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May 20, 2020

Why Budgeting Is Important and How You Can Start

By Team Stash

With a budget, you can manage spending, paying down debt, and saving within your means.

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Budgeting—making a plan for how you will spend your money and sticking to it—might sound like a drag. 

But here’s the secret all consistent budgeters know: Budgeting actually makes your life easier. In fact, research has found a link between preparing a household budget and feeling greater financial satisfaction. With a properly functioning budget you don’t have to sweat paying your bills on time, you can pay off debt, build savings, and you can even have fun. There aren’t many things you can  change by snapping your fingers, but making a budget can be a simple and powerful way to gain control over your finances.

Whichever budgeting method you use—the envelope method, zero-sum budget, the 50/30/20 method, or your own spin on a budget—the goal is to track your income or the money coming in, and expenses, or the money going out. With a precise understanding of how much you’re making and how much you’re spending in any given month, you can get more out of your money. For example, if you tend to overspend, budgeting can help break that habit and keep you out of debt. Even if you’re not struggling to make the rent and stop incurring overdraft fees, budgeting can help you prepare for the unexpected with an emergency fund. And it can help supercharge your savings and pay down debt cheaply and quickly.

Here’s a look at some of the most important objectives having a budget can help you accomplish:

Cover your basic needs

When you budget, the first thing you do is add up your monthly income. Next, you tally up your necessary expenses. These costs tend to be recurring, such as your rent or mortgage payment, groceries, utility bills, car payments, and phone plan. Before factoring in any other expenses,subtract this total from your income. This simple act ensures that the bills you need to pay to maintain your basic needs are covered. Anything left over can be allocated to discretionary spending, whether that’s putting money into savings, funding an investment account, or buying a new television. 

Because your necessary expenses don’t tend to fluctuate very much from month to month, they are predictable. You can use past bank statements and bills to determine your fixed necessary expenses. If you can see money’s going to be tight, you have a chance to look through your unnecessary expenses—streaming services or dining out,—and find somewhere to cut back before a utility bill goes unpaid or you get hit with overdraft charges and late fees.

Halt cycles of overspending

If you’ve spent more than your income allows, you’re not alone. Nearly one in five U.S. households overspent their income according to the 2019 National Financial Capability Study. There are many reasons people overspend. For example, they might indulge in retail therapy, or splurging to cheer themselves up. They might fall prey to “present bias,” a behavioral tendency in which individuals put more weight on the present than on future rewards. Or they might get caught up in mental accounting, a tendency for people to mentally classify money based on subjective criteria that might ultimately lead to poor results. For example, someone might not want to use money received as a gift to pay off debt, even if getting out of debt is their top priority.

Whatever the underlying reason, overspending can potentially create a vicious cycle of debt. The more debt you have, the tighter your budget becomes. The tighter your budget, the easier it is to overspend. The more you overspend, the more debt you are likely to incur.

Halting this cycle requires being deliberate about your spending—and that’s the goal of a budget. As you track your income and your expenses, you’ll know when and why overspending can put you in a difficult position.

Prepare for emergencies

Sometimes an expense appears unexpectedly. Perhaps your computer dies, your roof starts leaking, or your car’s muffler fails. To keep unexpected expenses from derailing your budget and forcing you to miss bill payments, build an emergency fund in a savings account equal to three to six months worth of monthly expenses.

If that sounds daunting, remember that even a small amount of money can be a lifesaver when you’re hit with an unexpected expense or loss of income. For example, $250 might be enough to replace your brake pads, $500 might fix a leaky roof, $1,000 might make up for a week of unpaid sick leave, and $6,000 might help you cover expenses for a month or more after a sudden layoff. The lesson: A small emergency fund is better than no emergency fund. And the sooner you start saving in an emergency fund, the better, since you’re giving time for the fund to grow.

Control your debt

Some debt, such as mortgages, can be useful by helping you build equity. Other types of debt, such as credit card debt, can have a more negative than positive impact on your personal finances if you’re not careful.

Controlling your debt is a necessary part of making your personal finances work for you, and budgeting is one way to start. Getting a handle on  overspending can prevent debt from ballooning. And a budget can help you make a plan to pay off your current debts. You may even decide to prioritize paying down debt, like student loans, early. Doing so can help you cut down on the interest you owe over the life of your loan, freeing up money that can be put toward something else, such as retirement savings. Just beware that some loans actually come with prepayment penalties, so before making extra payments, read your loan’s fine print.

You might also try one of two other strategies for paying down debt: the snowball method and the avalanche method. With the snowball method, you start by paying down your smallest debts first, and gradually work your way up. With the avalanche method, you start by paying down your debts with the highest interest rates first, to hopefully save you from accruing more debt in the long run.

Earn cheaper rates

Lenders look at your credit score to figure out whether to loan you money and what interest rate to offer you. Credit scores run from 300 to 850, and the higher the score, the better. Several factors affect your score. The most important factor is your payment history. Paying debts on time can help you build credit. Having a string of late payments, defaults, bankruptcies and liens in your recent past can hurt your credit score.

Using a budget to help you pay off your debt also lowers your debt-to-income ratio (DTI), another factor lenders consider. Your DTI shows what percentage of your gross monthly income goes toward debt every month. As your DTI increases, lenders become less eager to extend credit. Many consider 36 percent a cutoff point. If your DTI is higher than that, they won’t lend to you. Others will accept borrowers with DTIs as high as 40 or 43 percent. If your DTI is higher than that, your borrowing options may practically vanish. 

Just as overspending and falling behind on your debt can lead to a vicious cycle in which your debt keeps growing, using a budget to control your debt can lead to a “virtuous circle” for your personal finances. Consistent, on-time payments can increase your credit score. A stronger credit score may qualify you for cheaper interest rates. And cheaper rates make it easier to consistently make on-time payments.

Save money for future goals

Saving for the future is not always easy. In fact, 15% of Americans have no retirement savings at all. But if you’re trying to save without budgeting, you may be making saving harder than it has to be. When you know just how much you’re putting toward necessary expenses, only then can you get a sense of how much you have left over for discretionary—or nonessential—expenses, including savings. 

Decide how much of your discretionary income you can set aside for the future, and then consider setting up automated deposits to help you set those funds aside. As the money is taken out of your account and into a savings or investment account, you won’t be tempted to spend it on other discretionary items.  

Whether you’re saving for a new car, a vacation, home improvements or for long-term goals such as retirement, understanding where your money is going will help you achieve your financial goals. And you’ll create a virtuous circle of making a budget and sticking to it. Gaining ground in one area of your personal finances could set you up for success in others.

Consider Stash

Stash can help you get started budgeting with tools like Auto-Stash, which can automate your savings goals, and partitions,1 which lets users assign different spending and saving categories to their money.
1Money in a partition must be moved to the available balance in your bank account before it can be used and does not earn interest.

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Written by

Team Stash

1Money in a partition must be moved to the available balance in your bank account before it can be used and does not earn interest.


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