When to spend and when to save: How to create a solid budget
The first question we need to ask ourselves is What is a Budget?
The Cambridge Dictionary defines the word budget as:
“a plan to show how much money a person or organisation will earn and how much they will need or be able to spend.”
It is essential to know how much money is coming in and how much money is going out when creating a budget. When you start, completing a spending log is an excellent way to see exactly where your money is going – a takeaway coffee every day soon adds up.
A popular way to budget is to follow the 50/30/20 method, which was made popular by Senator Elizabeth Warren in her book: All Your Worth: The Ultimate Lifetime Money Plan. The 50/30/20 method divides after-tax income into needs, wants, savings and debt repayment.
How the 50/30/20 budget method works
The first step is to calculate your monthly income. This income could come from a salary, pension, or state benefits. After-tax, the remaining money is split into 50% needs, 20% savings and debt repayment and 30% to everything else. The 50/30/20 method aims to allow people to manage their money and save for emergencies and retirement.
Needs are bills that you must pay and are the things necessary for survival. These include rent or mortgage payments, groceries, insurance, minimum debt repayments and utilities.
Wants are all the things you spend money on that are not essential. Non-essential spending includes eating out, tickets to sporting events, vacations, the latest smartphone, and TV streaming services like Netflix or Disney+. Anything on the “wants” list is optional; You can work out at home instead of paying for a gym membership, cook instead of eating out or watch sports on TV instead of attending the game in person.
Finally, allocate 20% of your income to savings and investments. This includes building an emergency fund in a savings account, saving in an ISA, and investing in the stock market. You should have at least 3-6 months of emergency savings if you lose your job or an unforeseen event, such as a boiler breakdown, happens. Having an emergency fund stops you from getting into more debt. If the emergency fund is used, it is crucial to replenish the money as soon as possible. After that, focus on retirement and meet other financial goals. Savings can also include debt repayments, such as overpayments on debts to reduce the outstanding balance and future interest owed.
What is debt?
Debt is money that needs to be repaid to the person or company that lent it to you initially. Repayments usually include an interest payment added on to the cost. In 2021 the US’s average household credit card debt was $14,241.
While all debt needs to be paid eventually, not all borrowed money is “bad debt” money borrowed, which will enhance your future, such as student loans or mortgages, can be seen as good debt. Debt from credit cards, payday loans or store cards should be paid back as quickly as possible because the interest charged on these debts will be much higher than the “good debt.”
Paying off Debt
The quickest way to repay debt is to snowball. Snowballing can be done in two ways: first, paying off the debt with the highest interest rate. Pay the minimum payment on all debts, and then any additional money you have should be used to overpay the debt with the highest interest rate. Once this debt has been repaid, use the money you were paying on the first debt to overpay the debt with the second-largest interest rate. Keep doing this until all debts are repaid. Another snowball method is to overpay the smallest debt first, so psychologically, it seems like you are paying the debts off quicker.
If you are struggling with debt repayments, debt consolidation may be a viable option. There are online resources that can assist and provide information on consolidating debts. More information can be found here.