Budgeting is one of the most powerful tools you can use to set yourself up for long-term success and financial stability. Whether you want to get a handle on your monthly expenses, save money from your salary or pay off debt, creating a budget is the first step.
Luckily, planning a personal budget is easier than it seems — and there are many budgeting plans and resources available. Let’s break down how to budget effectively and how to use some of the most popular budgeting methods.
How to Budget
Creating a budget may seem overwhelming, but these simple steps can help you build a solid foundation for managing your money.
1. Figure out your monthly income
The first step to budgeting is determining how much money you’re bringing in each month. This means you need to look at your net income. This is the amount of money that comes into your bank account after taxes and other deductions. You should include all streams of income. Looking at bank statements or pay stubs can help you ensure you get the right number.
If you have a variable income, you can look at how much you brought in over the last few months and calculate an average to give you a realistic estimate of your take-home pay.
2. List out all your expenses
Now it’s time to figure out where your money is going. Review your credit cards and bank account and list out each of your expenses for the month and how much they are. These typically fall into two categories.
- Fixed expenses. These are costs that stay the same every month. They include things like rent, subscriptions, insurance premiums, car payments, student loans and cell phone bills.
- Variable expenses. These are costs that can change like groceries, transportation and entertainment. You can get an average estimate by looking at how much you’ve spent in these categories over the last few months.
After you’ve listed all your expenses, you can categorize them.
- Needs. These are things that absolutely must be paid each month. Including things like housing, utilities, groceries, childcare and debt payments.
- Wants. This category includes the non-essential things that improve your quality of life such as eating out, subscriptions, hobbies and travel.
- Nice-to-haves. This category encompasses the “extra” expenditures. It includes things like upgrading to a new phone when your current one works fine, buying luxury items, and paying for premium services.
3. Set your budget
To create your budget, you can start by subtracting all the “needs” expenses from your net income. After you’ve taken care of your needs and savings, the money left over can go toward “wants” and “nice-to-haves.” If your bank account is looking low at this point, you can either find ways to cut expenses here or explore ways you could increase your net income.
4. Set your personal finance goals
Your monthly budget isn’t just a way to manage your day-to-day spending — it’s also a tool that can help you achieve your financial goals. These could be short-term goals like saving up to buy a new laptop or these could be long-term goals like contributing to a retirement account. Think about your financial priorities and set goals that you want to achieve. People often have a mix of short-term and long-term goals.
5. Track your spending
Tracking where your money is going will help you understand your spending habits. This can help you keep control of your money and ensure each dollar is going where it’s supposed to. This can be done with a budget spreadsheet, budgeting apps, or with simple pen and paper. Find a way that works for you and stick to it.
6. Reevaluate your budget regularly
Life changes and so will your budget. Be sure to revisit your budget regularly to make sure it still aligns with your needs and goals. For example, if you get a raise you may want to start contributing more to your savings account. The key is staying flexible and adjusting as needed.
What are some popular budgeting plans?
Not every budgeting method will be the right fit. While there are some common plans, the one that works for you will depend on your lifestyle, goals and personal preference. One of the most important things to think about when choosing a budget method is whether or not you’ll stick to it.
50/30/20 rule
The 50/30/20 rule is a budget plan that splits your income into three categories:
- 50% for needs.
- 30% for wants.
- 20% for savings or debt repayment.
This is a very straightforward budgeting method and it can work well for those who don’t want to micromanage their expenses. However, it’s not very flexible. Depending on where you live and your financial situation, your “needs” may exceed 50% of your income and saving 20% isn’t realistic for many people.
The envelope method
This is a popular budgeting strategy that involves dividing your income into different “envelopes” for each spending category (e.g. groceries, entertainment). Once the cash in the envelope is gone, you’re done spending in that category for the month. Many modern apps have digitized this strategy, allowing you to allocate funds from your bank account into “virtual envelopes.”
This strategy allows you to set the amount you want to spend in each category and it can be more flexible than other budgeting plans. If you unexpectedly have to spend more in one of your “needs” categories you can use money from “wants” or “nice-to-haves” envelopes.
Zero-based budgeting
Zero-based budgeting is a budgeting plan that assigns every penny of your income a purpose — whether it’s for expenses or savings. At the end of the month, your total income minus expenses and savings will be zero.
With this budgeting method, you have to carefully keep track of all your spending. This often requires budgeting worksheets and detailed notes. It can help improve your financing awareness and help you avoid overspending. It’s also a time-consuming method and unexpected expenses can make it hard to plan perfectly.
Pay-yourself-first
Pay-yourself-first budgeting prioritizes your savings goals over other expenses. Each time money comes into your account a certain percentage goes directly into a savings account. A typical rule of thumb is to try to save about 10% of your net income — though this isn’t realistic for a lot of people. However, even saving a small amount can have a big impact over time.
What are some examples of financial goals?
Start an emergency fund. Unexpected expenses can throw your budget off track. An emergency fund is a savings account you can use to cover these emergency expenses without derailing your budget. Most experts advise to save between three and six months’ worth of living expenses. However this can seem to be an overwhelming number — instead to start, you can aim for $500 to $1,000.
Pay off debt. Paying off debt is a goal for many people. In fact nearly 44% of Americans carry credit card debt from month-to-month. Budgeting can help you stick to a debt management plan and put aside money every month to go toward debt.
Save up for a big purchase. Budgeting can help you save up for a big purchase such as a down payment on a new car, a dream vacation or higher education. Having a plan to put aside a set amount of money each month can help turn these goals into reality.
Build long-term wealth. Budgeting can help you build long-term wealth and success. It gives you better financial stability allowing you to set long-term goals like contributing to retirement or investment accounts and build long-term wealth.
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