Creating a budget is one of the most important things you can do with and for your money. Understanding your monthly spending habits and putting together a plan will help you save more money and hit your financial goals.
But budgeting isn’t the most exciting topic in the world, and it might feel like you need to cut out everything you love to save anything.
This is far from true, and putting together a budget can actually ensure that you still spend money on the things you enjoy, while prioritizing your savings and hitting your goals!
Erika Taught Me
- Understand your true income and spending habits.
- Set up a realistic budget.
- Track your spending against your budget and make adjustments as needed.
Identifying your goals
Before creating a budget, it’s important to get clear on why you want to budget in the first place. If you are struggling to save any money, or can’t seem to invest anything, you need to write down your goals.
Some examples might include:
- Get out of debt
- Build an emergency fund
- Retire early
- Travel more
Whatever your financial goals are, having them written down can give you clarity on what you are budgeting for. This will help you start to see that spending money on things that you don’t really care about is taking away from the goals you have. You’ll start to make better money decisions and save more naturally with these goals in place.
Creating a budget that actually works
Creating a budget doesn’t have to be confusing.
Step 1: Know your monthly income
The first step to any budget is figuring out how much money you make each month. Write down your monthly, after-tax income, because that's the money you can actually use throughout the month. If your income varies, write down the lowest expected amount so you can budget on guaranteed income instead of potential income.
In addition to your job, make sure to account for any extra income you might bring in on the side. This can include dividends, side hustle income, investment income, or other income sources. Account for everything so you can accurately track your income and savings rate each month.
Step 2: Know your fixed expenses
Your fixed expenses are monthly bills that you have every month. This can include things like your mortgage or rent payment, utilities, insurance, cell phone and internet, car payments, credit card minimums, or other monthly payments and regular bills. You’ll want to comb through your bank statements for the past few months to get accurate numbers for how much you spend on your bills each month.
Your fixed costs don’t typically change too much each month, but it’s important to see each bill written down. This can quickly show you how much money is going toward things that are required, like rent and loan payments, as well as the “nice to have” items, like your Netflix subscription.
You can then find ways to minimize your fixed costs, such as cutting services you barely use, or comparison shopping to find better rates.
Step 3: Identify your variable costs
The next step is to write all of your variable costs. These are the costs that you incur on a weekly or monthly basis that vary, such as groceries, gas, household items, shopping, entertainment, travel, and other daily expenses. Don't forget some extra spending money! Something always comes up.
You will need to write down all of your expected spending categories for the upcoming month and set a budget for each. This means choosing how much you’ll spend and limiting yourself for each of these categories.
This is the trickiest part of budgeting because variable costs can change drastically from month to month. To get an accurate estimate of your spending for each category, you should review your past month's budget for each category by looking through your bank and credit card statements. If you add up 90 days of spending for each category and average it out by month (just divide by three), you’ll get a much clearer picture of what you actually spend.
And don’t worry if you can’t stick to the budget the first time. The goal is to create a spending plan and try your best to stick to it. It takes at least three months (probably longer!) to settle in and actually nail your budget.
Step 4: Calculate your savings rate
Once you’ve estimated your income, fixed expenses, and variable expenses, you can now calculate your net income. This is the income left over after accounting for all of your monthly expenses, and it’s how much you have to put toward your financial goals on a monthly basis.
Your goal should be to save at least 20% of your income so you can start paying off debt, saving for a house, and investing toward retirement. If your savings rate is only at 10%, it will take you 10 years to save up to one year of expenses. But if you can increase your savings rate to 30%, it will take just over three years.
Consider that the average personal savings rate in the U.S. is only 3.5%, meaning it would take the average American almost 29 years to save one year of expenses. If you want to be above average, sticking to your budget will be critical.
Step 5: Track your spending
Once you’ve put together your budget and dialed in your savings rate, it’s time to put your plan into action. You’ll want to track every purchase in your budget to help you stay on track, which will help you become even more familiar with your spending habits.
Here's a breakdown of information for each transaction:
- Date. The date of your purchase.
- Description. What you bought or paid for.
- Cost. The total cost, including tax.
- Payment. The account you used to pay for the item or service.
- Category. The budget category for the transaction. This will help you see how much you’ve spent (in total) for each category throughout the month.
- Paid By. The person who made the transaction. This is helpful if you share your finances — obviously, if you’re just budgeting for yourself, you can skip this one.
This is the most tedious part of the budget, but I promise it's also the most powerful! Input your transactions on a spreadsheet as they happen or at the end of each day. This habit will help you make better money decisions because you will be hyper-aware of where every dollar is going.
If tracking your spending sounds terrible, you'll want to check out the 50/30/20 budget.
Bonus Step: Track your progress over time
The last step to budgeting is tracking your progress. You can adjust your spending over time to make sure you're sticking to the spending plan. Remember, budgeting isn’t a “set-in-stone” plan. It’s a compass pointing you toward your destination.
Feel free to change the numbers to fit your lifestyle, as long as you can maintain the 20% minimum savings rate. This is key to making sure you can hit your investing and savings goals.
Budgeting next steps
That’s it! You’ve successfully created a simple budget that works. Now all you need to do is keep track of your progress and start putting away more money toward things that are important to you. If you share finances with a partner, it’s a good idea to set up a regular money meeting to check in on your progress and make adjustments as needed.
Remember, budgeting is a habit, not a one-time process. However, sticking to a budget plan can help you save more money and unlock more wealth in the future.
FAQs
What is the 50/30/20 budget rule?
The 50/30/20 budget is where you take your take-home income and budget 50% to needs, 30% to wants, and allocate 20% to saving. It's a quick and easy way to budget, but keep in mind that it may not allow you to meet your specific goals.
Are there budgeting apps that can help me?
Absolutely! You can definitely start a budget in a spreadsheet or even on paper, but a budgeting app might be easier, especially if you really hate entering all your expenses into the budget by hand.
A few you might consider are YNAB, Rocket Money, and Simplify. But if those don't work for you, there are tons to try. There is likely something out there that will work for you.
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