You don’t have to reach the end of the month wondering where your money went. Doing a budget is simply telling your money where to go. And if you’re not good at budgeting yet, that’s okay! It takes a little time. By your third budget, you’ll be a pro. How to Create a Budget.
Read also this FintechZoom article: Maximizing Efficiency: How a Budget Planner Can Help You Save More.
While budgeting is always a great decision, it’s good to define goals and take a look at a budgeting calculator before you start the process, since the reasons you’re budgeting may impact choices you make during the process. Common reasons to create a budget include:
1. Determine why you want a budget
According to surveys, only around a third of all households live by a strict budget. By deciding to budget, you’re joining a select minority — and your decision will pay off. Budgeters are almost twice as likely to report no financial worries compared with spenders, and they’re less likely to live paycheck to paycheck or struggle with finances.
While budgeting is always a great decision, it’s good to define goals before you start the process, since the reasons you’re budgeting may impact choices you make during the process. Common reasons to create a budget include:
- Finding a way to save more money
- Reducing overspending on problem areas
- Ending fights about money for couples
- Making sure your spending reflects your goals and values
- Breaking the paycheck-to-paycheck cycle
- Avoiding spending money you don’t have
- Getting out of debt
- Staying on track toward long-term financial goals
While it may seem silly to think about your motivations, psychology plays a big role in how we handle money. In fact, University of Maryland research into budgeting showed the process of creating a budget makes it more likely goals will be achieved because the process of hashing out the numbers creates an emotional investment, enhances motivation, and discourages cheating.
2. Do a deep dive into current spending habits – How to Create a Budget
Before you can create a realistic budget, you need to know what your current spending habits are. If your budget isn’t realistic, it’s nothing more than a wishlist.
You won’t know if your budget is realistic until you’ve got an idea of where your money is currently going. Most experts recommend tracking your spending for about 30 days to get a clear picture of spending. There are a few ways to track spending:
- Enter your expenses into a spreadsheet or notebook: Whenever you make a purchase, write it down or enter it into a spreadsheet. This is the most hands-on approach but can be time-consuming and you might forget expenditures if not entered immediately. It helps to keep your receipts.
- Use an app: Apps such as Mint, Dollarbird, and PocketGuard make it easy to track spending by linking your credit cards and bank accounts. Link all accounts and ensure each purchase is labeled correctly to get an accurate assessment.
- Use your statements: Credit card and bank statements can help track spending, although this approach is less likely to produce detailed results because you may not remember what a particular transaction was for. Still, if you want to get started with your budget right away, going back over a month or two of old statements will give you a big picture to use as a jumping-off point.
Fewer than half of all Americans responding to Consumer Financial Literacy surveys indicate they have even a “somewhat good idea,” what they’re spending on food, housing, entertainment, and other essential expenditures — so figuring out where your money is going must be part of the budget process.
3. Use a calendar to catch irregular expenses – How to Create a Budget
While tracking spending shows you where money goes on a day-to-day basis, your budget should also factor in funds for irregular expenses, such as holidays and birthdays.
Americans who borrowed to cover holiday costs took on over $1,000 in new debt during the 2017 season, according to a Magnify Money survey. Half of those who borrowed would still be repaying holiday debt at least three months later. By budgeting throughout the year, you’ll never get into holiday debt again. Some irregular expenses in your budget might include:
- Christmas, Hanukkah, or other gift-giving holidays
- Annual car inspections and registrations
- Annual vacations
- Property taxes
- Professional dues
- Annual insurance premiums
- Annual medical exams, including veterinary exams
Your calendar and past credit card statements will help you make a list of all expenses that crop up throughout the year.
4. Add up all of your income
Budgeting is about making the best use of income, so you need to know how much money you have coming in. Factor in income from all sources including:
- Wage income
- Money from side gigs
- Alimony and/or child support
- Business income
- Income from investments
If your income is variable, one of the best budgeting approaches is to pay yourself a salary. This means you’ll decide on a monthly “salary” to base your budget around and when extra money comes in, save it in case of a bad month later. The monthly income you choose as your salary could be based off what you earn on average, or what you’d typically earn in a bad month if you want to build a bigger cushion and reduce the risk of overspending.
Those with irregular incomes could also live off last month’s income, updating their budget each month based on what they earned the month prior — but this is a more labor-intensive approach.
5. Identify your personalized financial goals – How to Create a Budget
Most people who make a budget do so because they want to accomplish more with their money. This usually involves achieving long-range financial goals such as:
- Saving for retirement
- Building an emergency fund
- Buying a house
- Purchasing a new vehicle in cash
- Paying off debt
- Saving for college
- Saving for a vacation or other big purchases
When you set goals, you can align your budget around achieving them by deciding how much you need to set aside to accomplish each goal. Goal setting has been shown repeatedly by studies to increase motivation and achievement. To be effective, your goals should:
- Be specific: Instead of “save for a house,” your goal should be “save $100,000 for a down payment.”
- Include deadlines: When do you want to buy that house or purchase a new car or retire or send your kids to college? Set a target date by which you’ll need to achieve your goal.
Setting goals is the single most crucial part of making a budget. If you don’t use your budget to make sure you’re working toward goals, all you’re doing is shifting spending and you’ll still have nothing to show for your money in the end.
6. Decide how much to save – How to Create a Budget
Once you’ve got your financial goals, decide how much you need to save for each goal. If you want $100,000 for a house down payment in five years, save $1,666 monthly. If you want to build a $1,000 emergency fund by next year, save $83.33 a month. If you want to pay off $5,000 in debt at 10% interest by the end of the year, make $440 in monthly payments.
The more specific you can be about how much to dedicate to each goal, the more likely you’ll achieve it. But if you don’t want to go through this whole exercise, take a shortcut and make a plan to save at least 20% of your income. You can devote 15% to retirement savings and the rest toward other goals.
7. Schedule a household meeting
If you’re single, you don’t have to worry about getting anyone else on board. But if you have a life partner, budgeting is a team project.
Money is a leading cause of relationship stress, with 35% of couples in a SunTrust Bank survey citing money as the cause. If you aren’t on the same page, your attempts to budget may be thwarted when your spouse hits the mall or splurges on Super Bowl tickets — and this is bound to cause strife.
It’s important to have a state-of-the-union meeting even if you maintain separate finances so your partner will understand why your spending habits may change and how he or she can support your efforts.
8. Decide what kind of budget you want to make
Now that you’ve done the preliminary work, it’s time to actually make a budget. Of course, there’s not just one type of budget, so you’ll need to choose which makes sense for you. Primary options include:
- A zero-based budget: This is the approach popularized by Dave Ramsey and it involves making income minus outflow = $0. With a zero-sum budget, every dollar you have is assigned a job, with some of those dollars going into savings and the rest assigned to different spending categories. This type of budget can be restrictive, so it’s not right for everyone — but it helps with avoiding overspending, and meeting goals including debt repayment.
- A 50-30-20 budget: With this approach, which Sen. Elizabeth Warren (D-Mass.) helped create, 50% of income is allocated toward needs, such as rent, food, and minimum payments on debt. Thirty percent is earmarked for wants, such as trips or entertainment. Finally, 20% goes toward savings. If you choose this approach, you’ll have a lot more flexibility — but may still up spending irresponsibly in some areas. Automating savings is key to making this budget work so you don’t ever shortchange yourself.