May 2021
Barbara O'Neill, Ph.D., CFP®
Distinguished Professor and Extension Financial Management Specialist Emeritus
Rutgers Cooperative Extension
One of the best small steps that people can take to improve their finances is to prepare (and follow) a budget. Budgeting is a fundamental financial planning practice and, without a budget, it is hard to manage other aspects of personal finance including credit, insurance, saving, investing, and achieving goals such as a new car or a comfortable retirement. Financial goals cannot be achieved if there is no money set aside for them.
Budgeting has also been found in research to be associated with performance of positive health and financial practices. People who budget their money may be inclined to “budget” their calories and self-restrict their food consumption and/or adjust their physical activity to stay within their daily calorie “allowance.”
Below are nine key things to know about budgeting:
- Positive Cash Flow is the Goal- A budget is a plan for future income and expenses, including savings. The goal is positive cash flow, i.e., income greater than savings. Ideally, a budget should be hand-written or computer-generated with specific categories of income, spending, and dollar amounts.
- Individual Factors are Important- Examples include individual needs and wants, whether you have a stable income (the same amount in each paycheck) or a variable income that fluctuates every month, and whether you prefer to use a “paper and pencil” worksheet, an Excel spreadsheet, or a budgeting app.
- Savings is a Fixed Expense- How much you need to save per month or per paycheck to fund future goals should be set aside as a fixed expense that stays the same from month to month in a budget. A general online financial goal-setting calculator can determine the correct amount to save.
- Budgeting Methods Vary- Many people use the same budget format from year to year, adjusting for changes in income and expenses. For example, they use computer software or apps or a plain sheet of paper. What matters most is that you have a budget, not how you budget.
- COVID-19 Impacted Budget Priorities- Many people are working less (or not at all) and are struggling to make ends meet. Others are earning as much or more than before and are saving more due to decreased household expenses. In either case, budgets need to adjusted according to cash flow changes.
- Unexpected Expenses Always Occur- It is not a question of “if,” but “when,” unexpected expenses happen. For this reason, financial experts recommend including a “fudge factor” (a.k.a., a “miscellaneous budget category) in household budgets. If the money is not needed, it can be rolled over into savings.
- Expenses Can be Trimmed- Experts recommend starting with flexible expenses such as heating/cooling, subscriptions, streaming fees, and food. Also, look for less expensive shopping options (e.g., thrift shops), do more cooking at home, and consider ways to reduce fixed expenses such refinancing a home mortgage, selecting a less expensive apartment or car, and shopping around for insurance policy discounts.
- Benefits Can Supplement Income- People who are struggling financially can receive public benefits (e.g., utility assistance or food from a food bank), if income qualified. This frees up income for other expenses. Other ways to increase income are to barter items in lieu of spending cash and to sell unneeded items.
- Budgets Affect Credit Scores- A budget can prevent negative credit report data by including funds to repay debt as a fixed expense. Also, if followed, a budget can help avoid overspending on credit, which reduces a credit cardholders’ credit utilization ratio, which is worth about 30% of a FICO credit score. Finally, a budget can include funds to build an emergency fund so people are less likely to use credit in emergencies.
To create your own personal budget, take these two steps. First, track your income and expenses for a month or two to get accurate data about your current income and expenses. Next, use this Spending Plan Worksheet from Rutgers Cooperative Extension to create a future plan to manage your money.
