A budget is the most fundamental part of your financial plan. Yet, only 41% of Americans actually budget and keep track of their spending, according to a financial literacy survey by the National Foundation for Credit Counseling. If you fall into this group and don’t know know how to make a budget, it’s time to find a budgeting style that makes sense for you.
Whether you want to increase your savings, eliminate debt or merely understand where your money is going each day, knowing how to budget is key to helping you achieve your financial goals.
Here’s how to make a budget in 5 steps:
Want to know how to start? By breaking the process down into these 5 steps, you can begin budgeting in no time.
1. Estimate your take-home pay for the month
To determine your budget for the month, you’ll need to know how much money you have to work with. Accomplishing this step can be easy if your take-home pay is generally the same each month.
But if your hours change each week, you have a side business, or you’re fully self-employed, it can get a little more complicated.
Do your best to estimate how much you’ll earn in the upcoming month. If your net pay changes each month, look at the last few months to see if you can find a realistic average. And don’t be afraid if your estimate is more or less than you thought it would be. You can always update your budget during the month to reflect any changes.
2. Prioritize your expenses
The point of maintaining a budget is to help you accomplish your financial goals. So, it’s important to know what those goals are before you go any further.
Specifically, write down each of your financial goals – both short- and long-term – and determine what it will take to reach them. Let’s say, for example, that you’re hoping to buy a house in a few years. Calculate how much you’d need for a down payment, and then divide that number by the number of months left until you plan to start house hunting.
If you have debts, do the same process for debt repayment. For example, if you have student loans with a $300 monthly payment but you’d pay them off a year sooner by paying $400 a month, make sure your new budget incorporates that extra $100 each month.
Nobody knows what your financial goals are better than you, so it’s important to take time with this step. And remember, budgeting for the sake of budgeting won’t help you accomplish any goals and will likely end up being more trouble than it’s worth.
3. Choose a budgeting method
There are a handful of budgeting methods you can use to achieve your financial goals. While some require you to spend more time working on your finances, others are more relaxed. Choose the one that best fits your organizational style. To help you start making a budget let’s take a look at 5 top budgeting methods:
1. Zero-based budgeting or Zero-sum budget
The concept of this budget type is straightforward: match your income and expenses precisely so that the difference is equal to zero.
In other words, you give every dollar you earn a job, making it possible to know exactly where all of your money goes each month. This means that you’ll need to plan out every expense as accurately as possible. If you go over on one spending category, you’ll need to take money from another category to make sure you don’t break your budget overall.
Because this budgeting style is so meticulous, it typically requires that you either have a set income each month, or you can accurately estimate what your income will be. Also, it’s best for people who love numbers and want as much control as possible over their spending.
2. Pay-yourself-first budget
Whether you use this budgeting method or one of the other ones, it’s important to pay yourself first. This style just makes the process easier.
Here’s how it works: determine how much you want to set aside each month for savings and debt payments, then spend the rest of your money however you want. This doesn’t mean you don’t need to keep track of where you spend your money. The last thing you want is to overspend and be stuck with credit card debt or overdraft your checking account. But since you’ve already taken care of your priorities on day 1, you have more freedom with how you spend the rest of the month.
This budgeting method is best for people who have specific savings or debt payoff goals but are scared away by the idea of a complex budgeting system.
3. Envelope system budget
This budgeting method, which was made popular by personal finance expert Dave Ramsey, is a form of the zero-sum budget that’s focused on using cash only.
At the beginning of the month, you’ll plan out your expenses for each spending category, such as rent, groceries, entertainment, and utilities. Then, you’ll label an envelope for each category and withdraw enough cash from your checking account to fill each one.
When you go grocery shopping, for instance, you’ll bring your “grocery” envelope to pay the cashier with cash. If you go over on one category, you’ll need to pull cash from another envelope instead of going to the bank and pulling out more money.
This budgeting style is best for people who prefer using cash or who are open to using an envelope budget app.
4. 50/30/20 budget
The 50/30/20 budgeting method is another style that doesn’t require a lot of hands-on management.
Simply put, you split your expenses into three buckets: 50% goes toward necessary living expenses, 30% goes toward discretionary expenses and 20% goes toward savings and debt payments.
This budgeting method is an excellent option for many beginners because it doesn’t require strict and meticulous tracking. You just need to know the difference between wants and needs and set aside enough for savings and debt.
That said, it’s important to consider the actual proportions as a guideline rather than a rule. If you have a lot of debt, for instance, it may be unrealistic to only put 20% of your take-home pay toward debt and savings.
So, take a look at your expenses for the past few months to determine which percentages are best for you. Just be aware that skimping on necessary expenses and debt payments to spend more on your lifestyle may hurt your financial health instead of boosting it.
5. The ‘no’ budget
Technically, this method isn’t a budget at all because it doesn’t require you to set goals or track your expenses. But it can be a good alternative for someone who doesn’t want to budget and has good spending habits.
The idea behind this style of budgeting is to simply keep track of your checking account balance and tell yourself “no” when you don’t have enough money to pay for something. Of course, you’ll still need to have some idea of what your recurring bills are, and it’s still wise to set money aside for savings and debt repayment. But otherwise, you just need to know how much money you have available to spend and avoid going over that amount.
That said, this budget may not be a good idea for someone who has trouble saying “no.” So, if you have spending problems that you’re dealing with, consider one of the other budgeting methods instead.
4. Make adjustments during the month as needed
Unless you’re a clairvoyant, it’s impossible to know exactly what your expenses will be each month.
Sometimes you’ll forget about certain things, such as a recurring expense that happens only once or twice a year. There may also be times when you make an impulse purchase that you didn’t account for. Or, perhaps an emergency can threaten to break your budget.
Regardless of which budgeting method you choose, it’s important to keep an eye on your expenses throughout the month to determine if you need to make some tweaks. It’s also essential that you have an emergency fund to cover unplanned expenses so that they don’t factor into the success or failure of your budget. If you don’t have an emergency fund, make it your top priority to set aside some cash for a rainy day.
For most people, $1,000 may be enough to provide you with some peace of mind. Over time, however, work toward having three to six months’ worth of expenses to handle larger emergencies.
5. Track your progress
Depending on the type of budgeting method you choose, you may or may not need to track your expenses throughout the month.
Either way, it’s important to check in every month to determine whether your new budget is helping you progress with your financial goals.
If you’re using the pay-yourself-first budget, for instance, ask yourself whether you’re prioritizing savings and debt repayment as much as you wanted to when you first started using the method. If you opted for the zero-sum or envelope budget, look back to see how often you went over on one category and had to pull money from another.
Things may not to work out perfectly every month, especially in the beginning. It’s important, however, to recognize the real problem. For example, if you’ve consistently gone over your budget with the zero-sum or envelope method, it may not be a matter of overspending but a lack of careful planning when it comes to your expenses. In this situation, you may want to switch to a budgeting method that doesn’t require as much attention to detail. The important thing is that you determine whether your budget is helping you achieve your financial goals or not. This way you can make any necessary changes to get on the right track.
The bottom line
Learning how to make a budget is one of the best things you can do for your financial health, so it’s important to do it the right way. Fortunately, there are plenty of ways to tailor your budget to your specific needs and goals.
Just remember: focus on making your budget a tool to reach your goals instead of a chore. Also, check out some money saving apps and money transfer apps that can help you budget and save money. This way you’re not doing all of the legwork on your own. While it can take some time to get used to budgeting, you’ll be better off in the long-run.