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A budget is a plan for your money. At the most basic level, budgeting involves tracking your income and expenses. You can then use this information to better understand when and where you're spending money, and realign your expenses to help you progress toward your financial and personal goals.
How Budgeting Works
The word "budget" can have a negative connotation and evoke feelings of constraint or restriction. But a budget is merely a tool you can use to take control of your money and make sure your habits match your ambitions.
To start, you'll track your income and expenses. You'll also create specific categories for your expenses, which often get split into fixed (or necessary) expenses and variable (or discretionary) expenses.
Your fixed expenses could include regular bills, such as rent, debt payments, utilities and transportation. Variable expenses could be for entertainment, dining out and other spending you can determine—they're often wants rather than needs.
The categories you choose should reflect your goals. For example, if you're focused on increasing your savings, you could create a fixed expense for savings and set aside that money each month before allocating funds to your variable expenses.
Over time, the amount of money you assign to each category can shift as your income, expenses and needs change. However, you always want your income to be equal to or greater than all your expenses each month.
What Are the Benefits of Having a Budget?
Often, people are surprised when they start tracking their expenses because they didn't realize how much (or how little) they spend throughout the month. But getting this insight and creating an intentional plan for your money can give you a greater sense of control.
Once you know exactly how much money you have coming in and how much you need for your fixed expenses, you can better plan your discretionary expenses. You might then look for ways to earn more money to meet your goals, or save money and free up room in your budget.
Over time, budgeting could help you:
- Get out of debt: With your budget in mind, you'll know exactly how much money you can put toward your debt payments and how long it'll take you to get out of debt. You can make it a priority to get out of debt and move money from one of your "fun" categories to debt payments. If you keep track of your spending and stick to the plan, you may be able to get out of debt sooner and pay less interest.
- Build an emergency fund: An emergency fund can keep you from having to take on high interest debt to cover expenses from an unexpected setback. Create an emergency fund category in your budget and build up your fund every month. It can be helpful to open a separate savings account for your emergency fund, so you're not tempted to dip into it.
- Stop living paycheck to paycheck: Once you build up your savings, you can stop worrying about when you get paid and focus your attention on sticking to your budget. As long as your income continues to be equal to or more than your expenses each month, you'll be on track to pay all your bills each month.
How to Create a Budget
It can be easy to try something for a few days or weeks, but budgeting is most effective when you can stick with it long term. Fortunately, there are many ways to create and manage a budget.
Some people prefer using budget software that connects to their financial accounts. The software can automatically sync transactions, which makes it easy to run the numbers. Others prefer a more hands-on approach and use a notebook or mobile app to manually track their income and expenses. They can then analyze their income and expenses on paper, or enter them into a spreadsheet.
Once you decide how to gather your data, it's time to choose the type of budget you'll use. You might use a zero-based budget where you assign every dollar you earn to a specific category so your income equals your expenses each month. Or, maybe you'll use a 50-30-20 budget, where 50% of your income goes to necessary expenses, 30% goes to discretionary expenses, and the remaining 20% goes to paying down debt and building savings.
You might have to try a few different budgeting systems and types before you find one that's a good fit for your habits and financial goals. It can also take a few months to figure out how much money you need to set aside for each category. Don't give up. Budgeting can take practice and flexibility, but it can also make a big impact on your finances in the long run.
How Budgeting Can Impact Your Credit
Your credit report doesn't include your income or keep track of whether or not you budget. Budgeting can, however, have a positive impact on your finances and may indirectly help you improve your credit.
For example, if you're sticking to a budget, you may be less likely to fall behind and pay a bill late, which could hurt your scores. Or, you may be able to use a budget to make progress on paying down credit card balances, which could lower your utilization rate and help your credit scores.
You Can Track More Than Your Money
A budget can help you foresee financial problems, adjust to changes and take advantage of opportunities. Similarly, you can monitor your Experian credit report for free. You'll get alerts when there are important changes that could indicate fraud, such as a new account opening, and be able to react quickly. You can also use Experian's CreditMatch™ tool to get personalized credit card offers based on your credit history.