Lesson 1: Creating a Personal Budget

I. Overview: Tracking Income and Expenses

The first step in creating a budget is understanding where your money comes from (income) and where it goes (expenses). A budget helps you stay in control of your finances by providing a clear picture of your financial situation. Without a budget, it’s easy to lose track of spending, which can lead to overspending, debt, and difficulty reaching financial goals.

Here’s how to get started:

1. Track Your Income:

• Income includes any money you earn, such as your salary, wages, freelance income, side jobs, government benefits, or investments.

• You need to calculate your net income, which is the amount you receive after taxes and other deductions (like Social Security, health insurance, 401k contributions, HSA contributions, etc.).

2. Track Your Expenses:

• List all your monthly expenses. These can include rent, groceries, transportation, utilities, entertainment, debt payments, and savings.

• Be honest about your spending. Look at bank statements, receipts, or use a budgeting app to help you track spending over a few weeks or a month.

Exercise: Take a few minutes to jot down your sources of income and major expenses. This will help you identify areas where you might need to cut back or allocate more. How much money do you have left over each month?

II. Key Concepts of Budgeting

Let’s dive into three important budgeting concepts: income vs. expenses, fixed and variable costs, and the 50/30/20 rule.

A. Income vs. Expenses

At its core, a budget balances your income against your expenses. Here’s what each term means:

• Income: As mentioned earlier, this is all the money you receive, usually monthly, after taxes.

• Examples: salary, freelance earnings, rental income, investment dividends.

• Expenses: These are the costs associated with your daily life. Expenses can be grouped into different categories such as housing, transportation, food, entertainment, and savings.

To maintain a healthy financial balance, your income should ideally cover all of your expenses with some left over for savings and investments. If your expenses exceed your income, you may need to adjust your spending or find ways to increase your income.

Key Tip: Try to live below your means, meaning you should spend less than you earn. This leaves room for savings and investments. It also provides a bit of peace of mind knowing that you don’t have to worry about covering unexpected expenses.

B. Fixed vs. Variable Costs

Now that we know what expenses are, let’s break them down into two categories: fixed costs and variable costs.

• Fixed Costs: These are expenses that stay the same every month. They are predictable and don’t fluctuate based on usage or spending habits.

• Examples: Rent or mortgage, car payments, insurance premiums, subscriptions (like Netflix), loan repayments.

• Variable Costs: These are expenses that can change from month to month, depending on your habits or lifestyle.

• Examples: Groceries, dining out, entertainment, gas, utilities (electricity, water), shopping, and travel.

Key Tip: Fixed costs are usually necessary expenses that you can’t easily change, but you can often control or reduce variable costs. For instance, by dining out less or cutting back on shopping, you can lower your variable costs. Variable costs are one area that most people can cut back if you find that you are running in the negative on a monthly basis.

C. The 50/30/20 Rule

One popular guideline for budgeting is the 50/30/20 rule, which divides your after-tax income into three categories: needs, wants, and savings/debt repayment. The 50/30/20 rule is the golden rule, but if you are just starting out with a budget, you may find it easier to follow a 70/20/10 rule for the first few months.

1. 50% Needs: These are essential expenses that you can’t avoid. They cover your basic living expenses, like:

• Rent/mortgage

• Utilities (water, electricity)

• Groceries

• Insurance

• Minimum debt payments (credit card, student loans)

Key Tip: If your "needs" exceed 50% of your income, try to find ways to reduce them, like downsizing your home or switching to a cheaper service provider.

1. 30% Wants: These are non-essential expenses—the things you enjoy but can live without. While important for maintaining your quality of life, they should be kept in check to avoid overspending. Wants include:

• Eating out

• Entertainment (movies, concerts)

• Travel

• Shopping for clothes or gadgets

Key Tip: Be mindful of how much you spend on wants. It's easy to overspend in this category, so setting limits can help keep your budget balanced.

1. 20% Savings and Debt Repayment: This category is crucial for building your financial future. It includes:

• Savings for emergencies- we recommend working towards saving 3-6 months of expenses in your savings account.

• Retirement savings- make sure to take advantage of any employer matching programs

• Investments (stocks, bonds, mutual funds)- this goes hand in hand with retirement savings

• Extra debt repayments (anything beyond minimum payments)- the general rule is to pay down debt first.

Key Tip: Aim to save at least 20% of your income every month. If you have high-interest debt, prioritize paying it off as quickly as possible.

Example: If your monthly after-tax income is $3,000, here’s how the 50/30/20 rule would break down:

• 50% for needs = $1,500 (rent, groceries, utilities)

• 30% for wants = $900 (dining out, hobbies)

• 20% for savings/debt repayment = $600 (retirement, emergency fund)

Exercise: Using the example above or your own monthly income, try to categorize your expenses into needs, wants, and savings. See if your current spending aligns with the 50/30/20 rule, and identify any areas where you may need to adjust.

III. Practical Steps

Creating a personal budget is one of the most powerful tools for managing your finances effectively. By understanding the difference between income and expenses, recognizing fixed and variable costs, and applying the 50/30/20 rule, you can take control of your financial future.

Here are some practical steps to get started:

1. Track your spending: Start by tracking your expenses for a month to see where your money is going. This will give you a clear idea of what adjustments are needed.

2. Set financial goals: Whether it’s saving for an emergency fund, paying off debt, or planning for retirement, having clear goals will help motivate you to stick to your budget.

3. Adjust as necessary: Life changes, and so do your financial circumstances. Regularly review and adjust your budget to ensure it stays aligned with your goals.

By following these steps and committing to a budget, you’ll be able to live within your means, save for the future, and avoid unnecessary financial stress.