For many people, creating and sticking to a budget is easier said than done. Strict budgets can feel impossible to follow. But, having a budget doesn’t mean you need to completely restrict yourself.
A budget is about taking control of your finances and doing what you can to afford your best life. Creating a budget that’s tailored to your unique financial needs can make it easier to stick with.
What is a budget?
A budget is a plan for your money based on your income, expenses, and a specific period of time. Having a plan for your money will enable you to do what you want and when you want, without going into debt.
In other words, you can use a simple budget to manage monthly expenses, prepare for unexpected events, and achieve your 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 may work for one person might not work for another. Creating a budget plan that works for you may take some time through trial and error.
Fortunately, there are several tried-and-true steps you can take to help you create a plan that works for you.
How to make a budget
To create a budget that actually works and helps you live your best life, you need to complete a few essential steps.
1. Determine your net income
Before you can create a plan, you need to know exactly what you’re working with. Set the foundation for your budget by figuring out what your net income is.
Your net income is what you make after taxes, retirement contributions, and health insurance payments. To calculate your net income, take your gross income, which is the total amount of money you earn, then subtract expenses, such as taxes and interest payments.
2. Understand your spending habits
Now that you know exactly how much money you’re taking home, you need to track your spending so you know where it’s going. Collect your credit cards and bank statements from the last month or two and review your expenses.
Start by listing your fixed expenses, which are your recurring monthly bills such as rent or mortgage, utility, and car payments. Add up your total fixed expenses and subtract it from your net income to see how much you have left for your variable expenses.
Next, list your variable expenses. These typically change each month. Variable expenses may include your grocery, gas, and entertainment expenses. Calculate the average monthly variable expenses and then add that number to your fixed expenses total.
If the combined number is more than your total net income, you’re likely overspending. If you are overspending, go back to your monthly expenses lists and categorize your expenses into broad categories. Total the cost of each category to help you understand where you might be overspending.
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 can include short-term goals, such as creating an emergency fund, paying off debt or saving up for a vacation. You can also include long-term goals that may take a few decades to achieve, like funding retirement or a child’s education.
4. Create a budget plan
Now that you know what 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.
Additionally, think of ways you can cut your expenses. For example, if you have several high-interest debts, consider trying to consolidate your debts into a new loan with a lower interest rate. You might also research ways to lower your 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 a strategy as a blueprint to help you create a budget plan that’s tailored to fit your lifestyle and needs. Some common budgeting strategies include the 50/20/30 rule, the all-cash diet, the pay -yourself-first method, and the paycheck budget.
- 50/20/30 rule: With the 50/20/30 budget method, you need to organize your after-tax 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. Split the other half of your income into 20% toward your savings and 30% for your wants.
- 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, you use cash instead of a debit or credit card to make everyday purchases, like groceries, gas, or morning coffee runs. Fixed household expenses, such as rent, bills, or debt payments, typically aren’t included.The purpose of this strategy is to make you more mindful of what you’re spending. When you use cash, you can feel the loss of each physical dollar spent. When using cards, it’s common to swipe without thinking twice, making it easier to overspend or rack up debt.
- Pay-yourself-first method: With the pay-yourself-first method, you schedule a specific amount of each monthly paycheck into your savings. By scheduling this transfer, money will be deposited into your savings before you make any purchases or pay any bills. This works because you’ll be less tempted to skip a contribution and spend the funds on other 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
Once you create a budget plan, remember that it 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 the plan and 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 and achieve your goals. All you need to do is create one that works for you. Pick a tried-and-true method or DIY your own with bits and pieces of other methods to fit your needs.