INCOME
BASIC EXPENSES (NEEDS)
Home
Rent or mortgage payments
Property taxes/condo fees
Home insurance
Utilities (such as electricity, water, cable or telephone)
Repairs and maintenance
Transportation
Public transportation
Car loan payments
Car repairs, gas, etc.
Car insurance/registration, etc.
Living expenses
Groceries
Child care
Medical and dental
Outstanding loan payments
Basic clothing
Life, disability and medical insurance
Emergency fund
Other
OTHER EXPENSES (WANTS)
Restaurants and entertainment
Clothing (extra)
Hair care
Gifts
Vacations
Other
Total EXPENSES
SAVINGS TO REACH GOALS (Total income minus total expenses)

See also

• Cash management
• Net worth
• Record retention

External links

• Financial Consumer Agency of Canada, Making a budget
• Financial Consumer Agency of Canada, Financial toolkit Module 1: Income, expenses and budget
• Top 3 budget software in Canada
• Statistics Canada, Household spending by household type, 2010-2019
• Investor Education Fund, Budgeting, includes a spreadsheet
• Household budgeting, from the Bogleheads Wiki
• Saskatchewan, Household Budgeting; includes tips for lowering costs
• Mental Budgeting and Consumer Decisions, Journal of Consumer Research, 1996
• The Globe and Mail, How to make a budget: Best apps and templates, cash-only budgeting and more