Budget Your Way to Financial Independence

By Rachita Sharma

People often (correctly) say that money is not the key to happiness. Whether or not you have a lot of experience managing your finances, you have probably noticed there is another side to this coin: poor money management can be a significant source of unhappiness and stress.

We all know people who exemplify good money management and others who let their finances spiral out of control. You might have observed that having money management skills can make a big difference in a person’s sense of security and ease in life, especially as they get older. Building such skills when you are young makes sense because as any older person will tell you, doing so will reduce your stress every year of your life thereafter.

The truth is that managing money well is about balance, and all you need to do to achieve that balance is acquire simple competencies surrounding earning, spending, saving, investing, borrowing, and protecting your money. This isn’t rocket science, yet it can be the key to achieving many of your financial goals, including intangible goals, such as achieving peace of mind. Importantly, it can also put you in a position where you don’t have to rely on others for financial support.

No matter what your income level currently is, you can give yourself a meaningful advantage by educating yourself about money. So what’s the first step in building your financial IQ? Creating a personal budget.

“When implemented effectively, a budget provides a flexible blueprint for how to achieve your financial and life goals,” says Roy Jones, CFP, co-founder and chief operating officer of Everspire Global. “The base framework for anyone's financial well-being includes managing income, expenses, and spending patterns. This element of the financial planning process empowers families with the confidence to make more informed decisions on the road to financial independence.”

Why create a personal budget?

People with poor financial literacy skills tend to go into debt and not know how to get out of it. They also tend to be unprepared for retirement when it comes. A personal budget gives you a plan for how you should spend your income today so that you can be secure both now and in the future. Having a plan for your money will help you make smarter decisions than someone without a plan would.

Creating a budget also gives you a monthly reality check. Many of us don’t put much thought into the cumulative effect of our spending habits, but even small expenditures will add up. The depth of some people’s denial about the amount they spend on “fun things” is amazing. They receive their bank statements, but don’t want to look at them—after all, wanting to avoid something that could be a source of stress is just human nature.

Budgeting brings all the relevant information out into the light so it can be understood and dealt with. Although the process may be uncomfortable at first, the benefits are worth the discomfort. With clarity on your income and expenses, you can make more informed life decisions and take steps toward financial independence.

You might be surprised to learn just how much of an advantage you will have in life if you start budgeting and learning other early. According to one study, only about one-third of the global population is familiar with the basic concepts of financial literacy. What is even more shocking is that this one-third statistic remains constant across affluent and non-affluent countries, and even among affluent and non-affluent people within each country. Another troubling trend is that fewer young people and women have learned these skills.

It is safe to say that people from every walk of life could benefit from focusing more effort on budgeting.

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Steps to creating a personal budget

Understand income vs. expenditures

Your budget involves two main components: income and expenditures. The amount of money you spend (expenditures) must be equal to or less than the amount money you bring in (income), or you will risk falling into debt. Most people find that comparing their income and expenditures every month is best. Paychecks tend to arrive once a month at a minimum, and rent/mortgage and household bills are usually due monthly, making this a convenient time frame to use.

If you have never budgeted before, take a close look at your past month’s income and expenditures. Also, take a moment to understand your paycheck. Note your gross income (the pre-tax and pre-deduction amount you were paid for that time period) and your net income (your take-home pay after taxes and deductions). Notice where your deductions go, such as to income tax, health insurance, unemployment benefits, and/or a retirement plan.

Implement the "50/30/20 budget rule"

Once you have an idea of what your expected income should be for the coming month, you need to start tracking your expenditures and creating realistic expectations for each. A good departure point can be the “50/20/30 budget rule.”

50% = Needs. Allocate the largest share of your net income to basic needs such as housing, groceries, health care, utilities, and transportation. If you have debt, such as student loans, include the minimum payment in this category. Some of your expenses in this category might cost the same every month and some might vary. Record all these numbers, establishing a realistic estimate for any expenses that vary.

The cost of living in your area will have the biggest impact on the value of your “needs” expenses. If you are not sure whether an expense is a true “need,” ask yourself what would happen if you didn’t pay for it. If the consequences are dire (e.g., eviction or starvation), the expense qualifies as a “need” and goes in this category.

30% = Wants. Another way to describe this category is “nonessential spending,” which includes entertainment, travel, eating out, shopping, and anything else that is not a necessity. Limit these types of expenditures to 30% of your net pay. Some nonessentials might be emotionally, physically, or psychologically quite important to you, such as a fitness class that helps you to be healthier, but you could technically live without it if you absolutely had to.

Distribute the allocated 30% of your net pay over the products and services you spend in this category. If you find that you need to cut back on nonessential spending to make ends meet, try ranking your wants and prioritizing those that are most important to you.

20% = Your future financial health. Ideally, every month, you should save approximately 10% of your net income for retirement. This is something you should prepare for even if you are young, because in order to achieve financial independence, your investments need time to grow. Waiting until you are 40 years old to begin saving for retirement is far too late.

Building an emergency fund is also a good idea. An unexpected expenditure, such as a large health care bill or significant car repair, hurts most when you are not financially ready for it. One option is to split this 20% portion of your income in half, allocating 10% to retirement savings and the other 10% to a “buffer budget” that can serve as an emergency fund to pay down debt or to work toward achieving a larger financial goal, such as investing or buying a home, should the funds not be needed for something unexpected.

Track your expenses

If you find tracking all your expenses on paper daunting, multiple apps are available for download that make the task easier. Not only do these apps make recording expenditures simple but many can also analyze your data to produce simple graphs that show you instantly whether your budget is on or off course. They can also give you strategies to help you reach your long-term financial goals more quickly without your having to crunch the numbers yourself.

Personal psychology of budgeting

Once you have mastered the discipline of tracking expenses, you are likely to learn a lot about your personal psychology with respect to money. A budget holds you accountable to yourself and prevents you from clinging to misperceptions.

You might think, “I don’t eat out that much” but then find out the first month that you actually spend 27% of your net pay at restaurants. That is not to say that occasional indulgences are a bad thing, however. Giving yourself small, measured rewards for underspending on your budget will help you to achieve success with budgeting in the long term, and financial independence down the road.

Take your first step toward financial independence today

When you learn how to budget, you are taking a step—or even a leap—toward enjoying a secure and independent future. Although you can never anticipate or eliminate all sources of stress in your life, managing your money intelligently can help you circumvent many of them.

When you create a budget, you give your money a purpose: helping you meet your short-term, medium-term, and long-term financial goals. And you might find that learning to budget is a springboard to other proficiencies that will give you financial independence and stability throughout your life.

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