The real reasons you need a budget

Setting a budget can seem like going to the dentist. It takes effort. It might be painful. Ideally, you don’t need to do it and can simply go about living life.

But that perspective is usually premised on the idea that a budget is all about how to curb your spending. When viewed appropriately, having a budget can offer a range of benefits even if spending is not an issue. It also can be easier to create than you realize.

The full benefits of a budget

Whatever your financial situation, setting and following a budget can help you in several ways that you may not have initially considered.

It helps you set and meet goals: A budget can help you plan for the future by aligning your assets with specific financial goals. Goals can be short-term (paying off credit cards, gifts, home maintenance, emergency funds) or long-term (retirement, a child’s education, health expenses).

Creating a budget requires you to focus on your goals. What are you saving for? What are you spending for? How long will it take you to achieve your plan? By allocating funds to your goals on a regular basis, you set a path to achieving them over time. It is also a first step in refining your goals over time.

It ensures you have money when you need it: By having goals and a budget, you easily identify when you may have excess and when things might get tight. By knowing when your finances are likely to get stretched, you can prepare and not be surprised. You might decide to cut back. You might simply set yourself up to make better decisions by knowing about the stress points and how long they may last before they hit. This can apply as much to liquidity needs, where you have the assets but don’t want to sell, as it can to paying the bills.

It prioritizes your spending: People often avoid keeping a budget because they don’t think it will make a difference in how they spend. But the act of creating a budget is likely to influence your behavior, even if you don’t otherwise try to make any changes. By being aware of how you spend, if nothing else, you’re likely to sort out your priorities. You may notice you’re spending money on things you don’t need, and not spending as much on things that are more important to you, like having the peace of mind of an emergency fund or saving to help children put a downpayment on a first home.

It helps you manage the unexpected: A budget is designed to set a predictable flow of money. But it also helps with the unpredictable. Circumstances outside your control can impact your expenses at any time (medical bills, home maintenance, a large tax bill, an investment opportunity). With a budget, you can evaluate your upcoming needs and adjust to meet the situation. Better yet, you can build in flexibility -- setting aside funds or a cushion in advance for emergencies and unanticipated expenses.

It supports your investment strategy: A core parameter in setting a long-term asset allocation strategy for an investment portfolio is how much you plan to spend from the portfolio. If you have confidence in your budget, you may feel comfortable taking more risk in your portfolio and giving yourself the chance for larger long-term growth. Alternatively, having a budget may reveal the need for greater stability in a portfolio to meet your liquidity needs without the risk of needing to sell on a downswing in the market. How your portfolio is invested in equity, fixed income and alternatives should be based on both your long-term goals and the budget tied to achieving those goals. Not having a budget tied to your portfolio presents an additional form of risk on top of the risk of your investments.

It models responsibility: Sound budgeting is a great way to show the children or students in your life how financial responsibility works and why it matters. The best way to instill discipline is to show discipline yourself. You can also share the results in terms of the financial requirements of buying a home, retiring or paying for education. If you want your children to have a budget for themselves, start by having one for yourself.

Find your formula
Budgets offer many benefits. They also don’t take a one-size-fits-all form. There are multiple ways to develop a budget. The key is to find a way that fits your preferences and is workable for you.
Start by figuring out what you spend. Download the information from your credit card and bank accounts. Aim for a total amount. If your monthly expenses vary, look at it annually. Don’t rationalize away what you think about as one-time spends. Instead, focus on pulling everything in.
Then, you can organize into categories and time periods that make sense for you. For some, an annual target is what matters. For others, a detailed monthly budget with itemized categories is what gives them focus. You can often download transaction information directly from your bank or credit card company’s website as well as assign repeat transactions to categories to ease the bookkeeping.Set a guideline

Once you have your figures, think about what guidelines you may set for yourself to keep things in line. Here are three common personal budgeting methods to consider:

• 50-30-20 method: This is also known as identifying “needs, wants and savings.” Divide your monthly income into three categories, enabling you to cover necessary expenses while also allotting money for savings and entertainment.
  • 50% for essential expenses (needs): includes necessities such as housing, food, utilities, transportation, and other bills that are required for day-to-day living.
  • 30% for discretionary expenses (wants): covers things that are not essential but add enjoyment to your life, such as dining out, entertainment, travel, hobbies, and other fun activities.
  • 20% for reserve funds, debt and investments (savings): this is for building an emergency fund, paying off larger debt and saving for long-term goals, such as retirement or buying a home.
• Zero-based method: This centers on the idea that income minus expenses should equal zero each month. It means that every dollar earned is assigned to a specific expense category or savings goal, ensuring that there is no leftover money at the end of the month.

If there is money left over after all expenses are accounted for, you can allocate the extra to savings or investing. If expenses exceed income, you will need to find ways to reduce expenses or increase income. This encourages you to be intentional with your money and helps you prioritize expenses based on your financial goals. By starting from zero each month, you can adjust your spending to ensure that you are not overspending or underspending in any category.

• “Virtual envelope” method: This takes the old notion of physically dividing your monthly income into envelopes labeled as bills/savings/discretionary and adapts it for use in an online budget app. A variety of online tools are available that can guide you through the budget category breakdown process based on your monthly income.

You’ll allot a specific amount of your income each month into virtual categories: essential expenses, entertainment/discretionary and savings/investments. Once you have your cash divided up, the money in each "envelope" is meant to be spent only on that category. Once the money in an envelope is gone, you are done spending. This forces you to adhere to spending and saving exactly what you have on hand each month.

Control brings confidence

When you put in the effort, a budget gives you control. That control in turn should give you confidence. Even if you are already secure in your finances, a budget allows you to live your life with greater peace of mind and strength to optimize your assets to achieve your goals.