How to Make a Budget
Understanding how to make a budget is one of the first steps to securing financial freedom. Whether your goals are to save for a family vacation, pay off debt or move to your dream home, creating a budget can help you make these goals come true.
Don’t worry if you feel overwhelmed about it all – here, we break down the steps, including modifying common budgeting styles, to help you find one that you’ll want to stick with.
How Do You (And Should You) Budget Your Money?
No matter which method you use, at its core, making a budget involves following a simple framework:
1. Track and Calculate Your Expenses
This first step is classic budgeting 101: understanding where your money goes. It’ll be hard to determine a realistic spending and saving plan if you don’t understand how you’re currently allocating your funds.
You don't need a complex system to track your expenses – check your bank or credit card statements to help decide what you spend each month. Don’t forget to look at any investment accounts or automated savings you already have and your bills for any fixed expenses.
Ideally, you want to come up with three months’ worth of expenses so you can get a better picture of the averages you spend in certain categories. For example, if you spent $100, $200 and $150 in gas in October, November and December, then you can estimate that you tend to spend about $150 each month.
Do the same with other spending categories, including monthly debt such as credit card payments.
2. Find Your After-Tax Income
Figuring out your net income is simple if you have a full-time job. Take a look at your pay stubs or bank statements if you have direct deposit. Add in any deductions you make for health insurance, life insurance, and any retirement savings so you have an idea of what you’re spending overall.
For those who have multiple sources of income (such as those who are self-employed or work side gigs), add them all together and subtract any business expenses and taxes you’ll need to pay.
By getting a general spending overview, you’ll recognize the categories where you’re prioritizing your wealth, and learn whether or not you need to cut spending or start rearranging your funds.
3. Determine Your Savings Goals
Sit down and take a look at what’s going on during the next few years. Are there any goals or milestones you want to reach? For example, you want to surprise your spouse with a trip to Paris on your 10th wedding anniversary by the end of next year. Or maybe you’re looking to buy your dream house in the next five years.
Take this time to look at how much it’ll cost you to achieve these goals, and break it down. For example, let’s say the trip to Paris will set you back $5,000 – how much will you need to set aside each month to pay for it in a year? For your dream home, is it realistic to save up for a 20% down payment within the next five years?
If you have loans you’re paying off, take this time to write them down, including the minimum payments and how much you’ve been putting toward them. How much can you save each paycheck without going into any debt?
4. Plan Out a Budget
Now’s the time for the moment you've been waiting for: to look at whether your spending aligns with your goals and within your means. In other words, add up all your expenses, plus money you want to set aside for savings goals, and compare it with your take-home pay.
If your expenses are greater than your income, it’s time to figure out how to trim your expenses or loosen up on your savings goals. If there’s extra money, work out where to allocate the rest of the funds.
Once you’ve determined where you’ll allocate your money in any given month, you’ve got yourself a budget.
5. Track Your Progress and Refine as Needed
A budget isn’t a static entity – it can vary depending on your circumstances. Maybe you got a raise and now need to figure out where to allocate the extra cash, or the holidays are coming up and you need to set aside some savings for gifts. This is why it’s helpful to revisit your budget month-to-month, compare it with how much you spent – find an easy way to track your spending – and adjust if you need to. Keep in mind, there are also great resources available to track your progress and financial savings, like Rocket HQ or enabling bank notifications.
How the 50/20/30 Rule Can Help
Many folks who need financial planning help may have heard about this popular type of budgeting.
The 50/20/30 rule represents the percentage of your income you should allocate for certain aspects of your budget – 50% should go toward your necessities, 20% toward savings, and 30% toward your wants.
So, the majority of your budget should go toward items like housing, food, insurance and transportation. The part allocated toward your savings also includes any debt repayment – think car loans and credit card bills. The rest then can go toward wants like vacations and new gadgets.
What tends to make this type of budgeting popular is that it’s a fairly straightforward guideline and leaves some room for flexibility. Given that, you may find that it won’t work for your circumstances –maybe you're looking for more aggressive solutions with debt payoff or your savings goals.
If that’s the case, feel free to ditch this method and find something better suited for your needs. At the end of the day, it’s your money – do whatever you want with it in a way that aligns with your goals. Besides, figuring how to set a budget requires that you are aware of all the money that comes in and out of your hands and being honest with what is or isn't working. As long as you keep learning new ways to improve your situation and stay up to date on your spending, your budget acts as your ally toward a sound (and exciting!) financial future.
Check out our financial smarts center for more articles on budgeting and securing your finances to achieve your goals.
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