published 2023-07-16 13:00:00 2 Budgeting When You Don't Make Enough /content/thumbnails/p-62-budgeting-with-a-low-income-1-small.webp budgeting-with-a-low-income Budgeting on a low income follows the same fundamental principles as budgeting at any income level. However, specific money management strategies can empower low-income earners to create a sustainable financial plan, avoid debt and break free from the paycheck-to-paycheck cycle. Let's explore what this means.

Budgeting When You Don't Make Enough

Budgeting on a low income follows the same fundamental principles as budgeting at any income level. However, specific money management strategies can empower low-income earners to create a sustainable financial plan, avoid debt and break free from the paycheck-to-paycheck cycle. Proper fund organization is the key to successful money management on a limited income. Let's explore what this means.

How to Budget Money on Low Income

How to Organize Your Money

First, ensure your bank doesn't charge you for low account balance - paying fees for having not enough money is unfair. Some banks may impose fees if your deposit falls below a certain amount. If you discover that your bank follows this practice, consider switching to one of the many no-fee banks that offer checking and saving accounts without charges.

Before delving into budgeting, let's discuss the strategy of maintaining different accounts for specific purposes and why it can help low-income earners. The concept involves segregating your funds into three accounts: a checking account for living expenses, a savings account for emergencies, and an investing account for wealth-building.

The rationale behind this approach is to prevent mixing money meant for different objectives, thereby avoiding impulsive and unnecessary spending. This approach also fosters accountability and motivation by allowing you to see your progress.

Spending Account

The first account is the checking account, which serves as your day-to-day spending money. The objective is to maintain a balance as low as possible - just enough to cover your living expenses with a buffer to avoid overdrafts and miscalculations.

By keeping only the necessary amount for your living expenses in your checking account, you prevent the mingling of savings and spending funds, which could otherwise lead to the temptation of dipping into your savings and overspending. This separation ensures better financial discipline and helps you stay on track with your saving goals.

Emergency Fund

The second account is the savings account designated for your emergency fund. This money serves as a safety net in case an emergency arises and you do not have sufficient funds in your checking account to address it.

The purpose of this account is to provide financial security during unforeseen circumstances. For guidance on how to start building your emergency fund, you can refer to this guide - Emergency Fund: An Important Part of Financial Planning.

Investment Accounts

The third account is your investment account, intended for your long-term goals and wealth growth. This money should be viewed as a long-term commitment, allowing it to work for you over time and benefit from the power of compound interest. It's best to treat this money as if it's not readily available for immediate use (or even as if this money doesn't exist), avoiding the temptation to tap into it for any short-term needs.

Allocating Your Money

Your spending account should maintain a stable balance, where you spend money and replenish it with each subsequent income. Meanwhile, your savings and investment accounts should consistently grow, providing a cushion to navigate any unexpected emergencies and moving you closer to your financial goals.

By segregating your money and monitoring specific amounts, you improve accountability and stay motivated to work towards your financial goals. Budgeting lets you estimate your expenses and allocate funds to your spending, savings, and investment accounts.

How to Budget Money on Low Income

Budgeting helps you assess the sustainability of your spending habits and identify areas where you may be overspending. Without a budget, it's easy to overlook whether you're spending more than your income allows, making it harder to recognize specific areas where you might be overspending. Start by figuring out your income and understanding all expenses. This step provides a clear picture of your financial situation, enabling you to identify areas for improvement and reduce unnecessary spending.

Start by Choosing a Budgeting Tool

You will need a tool to track your income and expenses to create a budget. Don't get caught up in choosing the perfect budgeting tool right away. You can explore different options and switch between them without any hassle and find what works best for you.

Your budgeting tool can be as simple as an Excel spreadsheet, or a printable budget worksheet, or you can opt for a dedicated budgeting app. Alternatively, you can start with the pen and paper method - it would work fine. Here is a list of budgeting tools for you to consider:

  • Use Money Knack's free online budget planner and calculator. This tool automatically calculates your expenses and provides a clear summary of how your money is allocated.
  • If you prefer a physical format, download our printable budget worksheet to see how much money you've spent this month, and then use this information to help you plan next month's budget.

Decide on Your Budget's Cycle

Determine the budgeting cycle that best suits your pay schedule. Since many bills are monthly, such as rent and utilities, a monthly budget is the most logical choice for most people. However, if a bi-weekly budget suits your situation better, you can opt for that. You should base the budgeting period on what works best for you. Calculate your monthly income and expenses if you decide on a monthly budget.

Figure Out Your Income

Start by calculating your monthly income if you are creating a monthly budget. For those on a salary who receive payment every two weeks, it's a simple matter of adding up two paychecks together to determine your monthly income.

If you have irregular income, start by analyzing your earnings over the past several months to identify patterns or averages. Consider all sources of income, such as freelance gigs, part-time work, rental income, investments, or any other irregular earnings. Once you have a few months' worth of data, calculate the total income for that period and divide it by the number of months to get an average monthly income.

This approach may not provide an exact figure for each month, but it will give you a reasonable estimate to work with. Another safer approach is to figure out and use the lowest monthly income to ensure you can cover essential expenses during leaner months and use any surplus during higher-earning periods to save for emergencies or future expenses.

Regardless of the income type, ensure the figure you calculate represents your after-tax income. This amount reflects the money you receive after all applicable taxes and deductions have been subtracted from your earnings.

Track Your Expenses

The next step is to learn where your money is going. There are a few ways you can take to capture all of your expenses:

1. Review Bank and Credit Card Statements: Go through your bank statements and credit card statements for the last few months.

2. Check Cash Spending: If you frequently use cash for small purchases, consider keeping a spending journal for a month to jot down every cash expense, no matter how small.

3. Track Online Payment Platforms: If you use online payment platforms like PayPal, Venmo, or other digital wallets, review their transaction history to catch any expenses that may not be on your bank statements.

4. Recurring Bills: Make a list of recurring bills like rent/mortgage, utilities, insurance premiums, loan payments, etc.

5. Annual and Quarterly Expenses: Check for annual or quarterly bills, such as property taxes, insurance premiums, or memberships, and divide them by 12 or 4, respectively, to get their average monthly cost.

6. Home Expenses: If you own a home, account for maintenance costs, property taxes, and all association fees.

7. Vehicle Expenses: Include all vehicle expenses, not just monthly car payments and fuel costs but also factor in maintenance, insurance, and registration fees.

8. Healthcare Expenses: Take into account health insurance premiums, medical bills, prescriptions, and other health-related costs.

9. Miscellaneous Expenses: Account for irregular or miscellaneous expenses like gifts, holidays, dining out, hobbies, etc.

Categorize Your Expenses

The initial step in fine-tuning your budget and finding areas of overspending and which expenses you can reduce is categorizing your expenses. Organize your expenses into the following groups: essential expenses (Needs), savings and goals, sinking funds (Unusual expenses), and discretionary expenses (Wants).

1. Essential expenses (Needs) are the expenses that you need to live and function. Examples of essential expenses are rent, food, and transportation costs.

2. Savings and goals are essential components of achieving financial stability. These encompass various objectives, such as building an emergency fund, saving for retirement, purchasing a house, and other similar endeavors.

Related: How to Set Your Financial Goals

3. Sinking funds (Unusual expenses) are money set aside to cover irregular or less frequent expenses that are not part of your regular monthly budget. Some common examples of what sinking funds can be used for are vacations, big purchases, holiday spending, etc.

4. Discretionary expenses (Wants) are non-essential or optional spending items, not vital for day-to-day living, and can be easily reduced or eliminated. Examples of discretionary expenses are subscription services, dining out and entertainment, electronics and gadgets, accessories, etc.

It's important to distinguish between needs and wants during this budgeting phase. While paying for multiple streaming services might appear essential to keep up with favorite shows, it's important to recognize that this expense falls under the wants category rather than needs.

Related: Budgeting: The Difference Between Needs and Wants

Organize your Money and Control Your Spending

You have now reached a point where you can monitor your spending and understand how each category impacts your income. Essential expenses tend to be relatively fixed and challenging to reduce unless you are open to significant lifestyle changes, such as relocating to a place with lower rent or finding roommates to share expenses. However, you can focus on other expenses and fine-tune your budget to make the most of every dollar.

By subtracting your essential expenses from your income, you can determine the amount of money remaining that you can allocate to your savings, goals, and discretionary expenses.

Get Choosy

At this stage, you can begin examining your discretionary expenses (Wants), reassessing your goals, and identifying areas of wasteful spending. Wasteful spending refers to money spent that does not provide significant value, such as consumer spending or convenience purchases. If you have a low income, it's especially important to limit this type of expenditure. After eliminating any non-essential items, the next step is to assess if you can reduce the remaining expenses.

For instance, while cell phone service may be essential, an unlimited everything plan may fall under the "wants" category. In such a case, you can explore cheaper plans that still fulfill your needs. If your current plan is already budget-friendly but still stretches your finances, consider switching to a mobile virtual network operator (MVNO). By shopping around, you can find more affordable alternatives for practically any expense, ensuring your budget remains manageable.

Related: How to Save Money on Your Cell Phone Billwith an MVNO

By reducing or eliminating wasteful spending, you free up money that you can allocate to your financial priorities, such as the items in the "savings and goals" category of your spending plan. You can use this extra cash to pay off debt, bolster your emergency fund, or contribute more to your retirement savings. Making these adjustments allows you to make better use of your financial resources and work towards achieving your long-term financial objectives.

You can adjust the allocation of money among spending categories until you are satisfied with your financial plan. Once you've determined how your money should be spent, you can follow this new spending plan in the coming months. Budgeting for sinking funds, essential and discretionary expenses will help you calculate the necessary amount to keep in your spending account for monthly living expenses. The savings and goals category will let you plan how much money you should allocate to your emergency fund and investment accounts.

Zero-Based Budgeting

Consider a budgeting strategy known as zero-based budgeting, where you allocate every dollar to specific categories, ensuring a clear understanding of how it will be spent and how it will benefit you.

After deducting essential expenses from your income, assign the remaining amount to your goals, savings, sinking funds, and discretionary expenses until there are no funds left unallocated. This method prompts you to evaluate your spending priorities and may encourage you to save more.

As for determining how much to save, as with everything in personal finance, it depends on your financial goals. The 50-30-20 saving rule can serve as a good starting point.

How Much Should I Save? Start with 50-30-20 Rule

The 50-30-20 rule is a personal finance guideline for budgeting and money management. It has gained popularity as an approach to financial planning and allocation of income after Elizabeth Warren introduced it in her book, "All Your Worth: The Ultimate Lifetime Money Plan."

The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. You can use this as a starting point and tailor it to suit your situation.

What to Do When Your Bills Exceed Your Income

If you find yourself spending more than you earn, resulting in a reliance on credit cards to supplement your income - your budget is unsustainable. It's crucial to prioritize reducing your discretionary expenses more aggressively. High-interest debt, such as credit card debt, can quickly spiral out of control, leading to financial strain. Consider making it a priority to pay off this debt as soon as possible.

Borrowing money comes with a cost, and compounding interest can make borrowing significantly expensive. For instance, a $5,000 revolving credit card balance for a year will accrue $1,300 in interest, requiring a total repayment of $6,300 to the bank. Carrying the debt for an additional year will further increase your debt to $7,938.

It's essential to be mindful of the long-term consequences of high-interest debt and take proactive steps to address it promptly. Carrying such debt over a few years can lead to interest payments surpassing the original borrowed amount, making it even more challenging to break free from debt.

When You Get Paid

When you receive your income, it goes directly into your checking account, and from that point, it's crucial to be strategic with your spending. Thanks to tracking all your expenses and creating a sustainable budget, you now have the plan to follow. Begin by ensuring that you cover all of your essential expenses first.

You may have heard the saying "pay yourself first," which means setting aside a portion of your income for savings and investments before spending on other things. Prioritizing paying yourself first is essential for securing your financial future and maintaining consistent savings and wealth-building habits. As your next step, allocate the designated money to your savings and goals, watching the growth of your savings and investment accounts over time.

Always avoid depleting your checking account entirely. Instead, have a buffer left in your checking account after paying all bills and expenses. This buffer accounts for any miscalculations in your budget and provides a safety net until you receive your succeeding income. If the balance in your checking account becomes excessively high, consider transferring some money to your savings and investment accounts.

Final Word

Don't use low income as an excuse to avoid creating a financial plan. People with limited earnings tend to forgo making a plan because they perceive their situation as hopeless. However, having a plan allows you to focus on scrutinizing every expense. It's essential not to overlook even the smallest costs, as every dollar matters. Concentrating on reducing even these minor expenses, taking proactive steps, and being mindful of your spending can significantly improve your financial well-being, regardless of your income level.

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