A budget is perhaps the single most important tool when it comes to building a healthy financial future. Why? Because it gives you control over your money allowing you to be in charge of where it is spent. It eliminates impulse purchases, overspending, promotes saving, and lets you move towards your financial goals. It's essentially the basis of personal finance.
But, how do you make a budget that fits your finances? By following these five steps below, I'll teach you how to build a budget in under 10 minutes, and give you trusted budgeting tips to follow.
How to Create A Budget In 5 Steps
If you don't know where you want to go, how do you plan on getting there? A healthy financial future depends on setting objectives on where you want to be five to ten years from now, and then building a plan to achieve those goals.
These five steps to create a personalized budget are built around your financial goals and current financial situation.
1. Write Down Your Financial Goals
Your entire budget should be based on your financial goals. Where do you want to be five to ten years from today? Follow the SMART goals system by ensuring your goals are
- S – Specific
- M – Measurable
- A – Achievable
- R – Realistic
- T – Time bound
An example SMART goal might be: “I want to pay off $5,000 of credit card debt by one year from today.” Avoid goals that are too vague and generic like “I want to save money each month.”
Consider making goals around paying off debt, emergency savings, retirement savings, progress towards major purchases like a home, setting money aside to invest in the stock market, and even growing your income.
2. Calculate Your Total Take Home Pay
Your take home pay is the amount of money you see deposited in your bank account after taxes have been paid. Your salary might be $60,000, or $5,000 per month, but your take home pay will be closer to $4,000 per month after taxes have been withdrawn from your paycheck.
A common mistake many people make is building a budget around their stated salary instead of their take home pay. Knowing your take home pay sets realistic expectations on the type of living you can actually afford.
3. List, Prioritize, & Update Your Expenses
After calculating your take home pay, the next goal is to get your monthly expenses under management. This begins with listing all of your monthly expenses and putting them on paper in front of you to see all at once. Your expenses will likely be split up between fixed expenses and variable expenses.
Fixed expenses may include:
- Mortgage or rent
- Car payments
- Phone bills
- Internet service
- Personal loan payments
Variable expenses are expenses that are different from month to month. These include things like:
- Credit card payments (may vary depending on the monthly balance)
- Transportation expenses
With variable expenses, it's a safe idea to overestimate rather than underestimate. An easy rule of thumb to follow is to set aside 105% – 110% of your previous months bill for the upcoming month. If your utility bill was $100 last month, set aside $105 – $110 for the upcoming month. You be the judge.
After listing all your fixed and variable monthly expenses, begin prioritizing them from most important to least important, and eliminate any unnecessary expenses that you no longer need.
Why should you prioritize your expenses? Because should your finances go sideways or you have a variable income, making sure you pay for food, water, and shelter should be a top priority before paying for your Netflix subscription.
4. Subtract Your Expenses from Your Income
You've got your income written down, your expenses written down and prioritized, now you need to subtract your monthly expenses from your take home pay to see if you're living within your means.
Do your expenses add up to be more than your take home pay? Then you need to adjust your budget accordingly.
Does your take home pay add up to be more than your expenses? Great! Determine how to allocate the leftover funds to meet your financial goals.
5. Review & Update to Meet Your Goals
The hard part is over. You've got a grasp on your income and expenses and know whether you're actually living within your means or not.
We haven't done much up to this point other than give you a clear picture on your overall financial picture. This step is totally focused on updating your budget to meet your goals you listed out in step one.
An example goal we used in step one was to payoff $5,000 of credit card debt one year from today. Does your current budget put you on track to achieve this goal?
If not, you will need to adjust your budget to give you the wiggle room needed to pay off $5,000 in one year.
The same concept is true for all your financial goals including savings, retirement, and major purchases. Keep in mind that your goals must follow the SMART goals system, so they must be “REALISTIC” as well, meaning you may not be able to achieve all your goals at once. Focus on the ones most important to you, then tackle the next once achieved.
Set Regular Budgeting Reviews & Stay Consistent!
Setting a budgeting meeting for 10 minutes once every week is ideal to staying on track of your money. You may choose to do it once per month, once per week or once every other week as you see fit.
Following this 5-step process and reviewing and updating it on a regular basis is the final ingredient REQUIRED to make your budget customized, goal oriented and ultimately successful.
Tips to Improve Your Budget
There are a few timeless strategies used by many that have proven to be extremely helpful over the long run. Consider the following budgeting tips to improve your finances:
Pay Yourself First
The only way to build a financial nest egg is to keep a portion of the money you make. Pay yourself first, even if it's just a few bucks per week, before anything else.
Establish an Emergency Fund
Unexpected events can and will happen, and likely when you least expect. Having an emergency fund of at least $500 – $1,000 should be a financial priority if you do not yet have an emergency fund in place. Make this one of your top goals in step one.
Consider the Envelope System
Having a debit card to spend money can often lead to overspending without realizing it. Dave Ramsey's popular “Envelope System” is a strategy used to avoid this problem.
Simply eliminate using a debit card, and just pay in cash. Set aside your allocated funds to different expense categories and put them in different envelopes. When the envelope is empty, you've met your budget for that category, no more spending!
Open A Separate Checking Account for Bills
Another common problem people have is using one account for all their payments, forgetting they just submitted a credit card payment that hasn't yet come out of their checking account.
To avoid this, consider having one checking account allocated to monthly bills so your everyday spending doesn't alter the balances set aside for recurring bills.
Use A Zero-Based Budget
A zero-based budget means giving every dollar you earn a name and a place. At the end of your budgeting meeting, your balance should be zero because all your income has been accounted for, including savings.
Automate Your Budget with A Budgeting App
There are many popular budgeting apps that automate your budget for you and analyze your spending without much effort on your end. Here are 10 of the top budgeting apps to consider.