How to Create a Budget
If you hate admin, creating a budget may sound about as exciting as trimming your nails. The good news is going through and sticking to the process can help you get on top of your finances, reduce stress and set you off on a path towards attaining the financial freedom to do more of the things you love!
Below, you can find an easy step-by-step plan to get you started.
Calculate Your Income
The first step in creating a budget is to calculate your income after taxes. This is the fun part because it’s all about the money coming in.
If you’re an employee with a regular paycheck, this is easy–your taxes are automatically withheld.
If you’re self-employed, you’ll want to deduct your estimated tax liability for the year or you can use the amount from last year’s tax return.
Now that the icky taxes are out of the way, you’ll also want to add back in any deductions from your paycheck such as 401(k) contributions, automatic savings and insurance.
Finally, if you’re lucky enough to receive other funds, such as rental or dividend income or alimony, then lucky you! Include this in your total.
Calculate Your Expenses
Now for the not-so-fun part of calculating your expenses. Your goal for this step is to figure out how much you spend each month on average.
When it comes to expenses, there are two types: fixed and variable. Fixed expenses are bills that don’t change, such as your rent, mortgage or internet bill.
Variable expenses are costs that often change and are a little unpredictable, such as groceries, clothing and gas. (Your impulse buys on Amazon will count here, too!)
To get an idea of your average costs for these, you could keep your receipts for three months, total up the costs for each category and then divide by three.
Another option is to use your credit and debit card statements. If you never use cash for these expenses, you could look at the charges on the last three statements and calculate the average that way.
Some variable expenses can fluctuate depending on the season, like utilities. You may also have other seasonal expenses, such as lawn care or snow removal. Your annual summer vacay to the beach is a seasonal expense as well.
To include these costs in your monthly budget, you could take last year’s totals and divide by twelve. Costs may have gone up a bit since then but at least you’ll have a rough idea.
Finally, don’t forget other costs that may be billed quarterly or annually. Some subscriptions, for example, are paid once a year.
So you don’t overlook (or conveniently “forget”) a bill, we’ve compiled a list of everyday expenses by category:
- Housing–mortgage, rent, maintenance
- Utilities–electric, gas, water, trash
- T-comm–internet, cable, cell phone
- Insurance–medical, life, homeowners, renters, auto
- Debt payments–credit card, medical bills, student or personal loans
- Transportation–gas, maintenance, public fees
- Other essentials–groceries, toiletries, essential clothing, office or school supplies
- Extra medical–prescriptions, co-pays, deductibles
- Family–child care or support, alimony, gifts
- Entertainment – Eating out, Travelling, Shopping, Netflix etc
Choose a Budgeting Plan
Now that you’ve calculated your income and expenses, it’s time to pick a plan to follow. You can create your own or choose one that already exists in the magical world of finance.
Here are three of the more well-known plans:
This plan states that approximately 50% of your income should go toward everyday needs. 30% can be used for wants like eating out and traveling. The remaining 20% should go to other needs, which are classified as saving, investing and paying off debt.
While this is a sound plan, it doesn’t necessarily provide guidance on how to allocate money within each category. Another problem is that it could be tempting to consider a “want” as a “need” and so the categorization process will require some self-discipline. At the end of the day, if you could survive without it, it’s probably not a need.
The upside? This method is super easy and it works! The 50/30/20 rule helps you keep track of where all your money is going and easily spot if you’re over-spending in a specific category. It also allows a generous amount for “wants,” because being on a budget doesn’t mean you need to stop having fun! This also makes the budget easier to stick to.
With the 80/20 plan, you have 20% of your take-home pay automatically deducted and deposited into a savings or investment account. If you’re self-employed, this 20% would come out of your monthly revenue received. For this reason, it is also known as the “Pay Yourself First Budget”. The rest–80%–is used to pay for your expenses plus any extras.
The advantage of this plan is that it forces you to save and put your money to work for you.
A disadvantage is that it combines all spending, necessities and wants, into one big pot. This means this method won’t allow you to track your spending in close detail.
In this plan, you give every dollar you earn a job. The idea is that at the end of each month, your budget will equal zero because you’ve allocated each dollar to a category. Of course this doesn’t mean you have to spend all of it. Some of that money should definitely be going towards your savings, investments and other financial goals.
This plan can give you an overall picture of your spending so you can make adjustments. You may realize, for example, that you’re spending too much money on your shoe collection.
The downside is that this form of budgeting requires a lot of work that may not be sustainable for most. it also doesn’t provide you a guideline for saving and investing, which could cause you financial problems later on if you aren’t building these into your budget.
Which budgeting method is best for you will depend on your personal circumstances and preferences. To set yourself up for success from the start, make sure the budgeting method you pick suits you and is one you’ll have the best chances of sticking to.
Apply your selected plan
Once you’ve picked the right budgeting method for you, you will need to apply it to your current income and expenses and evaluate whether you need to adjust your expenditure.
For example, if you picked the 50/30/20 method, once you apply this method to your income and expenses, you may find that your spending split is actually 40/50/10. This would suggest you’re spending more than you should be on your “wants” and may need to reallocate your money towards your needs and financial goals.
If you choose the 80/20 rule, you might find that after “paying yourself” 20%, you don’t have enough to cover all your expenses and you will need to find ways to cut back.
And finally, with Zero-based budgeting, you will first need to determine all the categories you want to track and set goals. You will then need to assign each expense to a category and make adjustments accordingly to ensure goals are met. When setting your goals, don’t forget to budget for paying off debt, saving and investing.
Monitor Your Progress
There’s no point in making a budget if you don’t track your progress. Luckily, there are multiple ways you can do this.
One way is to use a simple spreadsheet. You can easily create one in Microsoft Excel or Google Sheets or look into budgeting app like Simplifi by Quicken, PocketGuard or Mint. You can find more of these types of apps through the iOS app store and Google Play.
Once you’ve tracked your saving and spending habits for a while–say, a few months–it’s a good idea to reassess. Look through these numbers carefully. Do you need to cut back on trips to Dunkin’ Donuts or ordering through Uber Eats? Could you be more aggressive in paying off your student loan?
Following a budget can feel like yet another task added to the dreaded to-do list. To most of us, it’s boring and even scary. (What do you mean I have to stop ordering take-out five days a week???)
But the payoff is worth it. You’ll gain more control over your finances and a greater peace of mind. And that, my friend, is priceless.