Whichever method you choose, personal budgeting involves three basic routines:
Track what you earn and what you spend.
Work to keep the second number lower than the first.
Lather, rinse and repeat each month.
Unfortunately, just because budgeting is simple doesn’t mean it’s easy. And if you’ve never created a budget, you may feel overwhelmed by what exactly you are supposed to do and how you’re supposed to do it.
Thankfully, despite reports to the contrary, starting a budget from scratch doesn’t have to be painful or difficult. Here’s how you can create a straightforward and simple budget that works for you.
Step 1: Embrace the Ongoing Process of Budgeting
Budgeting is frequently thought of as a one-and-done task. You sit down in front of your computer, surrounded by your accounts and receipts. You work out how much money you’ve been wasting. You make financial projections for the future.
Let’s look at an example with “Henry” and “Janine,” a composite couple. Janine and Henry discovered they had spent over $450 on dining out the previous month the first time they tried to set a budget. So they resolved to spend no more than $50 a week on dining out – and then went on their merry way, content in the knowledge that they’d set a budget.
As Janine and Henry discovered, if this is what you consider budgeting, getting ahead is quite difficult. The couple did not actively manage their spending after making their first budget, so they were unaware that they had exceeded their self-imposed restaurant spending limit. They couldn’t figure out why they were still having trouble making ends meet. It eventually came to a point where they had to sit down and prepare a budget all over again, and the entire process had to be restarted.
Accepting that budgeting is an ongoing plan for living the financial life you want is the best approach to set yourself up for budgeting success. Budgeting should be viewed as a monthly maintenance duty, similar to cleaning your laundry, rather than a one-time or occasional chore.
Laundry management, like money management, is a continuous obligation that cannot be avoided, neglected, or forgotten without major consequences. Going into your new budget with the understanding that you are committing to a regular and continuous process will aid with budget maintenance, which is far more important than just setting one.
To get ready for this new, ongoing task, Janine and Henry schedule weekly time to go over their budget together.
Step 2: Calculate your monthly income
Once you’ve embraced the realities of the budgeting process, you’re ready
to start getting into the nitty-gritty numbers. You’ll start by calculating your monthly income.
For anyone who receives a salary from a traditional employer, this part will be very simple. You’ll just need to take a look at your most recent pay stub to see how much you earn per paycheck. You can then multiply that by four if you’re paid weekly or two if you’re paid biweekly or twice a month.
Janine receives a paycheck of $1,550 on the 1st and 15th of every month. Multiplied by two, her monthly take-home pay is $3,100. Knowing this amount gives her a starting point for calculating her budget.
However, if you work as a freelancer, have side hustles, earn hourly pay or overtime or rely on tips or commission, your monthly income is a little more difficult to calculate. In that case, gather your income information for the past three to six months and calculate the average. This can give you an understanding of how much you earn each month on average.
Henry works as a freelancer, so his income fluctuates. By looking back at his income for the past six months, however, he learns that even though he only brought in $1,300 in one month and nearly $8,000 another month, his average earnings month-to-month (after setting aside his quarterly estimated tax payments) is $3,500.
Between Janine and Henry, their average monthly income is $6,600 (Janine’s $3,100 income + Henry’s $3,500 average monthly income).
Step 3: Add up your necessary expenses
Your essential expenses are the absolute bare minimum you require each month to live comfortably. These include both fixed and variable expenses.
The majority of people have a rudimentary understanding of their ongoing or fixed expenses. For example, you know exactly how much rent or mortgage you have to pay each month.
Now’s the time to look up and record every single one of your fixed expenses. These can include:
Rent/Mortgage
Utilities, including mobile phone and data/Wi-Fi access (if these fluctuate,
calculate the monthly average over the last 12 months)
Car payment
Auto insurance
Student loan payment
Alimony or child support
Daycare expenses
Monthly memberships (such as gym membership)
These fixed costs are the easiest to track, as they generally stay the same from month to month. But you’ll notice that some necessary costs are not included in these expenses, like groceries or prescriptions. These are the variable but necessary expenses that can change from month to month.
For variable expenses, it’s a good idea to calculate the monthly average over the last 12 months. (If there are expenses that don’t come up monthly, add up the total annual amount you have spent and divide that amount by 12 to determine your monthly average.) Include the following irregular-but-necessary expenditures:
Groceries
Medications
Medical appointments
Renters insurance/Homeowners insurance
Car maintenance and repair
Home maintenance and repair
Credit card payments
Once you have calculated the amount you spend each month on these necessities, you have your baseline spending budget.
For Henry and Janine, their baseline monthly spending budget is $3,430 ($2,190 in fixed monthly expenses + $1,240 in variable monthly expenses).
Step 4: Add the “Pay Yourself” line item
Paying yourself entails setting financial objectives and making strategies before spending money you don’t have. Many people overlook these goals in their budgets, expecting that they will be met with whatever is “leftover” at the end of the month. However, if you plan to use spare funds, it’s likely that your objectives will be overlooked. Developing line items in your budget for
your primary goal is the next stage in creating a sustainable budget.
Start by jotting down your financial goals. Some examples include:
Building an emergency fund
Paying off debt
Maxing out your retirement contributions
Saving up for a major purchase
Once you’ve decided on your objectives, calculate how much you’ll put toward each one each month. If you have a deadline in mind, divide the amount of money your objective will cost by the number of months until the deadline to find out how much you should save each month.
To your fixed expenses, add these “pay yourself first” sums. Consider your financial objectives as fixed expenses and line items in your monthly budget to help you develop the habit of prioritizing your objectives.
Henry and Janine have a number of financial objectives in mind, including paying off their college loans faster, saving for retirement, saving for a vacation to Machu Picchu, and eventually buying a home.
Step 5: Plan for your discretionary expenses
Now that you have calculated your baseline spending and the line items for your financial goals, you’re ready to add in discretionary expenses. These are the expenditures that you want rather than need. They may include things like entertainment, dining out, clothing, and the like.
While some discretionary expenses may be needed (such as clothing, unless your workplace is remarkably open-minded), how much you spend on these items is up to you.
Calculating these expenses is a little more complicated than the previous steps. That’s because you will need to know more than just what you have spent in the past. Start with those numbers, and use them to decide if those amounts are too high, too low, or just right.
For instance, you might discover that you spend $150 going out to lunch each month. This step gives you a chance to understand how much you’re spending on convenience and to adjust your spending plan. On the other hand, if you realize you’ve gone three months between haircuts to save money, but you really prefer how you look when you go every six weeks,
you might increase your haircut budget.
Step 6: Compare and adjust budgeting
Compare your expenses to your income. If the expense number is lower than or equal to your income number, then your budget is balanced. In that case, you are ready to implement your budget.
If, however, your expenses are higher than your income, then you need to adjust your spending. You can do this by playing with any of the non-fixed expenses. An important caveat about your adjustments is that you should focus on discretionary spending or variable spending (such as your grocery budget) before you reduce your savings for your financial goals. Protecting your pay-yourself-first line items in the budget will help ensure you reach the important financial milestones that matter to you.
For Janine and Henry, their monthly spending plan of $5,495 is well below their average monthly income of $6,600. However, since Henry’s income is variable, they will need to come up with a plan for the lower-than-average months. For instance, in the month Henry only brought home $1,300, their total income was $4,400. They will need to determine which items to cut during such months or how they can capture their surplus income during higher-income months to smooth over the lower-income months.
Step 7: Implement and track your spending
With a balanced budget, you’re ready to put your spending plan into action. Start spending and saving based on the budget you have created.
Implementing your new budget is about more than just keeping your spending limits in mind, however. You also will need to track your spending to identify any weak spots. The best way to keep track is via whatever tool works best for you, whether that means using a budgeting app, a spreadsheet, pen, and paper.
For example, Janine has been spending $10 every day on lunch at her workplace cafeteria. She and Henry have a weekly budget of $50 for dining out, but Janine’s cafeteria spending means she blows through that budget at work rather than on evenings or weekends. Rather than beat herself up, Janine works to figure out what is prompting her to buy food; thereafter, she has decided not to.
Janine might realize that she never remembers to pack lunch, so she and
Henry begins to pack a week’s worth of lunches every Sunday. Or she may realize that she brings her lunch, but it’s never as appealing as hot food. In that case, she decides to stop carrying cash to work to ensure that she eats what she brought.
As you implement and track your budget, you’ll notice patterns over time. These will help you make changes as needed to your budget and figure out what is important to you.
