Two Major Types of Budget Expenses

A solid budget is essential to the success of any financial plan. Through effective budgeting, you can make timely bill payments, keep debt to a minimum and preserve cash flow to buy assets that create additional wealth. When putting together your budget, you must differentiate between committed and discretionary expenses. For motivation to stay the course, it is important that you list out financial goals before mapping out your budget.

Your major financial goals may include saving up cash to fund a first-time home purchase, four years' worth of college tuition payments and, ultimately, retirement. In the short term, you could be concerned with paying off all outstanding credit card debt, while also planning out a summer vacation to the Caribbean. All financial goals should be categorized and prioritized according to total costs and time frame. Be advised that your financial goals will never materialize without a good budget.

After listing out your financial goals, you can make saving projections to determine whether those goals are actually realistic. To do so, you can use an online financial calculator to estimate the amount of free cash flow that should be invested monthly at a set rate of return to achieve your goals. With this free cash flow figure, you can make the proper adjustments to your current budget. Free cash flow subtracts your expenses away from your income. To immediately improve your cash flow, you will focus on reducing your discretionary expenses.

Discretionary spending is associated with consumer goods, which are bought for comfort and as status symbols. Consumer goods rarely add value to your bottom line and usually depreciate immediately after they are purchased. Examples of discretionary items include designer clothing, cable television, high-end consumer electronics and fine dining. To exercise financial prudence, you will work to keep your discretionary spending to reasonable levels. Failure to do so may result in high credit card balances, loan default and even bankruptcy.

Committed expenses are necessary for survival and to avoid bankruptcy. You will be unable to immediately reduce your committed expenses, but they can be lowered over time through significant lifestyle changes. Your monthly mortgage payment is an example of a committed expense. A missed mortgage payment can result in loan default, foreclosure and eviction. To lower your mortgage payment, you would need to complete a mortgage refinancing or sell your home and downsize to a smaller property. Beyond your mortgage, other committed expenses may include transportation to and from work, insurance premiums, utilities, groceries and minimum payments on all debt balances.

After mapping out a budget of committed and discretionary expenses, you are now poised to build assets with your free cash flow. Before investing money, you should establish at least six months' worth of committed expenses in cash reserves -- to help you meet everyday expenses and provide financial relief amid emergency. From there, you can put together a diversified portfolio of stocks, bonds and money market securities to create wealth over the long term.