Budgets are made to provide a method for organizing and optimizing your cash flow. Depending on your personal preferences and financial situation budgets can be very simple or very complex. The key is simply to have one and work with it. Without a budget, you’re far more likely to become delinquent on payments, spend more on credit than you can afford to pay back, reduce your savings potential, and eventually damage your credit.
Make A Budget That You’ll Stick To
The key to planning a budget that works is to find the right balance between aggressive and realistic, and you’ll be more likely to stick to it. Many people starting budgets tend to either be overly aggressive and stray from it, or are too relaxed which limits the usefulness that a budget can have.
Why Many Personal Budgets Fail
Keep these things in mind as you learn to budget.
- The rules of the budget are too strict
- Too many “exceptions” or adjustments to the budget that stray from the guidelines put in place
- Insufficient job of outlining expenses, which causes calculations to not add up at the end of the budgeting period. This most often cuts into the savings potential your budget had planned for.
- Overestimating income can have a similar effect to underestimating expenses. At the end of the budgeting period, you’ll have less cash to repay debt, invest, or save.
- Failure to adapt with changing income and expenses or learning along the way
The Process of Budgeting
The way that a budget works can vary due to different methods and your adaptation of how to most effectively distribute your income over time. The essentials of the budgeting process stay constant, however.
The basic concept of a budget is to start with your income and make a plan for every dollar – accounting for expenses, savings, investing, and other financial goals.
Step 1 - Calculate Your Income
The first step is to get a good idea of how much income you have. You’ll want to calculate your income after taxes (also known as your “take home pay”), but do not deduct any contributions to savings accounts, 401k plans, or other investments.
Be sure to include all sources of income if you have multiple, such as a fixed income source or a side hustle.
The most accurate way to determine your after-tax income is to take a look at your pay stubs and bank statements. If your income varies due to a seasonal position, commission, or an inconsistent schedule, we recommend using your lower earning months as a baseline to avoid planning for more money than you’ll actually have. Just be sure to have a plan for how to distribute excess money during peak months.
Step 2 - Outline Your Current Expenses
Make a list of all of your monthly expenses. This should include fixed expenses that are recurring set amounts such as subscriptions and loan payments, as well as variable expenses like credit cards or common purchases that will change from month to month.
Common Fixed Expenses to Consider
- Mortgage or Rent
- Car Payment
- Streaming or Product Subscriptions
Common Variable Expenses to Consider
- Credit Card Payments
Step 3 - Analyze Your Spending Habits
Next, compare your income to expenses that you’ve mapped out. How do they stack up? If your income is larger, you’re off to a great start.
See if there’s any opportunity to adjust your spending habits to improve the use of your money. If you primarily use a debit or credit card for purchases, many banks and credit unions will provide a helpful breakdown of your transactions by category. If you use cash for your purchases, start keeping a log of what you spend and categorize your purchases in a similar way.
Step 4 - Choose a Budgeting Plan & The Right Tools
Now you have a good picture of your cash flow – money coming in and where it’s going to. Next, you’ll need to choose a budgeting plan and find the right tools to use it.
Spreadsheets in Excel or Google Sheets are always a great option for budgeting, and they have the ability to easily scale and become more complex as your financial life evolves. There are also several apps that can aid in the budgeting process. Or you can go old-school with the classic notebook.
There are many kinds of budgeting rules, so it’s important to experiment with different methods to discover what best suits your needs. Here are a few of the most common budget methods.
- The Zero-Based Budget
- 50 / 30 / 20 Method
- The Envelope Method
Step 5 - Set Financial Goals
Setting financial goals is a crucial part of making any budget as effective as possible. These can be long-term savings goals, shorter-term ones for large purchases, or something more specific like reducing spending on eating out.
We recommend setting (or resetting) your goals here because at this point you know how much money you have coming in, where your money is going, and how you plan to distribute it with any of the budgeting methods.
It’s important to make your goals attainable and measurable. Using the SMART acronym can be helpful here (specific, measurable, achievable, relevant, timely).
Step 6 - Monitor Your Progress and Adapt
Monitoring and adapting are arguably two of the most important pieces to budgeting. That’s right, setting up a spreadsheet isn’t the end of your budgeting plans.
You should periodically revisit your budget and ask yourself – is it working effectively? Are there ways I can improve it?
Additionally, with any financial change it’s a good idea to revisit your budget and adjust accordingly.
- Changing jobs
- Pay raise
- New expenses
- Reduced expenses
- After moving
- Paid off loans
12 Helpful Budgeting Tips
- Budget in advance. Planning ahead of time is the only way to ensure your budget will work.
- If you have a variable income source, be aggressive in good times to account for periods of lower income.
- Automate your expenses through auto-pay so you’re never late and the money is already distributed and accounted for. Avoid this tip unless you’re sure you’ll always have sufficient funds available when the payments are due.
- Be strict with limits that you put on credit card spending.
- Plan in advance for infrequent expenses like insurance. Allocating money towards these expenses each pay period can reduce the stress on your budget for the months they are due.
- Be honest with yourself when categorizing needs and wants and cut unnecessary expenses where you can.
- Track all of your expenses and categorize them so you always keep tabs on your spending habits.
- Add a safety buffer in your budget to account for any unnecessary expenses.
- Set a cadence for spending retrospectives to see where you can improve.
- Keep an open mind to other ways to maximize earning potential and building wealth.
- Take advantage of direct deposit splits into different accounts if you’re able to.
- Don’t give up or get discouraged.