There's a reason that “make a budget" is one of the top pieces of financial advice you've likely seen over and over: Creating a budget and diligently tracking your cash flow is the foundation for reaching both short- and long-term monetary goals.
Yet, too often, people view budgeting in a negative light, mistakenly assuming it will be overly restrictive and infringe on their lifestyle. The good news is that the opposite is true. At its core, budgeting is simply the practice of taking control of your money so you can spend it with purpose and intention. One survey found that almost 90% of people credit budgeting as a way to help them get out or stay out of debt.
Think of your budget as a financial GPS that helps guide you toward your goals. The basic principles are straightforward: Know what's coming in, understand what's going out and make conscious decisions about where every dollar should go. Here's a step-by-step plan for building a budget that works for you.
Step 1: Assess Your Financial Situation
To know where you want to go, you first need to pinpoint where you are. Determine your total monthly income after taxes, which is the number your budget will be based on. That income could include sources in addition to your take-home pay, including:
- Bonuses
- Tips
- Tax refunds
- Income from a side hustle
- Investment income
Step 2: List Your Monthly Expenses
Now, figure out where your money is going each month. Start by collecting all your bills, whether by gathering paper copies or logging into your accounts. Your bank and credit card statements will typically offer a complete picture of everything that's going out, from utilities to subscription services.
Divide your expenses into three key categories:
- Fixed expenses. These remain relatively constant, like rent or mortgage and car or student loan payments.
- Variable expenses. These fluctuate month to month, such as groceries, clothing and entertainment expenses.
- Periodic expenses. These infrequent yet significant costs might include membership renewals, vacations, holiday shopping sprees and so on. You can smooth these out by averaging the annual cost and setting aside the monthly amount in a high yield savings account, where it will earn interest while remaining easy to access.
If you're spending more than expected, you'll need to figure out a way to slash some costs or boost your income, potentially through a side gig. If you find yourself flush even after accounting for all your costs, consider bumping up your savings and investment habits. Look into a money market account for an accessible emergency fund, or set your sights on the distant future with a certificate of deposit (CD).
Step 3: Set Your Financial Goals
Establishing money milestones gives you a clear, achievable target to guide your budgeting decisions. Divide your goals into two categories:
- Short-term priorities: Goals you hope to achieve within a year, such as paying off a credit card or shoring up your emergency fund.
- Long-term ambitions: Goals for more than a year away, such as saving for a house down payment or retirement.
Creating a spectrum of goals also means you should look into various savings products that support these different objectives, such as a high yield savings account for shorter-term needs or a certificate of deposit for goals with a longer time horizon.
Step 4: Create Your Budget
Selecting a suitable budgeting approach allows you to tailor your financial strategy to your situation and preferences. Here are a few of the most popular types of budgeting methods to consider:
- 50/30/20 budget: Here, you'll allocate 50% of your income toward necessities such as housing, groceries, utilities, transportation and debt payments; 30% toward discretionary spending in categories like dining out, clothing, gifts, entertainment and hobbies; and 20% toward savings and investments, taking your short- and long-term goals into account.
- Zero-based budgeting: With this system, your income minus expenses should equal zero. Create your budget by assigning a function to every dollar coming in during the month so that your entire income has a purpose—whether it's expenses, savings, debt or donations—with none left over.
- The envelope method: Currently popularized as “cash stuffing," this is a visual way to easily track your spending. Divide your expenses into categories like housing, food and entertainment, then put the appropriate amount of cash into labeled envelopes. You'll spend from the envelopes as you go, which makes it easy to monitor the remaining funds. For example, if your entertainment allotment is looking thin, you'll know you need to dial back this weekend.
Once you've selected your preferred method, allocate the funds accordingly based on your income and the categories you've created.
Step 5: Implement Your Budget
Now that you've laid the groundwork, it's time to put the plan into action. First, consider which tools and resources might suit your lifestyle as a way to effectively manage your finances:
- Spreadsheets offer flexibility and automation.
- Budgeting apps provide user-friendly interfaces and real-time tracking.
- Traditional pen-and-paper methods support simplicity and tangibility.
The key is to pick a method you'll stick with as you aim to record every transaction. Maybe a small notebook in your bag is an easy way to jot down every expenditure, from that bottle of water to your movie tickets. Or you might prefer to open a spreadsheet at the end of the day and add up all those expenses.
Consistently monitoring and tracking your expenses provides a real-time view of your spending habits, giving you time to correct them before it's too late. You also might consider automating your finances. Set up automatic bill payments to eliminate late fees, and arrange for a fixed amount of your paycheck to go directly to your savings account to guarantee steady progress.
Step 6: Review and Adjust Your Budget
While it's best to stay on top of expenses daily, set aside time for monthly reviews to assess your budget's effectiveness and modify it as needed. Keep in mind that budgeting is an ongoing process that requires tweaks when you recognize you've underestimated specific costs.
For example, if gas prices rise, your transportation costs may increase, prompting you to cut back on groceries. Or, if you've been keeping your thermostat low, you could redirect savings from utilities to your dining-out fund.
After meticulously tracking your budget, you might realize it's overly aspirational—as in, you're consistently underfunding certain categories. Here are a few strategies to address areas where you might be tempted to overspend:
- Subscriptions: Determine which ones you use regularly and which you can remove. Perhaps you can replace a spendy gym membership with at-home online workouts, or rotate streaming services.
- Groceries: Commit to making a list focused on what's in season (and more affordable) and on sale at the grocery store.
- Entertainment: Try a no-spend weekend once a month where you find free festivals or local events, or invite your friends over for a themed movie marathon
- Dining out: Monitor your favorite restaurants' social pages to find specials and sign up for their loyalty programs for added savings.
Sometimes budgetary changes are good news, such as when you've earned a raise or paid off your student loans. Consider how to purposefully allocate those funds rather than squandering them to lifestyle creep.
And don't forget to congratulate yourself on a job well done when you meet your goals. You might even build tiny splurges into your budget as small rewards.
Your Budget as the Foundation of Sound Financial Health
As the road map to financial freedom and peace of mind, a budget helps you enjoy your life purposefully. Whether you're saving for a dream vacation, planning for retirement or just trying to ensure you don't run out of money before the month is over, a personal budget is your most powerful tool for achieving financial success.
Need a little more budgeting inspiration? Consider taking advantage of the current trend of loud budgeting, where you vocally proclaim your spending goals to friends to help boost accountability. There's nothing like going on the record to confirm your intentions!
READ MORE: 8 Tips To Dine Out Without Breaking the Bank
