Beginners to money ask those with experience about where to begin. Many recommend starting a budget. However, most people that budget can’t correctly answer the question ‘Why is budgeting important?’
These people blindly follow a budget because someone told them it was good to do. This is one of the many reasons so many people start a budget then stop. They don’t know why they are doing it to begin with!
Another major budgeting mistake people make is building their budget incorrectly.
Not knowing why budgeting is important as well as building your budget incorrectly go hand in hand. Sadly, people don’t know why its important and do it incorrectly. Therefore, budgeting becomes a disadvantage instead of an advantage.
In this article I’m going to detail why budgeting is important as well as why its not! After reading this article, I recommend reading this article on how to budget money correctly.
Why Is Budgeting Important Reason #1
When building a financial plan, budgeting is the first step. Its extremely important because the budget organizes your finances. Therefore, you can see exactly where you are spending your money each month.
If you are building your budget and thinking about your budget correctly it will:
- Allow you to build a financial plan,
- See if you are going to hit your short-term and long-term goals; and
- Make adjustments very easily.
Why Is Budgeting Important Reason #2
Many think budgeting is important because they need to track every dollar every month. In my opinion its not!
The only thing that is important is if you are following your overall financial plan. That is, are you putting enough into your savings/investments and paying off your debts according to your financial plan?
I’ll provide an example to illustrate.
His financial plan consisted of the following:
- Put $1,000 a month towards savings for a house;
- $300 a month in his 401k to get his employer match;
- $100 a month in his Roth IRA; and
- $1,000 a month towards student loans so he could have them paid off in 5 years.
His worry was that he had over spent on restaurants each month by about $100. I asked why he thought that was a problem and he couldn’t answer.
In reality, it wasn’t a problem. He had been putting the money he said he was going to towards savings and paying off debt. That is the ultimate point of financial planning, i.e. hitting your goals.
If spending an extra $100 at a restaurant doesn’t prevent you from hitting your goals, then in my opinion it doesn’t matter. Live your life! In short, he was hitting his goals so his day-to-day expenses were not important.
Now why is budgeting important?
If the aforementioned person had called and he wasn’t saving $1,000 a month for a house or paying $1,000 a month towards his student loans, then we need to figure out why.
That is when you turn to the budget and see if you are overspending somewhere. For example, if he wasn’t saving $1,000 a month towards his house and overspending on restaurants by $100. Now that is an important problem that the budget would point out.
Why Is Budgeting Not Important?
One popular reason people tell others to budget is to build discipline. In my opinion, budgeting to be disciplined is a false myth. Doing so actually leads people to poor money habits. I’ll explain…
When you use a budget and you over spend on an expense, you are arbitrarily punishing yourself. This has two effects.
The first effect is that you may be punishing yourself for no reason. In the section above, why is budgeting important reason #2, I told the story about the FitBUX member panicking because he had overspent on one day-to-day expense.
In the grand scheme of things, it didn’t matter. He was still following the important part of his financial plan.
The second effect is that you are focusing on the negative and punishments. Human nature is to avoid pain. When you focus on negatives and punishments, there is only two ways to stop the pain.
Either reduce your spending (most likely the overspending was on something that gave you pleasure) or stop budgeting/following your financial plan completely. As you can guess, most people stop following their financial plan completely.
To summarize, the first and second effect lead to bad money habits because people stop actively managing their money completely!
A much better motivator is to think about why you want to accomplish your goals. Then focus on what happens when you achieve those goals. Check out this awesome financial planning example to see how to accomplish your goals.
Nickel & Diming Or Penny Pinching
When people hear or read my opinion on budgeting, they believe that I’m against penny pinching or nickel and diming. My personal opinion is penny pinching and tracking your budget that aggressively is a waste of time and not important. However, I’m not against it at all. In fact, I encourage it for some people but for most I don’t.
The reason why I don’t encourage it for most is that about 75% of penny pinchers that I meet are absolutely miserable. The reason why is they haven’t given themselves a good enough reason to be penny pinching. They are saving just to save. If you ask them what they are going to do when they have money they have no good answer.
As I previously mentioned, in order to continue with a financial plan you have to have a good reason. If your goal is to pay off your debt ASAP and penny pinching is going to allow you to do that, I encourage it.
Ashley is a perfect example of this. You can hear her story on our podcast but I’ll summarize here. Ashley graduated as a physical therapist with $220k in debt. Her family had always been in debt and she saw how much stress it caused in their lives. She had one goal and that was to be debt free in four years because she didn’t want to live life like that. Sure enough she did it but she had a deep meaning which motivated her. She didn’t do it just to do it.
Therefore, if you are going to penny pinch, you must have a really good meaning because you’re going to be sacrificing a lot of pleasure and a lot of time.
By Joseph Reinke, CFA