The Four Rules of Effective Budgeting

Effective budgeting means following some basic rules. There are four basic rules to follow. These are inspired by YNAB.

1. Give every dollar a job

Your money shouldn’t tell you what to do. When you earn money, you plan how you’ll use it, then you follow your plan. This means that instead of deciding to buy something based on the big (or small) pile of money in your checking account balance, you’ll decide based on a category balance. For example: Without Rule One: You have a $5000 account balance. You get the false idea that you’re flush with cash. You want to get a new TV for $1000 dollars. A few days later some bills come due and you’re in a pinch. With Rule One: You have $5000 in your checking account. You give each of those dollars a job by dividing the $5000 into various categories.

  • Rent-$2000
  • Utilities-$500
  • Car payments-$500
  • School fees for kids-$500
  • Groceries/Household-$1000
  • Miscellaneous-$500

You don’t look at your $5000 account balance and say, “Wow, that’s a ton of money! Sure!” You look at your ‘Miscellaneous’ budget balance of $500, wince, then smile, and stick with your old TV. A few days later some bills come due and you pay them with ease. So, the key thing with rule number one is to divide your earned money into categories. This creates laser like focus and helps your awareness of how you spend money so that you can spend it more effectively. Some other things to remember with regards to rule number one are: 1. Make sure you have a category called “fun money”. You can spend this money each month for whatever you like with no accountability. 2. The categories and the amount you allocate for your categories are flexible and can be changed as the month goes by and things happen. Say, for example, you have budgeted $250 for home repairs and $300 for miscellaneous. A home repair occurs and that costs $300. You can adjust by taking $50 from the miscellaneous category.This type of adjusting is normal, expected, and encouraged. It means you’re setting a plan, then adjusting that plan as new information arrives. You may simply want to spend more money on entertainment than you originally thought you would. Because every dollar has a job, the extra for entertainment will have to come from somewhere. You look things over, get a gauge on your priorities, and make the adjustment. 3. Every dollar should go into some category. 4. If you have a lot of money left, then you could put some money in the category called “Available next month”. This will be discussed in rule number four. 5. Try not to budget too far. Budget for the next 1-2 months. That is realistically possible. 6. If you are married, then you need to do this together with your wife.

2. Save for a rainy day

In rule number one, we allocated each dollar we got into a category. In rule number two we do the same in a slightly different way. Our expenses are not fixed and the same every month. We also have expenses that occur only once or twice a year but they are big.Rule Two forces you to look at the larger, less-frequent expenses (car insurance, life insurance, Christmas, school tuition, vacations) and break them down into monthly, manageable amounts. So this rule takes care of our true expenses. This is given by the formula:

Your True Expenses = What You Have/Want to Pay Now + What You Have/Want to Pay in the Future.

The future expenses can be expected( like insurance premiums) as well as unexpected( like a large medical bill). The future expenses can also be something you are going to enjoy( like a vacation) You have to make reasonable assumptions for the unexpected expenses. This way you make your financial life a lot more easier to handle.

3. Roll with the punches( be adaptable)

This is the rule that helps us stick to a budget. Life is imperfect. Your budget is never going to be perfect. You have to accept it and adapt to it.n boxing, a fighter moves his body in the same direction as his opponent’s punch, so as to lessen the blow. In budgeting, you do the same. Be flexible and address overspending before moving on to the next month. This helps you stay in the fight.When you overspend in a budget category for the month, roll with it! You make and change plans all the time. If you plan a weekend beach trip with your kids, but the day turns out to be rainy and cold, do you still go to the beach? Of course not! When circumstances change, you change your plan. Your budget is no different. If you overspend in a category, look through your budget and move some money around. If you cannot, then you borrow it from the next month’s salary. But that will hurt. So be adaptable but also responsible.

4. Live on last month’s income

This is the rule that inspires us towards saving enough money so that we have enough money for 2 month’s expenses( i.e this month’s income and the next month’s income). So if you earn $5000 and your pay-day is on the 25th of the month, you can follow this rule if your bank account has $10,000 on 25th of the month( this month’s pay + savings equal to one month’s income). This is a goal to aspire to and this makes life easy and less stressful. You are always one month ahead forever and that makes you habitually happy.

So that’s it. Four simple rules. Simple but not easy. But definitely possible. It’s up to you.

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