Having a budget is about taking control of your finances and living your best life within your means. A manageable budget with some room for extras is also easier to stick with than a more restrictive one.
What is a budget?
A budget is a spending plan based on your income and expenses over a specific period of time. Primarily, having a plan for your money will enable you to satisfy your obligations without going into debt.
In other words, creating even a simple budget can help you manage monthly expenses, prepare for unexpected events, and achieve your long-run financial goals.
How do I decide what budget is best for me?
There’s no perfect way to design a personal budget; a plan that works for one person may not work for another. It also may take some time through trial and error to find a budget that works for you.
Fortunately, there are several tried-and-true steps you can take to help create a sustainable plan around your spending.
How to make a budget
To create a budget, you’ll need to work through several steps:
1. Determine your net income
Set the foundation for your budget by determining your net income.
Your net income is your take-home pay after taxes, retirement contributions, and health insurance payments—amongst other deductions.
To calculate your net income, first find your gross income, which is the total amount of money you earn. From there, subtract deductions (you’ll find these on your paystub).
Put another way, your net income is the amount that actually hits your bank account on payday.
2. Understand your spending habits
Once you’ve calculated your net income, try to get a sense of your fixed (or recurring expenses every month). These expenses are the ones you can’t avoid (i.e., rent, mortgage, student loan payments, utility bills, and others). It’s likely that you won’t be able to trim much here without a major life change (like moving), but the upside is that your fixed expenses are predictable in nature—you know they’re coming.
Once you’ve tallied up your fixed expenses, subtract the sum from your monthly net income. The remainder is the amount you have left for variable expenses—the ones you have some control over. Think entertainment, clothes, and travel.
A great way to evaluate your variable-expense spending is by reviewing your last few months’ worth of bank account statements and credit card bills. Spending a bit of time investigating where your money is actually going every month is a worthwhile investment of your time.
If after going through your expenses you find that they exceed your net income, you’re likely overspending relative to the amount of money you make. If this is you, no need to worry. A careful analysis of your variable expenses can help reveal places to cut.
3. Set financial goals
Before you create your plan, create a list of your short- and long-term financial goals to help motivate you to stick to the plan. Your list might include common financial goals like creating an emergency fund, paying off debt, or saving for a vacation.
You should also consider including long-term goals that may take many years to achieve, like funding a multi-decade retirement or a child’s education. With any long-term goal, time is on your side; due to the power of compound interest, setting aside even small amounts of money today can make a huge difference in your account balances many years down the line.
4. Create a budget plan
Now that you know how much you make, what you’ve been spending your money on, and what your financial goals are, it’s time to build a budget.
Refer to your fixed and variable expense lists to get an idea of much you’ll be spending in the next few months. Compare your expenses to your net income to help you create realistic spending limits for each category.
There is also a multitude of financial planning and budgeting software available across the internet; if you don’t want to complete this exercise manually, there are tools available to help you.
Finally, think of ways to cut your expenses—particularly the variable ones. Large fixed expenses (like rent or a mortgage payment) tend to be harder to change without making major life moves.
If you have several high-interest debts, consider consolidating your debts into a single loan with a lower interest rate. You might also research ways to lower some of your smaller fixed expenses, such as refinancing your auto loan for a reduced monthly payment.
If you’d like to create a plan with more structure, consider using a budget strategy. You can use the strategy as a blueprint to help you stick to your spending plan. Some common budgeting strategies include the 50/30/20 rule, the all-cash diet, and the pay-yourself-first method.
- 50/30/20 rule. With the 50/30/20 budget method, organize your net income into three spending categories: needs, wants, and savings. Up to 50% of your income should go towards your needs, such as rent, groceries, and minimum debt payments. Divide the other half of your income: into 30% toward variable expenses and and 20% towards savings.
- All-cash diet. Carrying cash may seem like a thing of the past. But if you have debt, going on an all-cash diet may help you develop better spending habits. With an all-cash diet, use cash or a debit card instead of a credit card to make everyday purchases, like groceries, gas, or coffee. Fixed household expenses, such as rent, bills, or debt payments typically aren’t included.
The purpose of this strategy is to limit your spending to the amount of money you actually have available, and to prevent you from going into debt (or further into it!). When you use cash, you can feel more acutely the loss of each dollar spent, which can help you limit unnecessary outflows.
- Pay-yourself-first method. With the pay-yourself-first method, schedule a specific amount of each monthly paycheck into your savings. This is commonly done through a workplace retirement plan, like a 401(k), but it can also be done on an after-tax basis by contributing money to an IRA or a regular savings account. By scheduling transfers in advance, money is deposited into your savings before you have a chance to make any purchases or pay any bills. This works because it’ll be impossible to skip a contribution and spend the funds on other—potentially unnecessary—expenses.
- Paycheck budget. With this method, you create a new spending plan each time you get paid. To start, you simply need to list all your monthly expenses, including your savings and debt payments. Once your list is complete, you give each dollar of your paycheck a purpose.
5. Review and adjust your budget periodically
Remember that an initial budget isn’t permanent for the rest of your life. You need to review and adjust your budget as your circumstances change.
Set reminders to review your plan and, more importantly, your spending, every few months to ensure you’re staying on track.
To budget, or not to budget
Taking the time to make a budget may sound overwhelming, but it can truly help you develop better spending habits. Pick a tried-and-true method or DIY with bits and pieces of other methods to fit your needs. With a small investment of time, putting yourself on a better path to achieving your financial goals is undoubtedly possible with a solid budget.