How to create a budget

Toss a stone in any direction of financial wellness literature, and you'll find that creating a budget is foundational in financial planning.

It makes perfect sense – without keeping track of your cash flow and knowing how that money is being spent, you won't be able to make solid choices about your finances.

When you can assess your expenses and your income, you can make crucial decisions for Future You. 

Creating a budget doesn't have to be overwhelming. A simple spreadsheet can help you lay the groundwork and make plans for debt payoff, build a savings and emergency fund, and save for a home. Plus, we'll walk you through five simple steps on how to create a budget.

Create a budget in 5 steps

So what's the best way to budget money? While there's no one-size-fits-all approach, the good news is managing your money can be more simple than you think. Rocket Loans has demystified the process, and whittled it down to just five steps.

You can explore these steps to create a budget that works for your lifestyle and finances.

1. Track and calculate your expenses

First, you'll want to keep tabs and calculate your expenses. Before you do this, you'll need to review your fixed monthly expenses.

One thing to note: fixed expenses, for the most part, never change. They remain the same month to month. These might include:

• Car payments
• Rent and mortgage payments
• Insurance payments (car, health, home or renters, life, pet)
• Student loan payments
• Fixed-rate loans (personal loans, car loans)
• Cell phone bills
• Streaming services

You'll want to list each fixed expenses and note their monthly cost in a separate column. It's a good idea to list each individual expense, instead of clustering all, say, streaming subscriptions together.

Why's that? You'll be able to more clearly see every single expense. And when it comes to cutting back – which we'll get to in just a bit – it'll be easier to gauge and see what you can drop.

When you're jotting down all your fixed expenses, you'll want to factor in annual expenses too. For example, car registration and title fees, website domains, or anything you pay once a year. To keep things simple, you can divide it by 12, so you've noted the monthly amount.

Once you're done calculating your fixed expenses, it’s time to list all your variable expenses. These are expenses that can fluctuate month to month.

This might include:

• Utilities (can be higher during certain seasons)
• Eating out
• Groceries
• Gas
• Clothing
• Entertainment
• Personal care costs
• Household spending
• Hobbies

To get your head around the average cost of food expenses, fuel, entertainment, and what have you, you'll need to look over several months' expenses. You can look over bank or credit card statements, receipts, or if you have Rocket Money®, you can look at past expenses. When estimating these expenses, it’s best to aim higher rather than lower.

2. Find your after-tax income

Next, you'll want to figure out your gross income. This is the amount before taxes and other deductions, while net income is the amount that's left after taxes, health care, retirement contributions, and other deductions are accounted for. Net income is also known as take-home pay. This is the number you'll need when creating a budget.

If you're self-employed, and your monthly income changes month to month, figuring out your take-home pay can be a bit more complicated. For one, you're on the hook for self-employed taxes.

To figure out your annual income, you can use last year's tax return as an estimate. Divide the yearly income by 12 to get a monthly estimate. If you're new to the world of self-employment you can take the average of the last, say, 3 or 6 months.

Because you're responsible for your own taxes, you'll need to bump down your monthly gross income by, say, 25% to 30% to get your estimated net income. The money you set aside can be allocated for taxes.

3. Determine your savings goals

Every person has unique savings needs and goals. These are aligned with your personal values and what kind of life you ideally want to live.

The best method for creating a savings plan is to compare income and expenses. You'll want to figure out if expenses outweigh the income. Or, on the flip side, does income exceed expenses?

If your income exceeds expenses, you're in a great situation. You can set aside the surprise for different savings goals. For example, creating an emergency fund or saving for a down payment on a home or car. Or, you might want to invest in a college plan for your child, or put any extra toward your retirement plan.

Let's say that your expenses are greater than your income. In this case, you'll need to do some poking around to see how you can bump down your expenses. It's a good idea to look at how to create a budget that you can use month after month. That way, you can make sure you stay on track with both your short-term and long-term goals.

4. Make a budget plan

Once you've done the math to figure out your income and expenses, it’s time to map out the monthly budget. Create line items in a spreadsheet, budget template or create a table in Google Docs, Microsoft Word or some such.

For variable expenses, note the monthly estimate. A sample budget may look like this:

Once you've put together your budget, you'll find there to be a surplus of $325, which you can put toward your savings or other financial goals.

5. Track your progress and refine as needed

To make the most of a budget, you'll need to keep tabs on your expenses each month. By carefully looking over your financial activities, you can keep an eye out for unpredicted expenses or places where your money is getting siphoned. This might do damage to your monthly goals.

A few ways to go about this: You can look over your checking account to factor in budgeted expenses that have been withdrawn. From there, you can make tweaks to your budget balance throughout the month to see if there is indeed "leftover money."

Case in point: You might notice that you're eating out more often. In turn, this can drain your $325 surplus, which makes it that much more difficult to save.

What’s the best way to budget money?

The budget example is a very simple, straightforward and basic approach. It's a great method if you're just starting out. That said, it's a good idea to experiment with different approaches and figure out which is the best for you. And over time, you might want to switch it up – for variety or efficiency.

There are many different ways to go about budgeting. Let's look at some of the more popular approaches.

The 50/20/30 rule

With the 50/20/30 rule, you are to divide your budget into three main categories: 50% to necessities, 20% toward savings, and the remaining 30% toward wants or luxuries.

This isn't a perfect science. The example shows that necessities make up for more than 83% of income. In this scenario, you'll need to either work toward earning more income or paying down debt. That way, you can put more of your budget toward savings. Plus, it also offers more wiggle room for your wants.

The envelope system

The envelope system can work in sync with a simple budget spreadsheet. Here's how it works: you put physical cash in envelopes that are earmarked for specific expenses.

This might be best for variable expenses where you might be prone to impulse buying.

For example, one envelope is designated toward eating out, another is for shopping, and another is for entertainment, and self-care. Once the money from the envelope is spent, no additional funds can be allocated.

The two-account plan

A two-account plan involves creating separate bank accounts: One to pay fixed expenses, another for variable expenses. The best strategy for this method is to make sure the account for fixed expenses has the total amount you need for all your financial obligations. The variable expense account, on the other hand, keeps the remaining amount of your monthly income.

A major perk of this budgeting approach is that the fixed account makes sure there's enough funds set aside for major expenses. Do the math and figure out how much you need in your fixed account for your monthly expenses. You'll also want to note the due date of your bills. Ideally, set up autopay for your bills.

This system requires a bit of discipline and mindful spending. It might help to pretend the money for your fixed expenses doesn't even exist. That way, you won't touch the money in that account. Plus, you can still create subcategories for variable expenses. That could help you stay on track.

Zero-based budgeting

If you're keen on keeping meticulous track of your cash flow, zero-based budgeting might be the budget for you. It does require more work, so you'll need to keep close tabs on your spending and where every dollar is going. With zero-based budgeting, every dollar is assigned a task.

Zero-based budgeting involves keeping the exact amount of money needed in an account. This lump of cash should be enough to cover all fixed and variable expenses. Any "leftover" money can go toward your savings, short-term and long-term goals, and toward investing.

However, there is a downside to zero-based budgeting. If you're not careful about allocating too much money to say, savings or goals, this can leave your account in the negative – after all monthly expenses have been covered.

The bottom line: You have several options for creating a budget that works for you

Creating a budget is essential to financial wellness. Without one, you won't have a proper roadmap to track where your money is going, and you won't be able to make informed decisions about your finances. It can help you save for your future, hit milestone achievements like buying a home or sending your kids off to college.

This article is for informational purposes only, and is not a substitute for professional advice from a medical provider, licensed attorney, financial advisor, or tax professional. Consumers should independently verify any service mentioned will meet their needs.