Creating a budget is something many of us think about, but very few of us actually end up doing it. If you’re wondering “How to create a budget” you’re in good company, most people don’t know where to get started or why they should create a budget. In this article, we’ll cover what a budget looks like, how it can help you plan your financial future, and where to start.
Creating a solid budget doesn’t have to be complicated. You’ll learn the benefits of budgeting, the key steps involved in how to create a budget, and discover helpful tools to stay on track.
Why Is a Budget Essential?
Let’s be real—dealing with money isn’t always the most fun thing. But a budget is more than just numbers. It helps you visualize where your money is going so you can prioritize your spending based on what matters most to you and your financial situation.
A budget is a roadmap that leads to reaching your goals. A budget helps you set priorities. Whether it’s buying a home, paying off debt, or investing for retirement, a budget can help you get there.
You wouldn’t drive across the country without a map, right? Yes, I realize that’s all on your iPhone now, but you get the point. You need a path to reach your goals and creating a budget it essential to doing that.
Step 1: Understand Your Income and Expenses
Before building your budget, you need to know your starting point. This means getting a clear picture of your income and expenses. First, determine your monthly income, after taxes.
Going a step further, you need to project your future income streams after work. Things such as Social Security, rental properties, pensions, and annuity income are important looking forward.
Remember to account for any deductions like insurance or retirement contributions. Your net income is what you’ll work with for budgeting. Track your spending for at least a month.
Analyze your bank and credit card statements, look for spending patterns, and categorize your expenses as needs, wants, and wishes. This will help you pinpoint areas where you can potentially reduce spending. You may consider using a budgeting tool like the one Quicken has.
Categorizing Your Expenses
Knowing your net income and expenses is like knowing the players on your financial field. But to create a winning strategy, you’ll want to break those expenses into categories: needs, wants, and wishes.
“Needs” are things that are essential for daily living. When I create retirement plans for clients I describe this as “the most boring retirement you could imagine, where you just “exist”. Not a fun retirement, but you’ll survive.
“Wants”, although enjoyable, are not necessary for basic survival. This may include travel, a car budget, gifts for friends and family. These are the budget expenses that you’d “like” to spend, but aren’t critical for survival.
“Wishes” are low on the totem pole. These are things you can easily do without, but you’d like to spend the money if you have it to spend. Budget items for wishes are things like leaving money to your alma mater or your kids. Maybe a blowout 50th wedding anniversary that you “could” scale back.
Here’s how a budget differentiates between needs and wants:
| Needs | Wants | Wishes |
|---|---|---|
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|
|
Step 2: How to Create a Budget That Works for You
Different budgeting methods work for different people. There are several common methods to explore and see what feels right for your personal financial situation.
1. The 50/30/20 Budget Rule
One way to budget is using the 50/30/20 rule. In this situation, 50% of your after-tax income is allotted for essential needs, like housing and food. You allocate 30% for “wants”—your entertainment, dining out, vacations, etc.
The remaining 20% goes towards savings goals and extra debt repayment beyond those minimum payments. It’s all about achieving a healthy balance between living your life and taking care of your future self.
Many people will opt to donate to charity/church etc. You’ll have to juggle the expenses and savings to make these contributions from your income streams.
2. The Envelope System
This method can really click for people who prefer a tangible way to manage money and avoid the temptation of overspending with credit cards.
Label envelopes for specific categories, such as “groceries” or “transportation”, and stash a predetermined amount of cash in each. You’re literally only spending the cash in each envelope.
3. Zero-Based Budgeting
As the name implies, in zero-based budgeting every dollar of your income has a job assigned to it. This method can be particularly useful if you are managing an irregular income.
You create a new budget every month. You start with your income and allocate money to categories until you reach zero.
This method forces you to think critically about every spending decision, leading to more mindful spending habits. If you’re someone who struggles with impulse purchases, this could be an effective method.
4. The “Anit-Budget”
This is perhaps my favorite budgeting technique. You put a buffer in your checking account… say $10,000. That is the hard line which you can never drop below. Then you figure your actual expenses each month, say $8,000. Add that amount to your hard line of $10,000.
From here, you monitor your income and expenses, and throughout the month, you determine if you’re on track to hold the hard line! If you feel you’re under water, you don’t go out to eat or spend frivolously. You stop spending, period.
The Anti-Budget is the lazy man’s way of creating a budget, you simply just monitor the big numbers and spend as you normally would. You must hold the hard line however!
Step 3: Set Realistic Goals
Now, as you consider how to create a budget, it’s critical to envision the why behind your efforts. Without financial goals to motivate you, even the best budget plan might go by the wayside.
The type of goal will depend on where you are in life and what’s important to you. Whether you’re saving for a down payment on a house or planning for early retirement, having clear goals provides direction.
Saving Up for Retirement?
If retirement planning is a top priority, increasing contributions to a 401k might be your focus. Roth IRAs can also play a role, especially if you expect to be in a higher tax bracket in retirement.
Looking to Invest?
Learning more about investing might become a goal. One option for new investors is exploring a high-yield savings account where your money can grow more rapidly compared to a traditional savings account.
Sites like CNBC or Bankrate offer comparisons of the highest yielding options available to consumers. These resources can provide valuable insights into different investment opportunities, from stocks and bonds to real estate and more.
Step 4: Build Your Budget and Put It to Work
After calculating your income, categorizing expenses, and setting goals, now’s the time to put all the pieces together. Jot it down in a notebook, spreadsheet, or a budget app.
Don’t stress. Include your minimum debt payments as part of your “needs.” Any additional debt payment contributions above those minimums go under the 20% “savings and debt repayment” bucket.
Prioritize budgeting money toward saving a small emergency fund. This emergency fund is highly dependent on what you spend and how stable your income is. For a car salesman (unstable employment) a year or so of “needs” expenses should be a good starting goal. For a tenured teacher, 6 months may be just fine. This fund is critical for unexpected emergency expenses.
Step 5: Adjust as Needed
Life happens, things come up. Just remember, the purpose of this whole “how to create a budget” journey is not to restrict yourself completely, but to guide your financial decisions in a conscious and empowering way.
You might need to make adjustments based on unexpected costs, salary changes, or even shifting priorities. Flexibility is key when it comes to budgeting. As your life changes, so too should your budget.
Stay Flexible and Review Often
Regularly check in with your budget, at least once a month, to track progress, reassess your needs and wants, and adjust as necessary.
NerdWallet has a collection of helpful resources to assist in making budgeting easier and avoiding those moments of panic over unpaid bills. Don’t hesitate to try different methods to find the one that best fits your life and how you manage money.
Step 6: Make Use of Budgeting Tools and Resources
Today, tech can be a true game changer when you’re managing your money. Budgeting apps are like personal finance assistants.
They track expenses, remind you about bills, and analyze spending patterns for a big-picture view. They can even categorize expenses for you, making it incredibly easy to see where your money is going.
Beyond the App
But the support goes beyond apps. Many personal finance websites, including NerdWallet, provide valuable budgeting resources.
Look for free printable worksheets, budgeting guides tailored to specific financial situations, and expert advice on managing your income and expenses.
These tools make sticking with your plan way more efficient and way less intimidating. You can find support groups, online forums, and even financial advisors who can provide personalized guidance.
FAQs about How to Create a Budget
What is the 50 30 20 budget rule?
The 50/30/20 budget rule is a popular way to break down after-tax income: 50% on needs, 30% on wants, and 20% towards savings and debt. It is known for being a user-friendly method, promoting balanced spending. Don’t forget to squeeze in charitable contributions if that’s a priority for you.
You allocate funds to needs like housing and bills, leaving a portion for wants like entertainment and travel. This framework aims to ensure you prioritize essentials, while allowing for fun, and contributing towards financial stability.
How to create a budget for beginners?
Creating a budget can feel like venturing into uncharted financial territory. But don’t stress, we’ll break down a simple roadmap: First, grasp your net income after taxes. Gather bank statements or use online tools.
Tracking your expenses—listing out all your spending over a month, categorizing them as needs or wants will help get your spending under control. Opt for a straightforward approach like the 50/30/20 method to organize those finances.
Dedicate 50% of your income for necessities, like housing and bills. Designate 30% for flexible spending on your wants like hobbies and treats. Earmark 20% for goals such as tackling debt and building an emergency fund. Consider trying a free budgeting tool to streamline tracking. Don’t hesitate to make adjustments as you go. Remember, consistent budgeting takes time, and starting small makes it easier to manage.
What is the 70/20/10 rule money?
The 70/20/10 rule simplifies how you allocate your money. You’ll direct 70% of your after-tax income towards living expenses, including essential needs, but also those everyday wants. 20% gets earmarked specifically for savings.
That can include anything from building an emergency fund to achieving longer-term goals. Then, the last 10% goes toward debt repayment, be it credit cards, loans, or other forms of debt.
It promotes a less strict division between needs and wants. You are putting greater emphasis on building up savings and managing your debts over time.
What are the 7 steps in creating a budget?
Let’s dive into seven straightforward steps to get a good handle on your finances. Step 1 involves defining your goals for “why” you want to budget. Maybe you aim to pay off a student loan, boost retirement contributions, or save up for that special vacation you’ve dreamed of.
Step 2 is figuring out your income. Determine the consistent amount of money coming in each month after taxes, as this is your starting point. In step 3, delve into analyzing those spending habits. You’ll gather past bank statements or try using budgeting apps that neatly categorize transactions.
Step 4 gets strategic with picking your budgeting method. Try out the popular 50/30/20 method or explore options like the envelope system for cash spending or zero-based budgeting to track every dollar’s assignment. Next, it’s step 5 – you’ll take that income figure, the categorized expenses, chosen budgeting style, and start making a plan. Set specific spending limits for your “needs”, ”wants,” “savings,” and ”debt repayment” to build a workable structure. Personally, I include “wishes” as well, especially in a retirement budget.
Step 6 is taking action! Consistently track spending, using either digital tools or the old-school pen and paper. This awareness is critical for success.
Step 7 is making adjustments relative to your specific situation. Regular review, let’s say monthly, allows flexibility for life changes, income variations, or new priorities, keeping you in control and in charge.
Conclusion
Creating a budget can be empowering and a stepping stone toward reaching your financial aspirations. But, remember, sticking with it is essential for success. Remember how to create a budget: understand your financial position, pick a strategy, and review regularly, adjusting as needed.
Tools and expert resources make it simpler, allowing for informed decisions as you take charge. Now, start creating your budget to secure a brighter financial future for yourself.