Understanding the Importance of Budgeting

If you’re always spending more than you make or struggling to put money towards savings goals, budgeting may be the solution you need. Budgeting is a simple concept but it can be practiced in a variety of ways.

There’s no wrong way to budget, but it all starts with knowing how much money is coming into your bank account and where it’s going from there. Here’s everything you need to know to build your 2024 budget.

What is budgeting?

Budgeting is the act of balancing the income coming into your bank account with the expenses you need to pay to help meet your financial goals. When you create a budget, you want to look at the money coming into your chequing account (from paychecks, side hustles, passive income, or more).

Then, you’ll scrutinize how much is being spent on essential purchases, like rent, bills, food, and utilities, vs. non-essential purchases, like that new sweater you wanted but didn’t really need.

The goal is to free up funds to help you afford other financial goals, like paying down credit card debt, building an emergency fund, saving for a vacation, or putting money away for retirement.

How to create a budget to meet your financial goals

If you’re in need of a budget to promote your financial health, here’s the budgeting process you can follow to get started.

1. Review your previous month’s bank statement

To figure out if you’re overspending, have developed bad spending habits, or if you can pare down your monthly expenses in a particular category, you need to first comb through your monthly spending. The best way to do this is by examining your previous month’s banking transactions.

Look at every expense that came out of your account and categorize it into three different groups: essentials, non-essentials, and savings. You can go deeper with this organization method and catalogue your spending by purchase type: groceries, food, gas, entertainment, subscriptions, clothing, bills, travel, etc.

2. Determine where you’re overspending

You can use this data to see if you’re overspending in a category where you thought you were spending less. For instance, maybe you don’t think you go out to eat often but find after looking through your bank statement that you go out to eat at least three times a week, spending an average of $100 per week or $400 per month. Depending on your budget, lifestyle, and values, this might be an area you choose to cut back on.

You might also notice that certain recurring charges, like streaming or subscription purchases, are costing you more than when you first opened your account. You might even find a gym membership you no longer use but pay for monthly. Use this information to help you cancel unwanted services or negotiate your monthly payments.

3. Set spending and savings goals

Now that you know how much money is going into your account and what you’re spending it on, it’s time to set spending and savings goals for the month. Determine how much you want to spend on a certain category, using your previous month’s data to ensure your estimate is realistic. Set a spending goal and monitor your progress every week.

For example, maybe you don’t want to cut back on attending concerts with your friends, but you set a weekly $75 limit to your spending to save some extra money.

Do the same thing for your savings goals. With the money you’re freeing up by cutting expenses and setting spending limits, create realistic savings goals that you can track. You might find it helpful to participate in a savings challenge, like the 30-day savings challenge, to help motivate you even more.

You can also lean on the 50/30/20 budgeting rule. This rule dictates that 50% of your monthly income should go towards essential purchases (think rent and food), 30% toward your wants (like takeout and clothing), and 20% toward savings. You can adjust these numbers to fit your specific budget, but it’s an excellent framework to keep in mind.

Reasons why budgeting money is important

Creating a budget helps you take control of where you’re spending your money to ensure it aligns with your values and financial goals. It can help you stay out of debt, save for big purchases, and build up a nest egg of savings.

Without a budget, it can be easy to overspend, use a credit card to cover purchases you can’t afford and slip into debt. A budget helps you stay financially disciplined and establish a plan for every dollar coming into your account.

1. It helps you know exactly how much money you have at all times

You might know how much money you make in a month, but when you’re sticking to a budget, you check in on your bank account more frequently. This helps you know how much is in your account at all times, where this money is going, and how much is left over to spend on nonessential items, like a dinner out with friends.

Budgeting can create peace of mind so that you never have to worry about whether you can afford a purchase again — you already know and have tools in place to help you save for an expense if you can’t afford it right now.

2. It can get you out of debt

One reason why many Canadians start budgeting is to help pay down existing credit card debt. With interest rates at historic highs after several consecutive rate hikes from the Bank of Canada, carrying credit card debt is even more expensive now. Credit card interest rates can be as high as 25.99%, so if you carry a balance, you’re handing over a considerable amount in interest charges alone.

Average credit card debt stats

According to Transunion’s 2023 third-quarter report, the average Canadian carries a balance of $4,185 on their credit card. That’s up from 2022 when the average balance was $3,825. If you carry any balance on your credit card from month to month, creating a budget can help you pay down high-interest debt.

Debt repayment strategies

Creating a budget can help you incorporate a debt repayment strategy like the snowball or avalanche methods to get out of debt faster. With the snowball method, you apply any extra money you free up in your budget to the debt with the smallest balance (while still paying the minimum on all debts). When that’s paid off, you move on to the next smallest. This can help you stay motivated and see accounts paid off quickly.

The avalanche method, however, can help you save money in interest. With this method, you concentrate on paying down the balance with the highest interest rate first, then move on to the next highest. Whichever strategy you choose, knowing how much money you have available to pay down your debt is key.

It can help you build an emergency fund

Another plus of creating a budget? You’ll be able to start putting money away for a rainy day. An emergency fund can help you cover unexpected expenses so you can plan ahead for the future. Instead of charging a surprise medical bill, car repair, or travel expense to your credit card, you can dip into your emergency fund to avoid relying on debt.

The money you free up in your budget can be moved into a savings account or tax-free savings account. If you opt for a high-interest savings account instead of a traditional savings option, you can earn even more interest on your savings while keeping your money secure.

How much money should go into your emergency fund?

Experts have differing opinions on how much you should keep in an emergency fund. Ultimately, the number you decide on should be an amount that makes you feel comfortable. For instance, if you lost your job, what’s the cushion you’d want to have in savings to keep you afloat for a month or two?

Some experts recommend keeping six months to one year’s worth of expenses in your emergency fund, but working toward that number can feel daunting. Instead, start small, building up to one month’s worth of expenses, then two, and then three.

If that feels too challenging, you can focus on concrete numbers, like saving your first $1,000.

How to stick to a budget

The hardest part about creating a budget is sticking to a budget. It’s easy to veer, of course, if you want to splurge on an item or turn back to your credit cards to maintain a certain lifestyle.

The best way to keep your budget in check is to continue practicing the financial habits you learned while giving yourself grace to spend when you need to. Keeping a certain amount of money free for spending can let you feel less restrained than if every dollar is going towards a concrete goal.

You might even reward yourself when you hit certain milestones, like saving your first $1,000 or paying off your first credit card. It’s all about balance — you can enjoy your accomplishments, but be sure to jump back into your normal habits afterward.

KOHO can help you build a better budget

Whether you’re just starting out on your budgeting journey or need to focus on paying down credit card debt, KOHO’s alternative savings account and credit card tools can help.

KOHO offers a combined spending and savings account akin to a high-interest savings account that lets your money work harder for you. You’ll earn up to 5% back on your balance and can even earn 5% cash back on select purchases that might fall within your normal budget. This can help you squeeze a little extra out of your budget. And if you accidentally overspend, KOHO’s overdraft protection coverage will kick in and prevent you from paying hefty overdraft fees.

If you’re worried about credit card debt, KOHO can help you grow your credit with its helpful credit-building tools, including free credit score access. KOHO also offers virtual cards to protect you when shopping online.

KOHO has the tools you need to get your budget checked once and for all.