According to a Debt.com survey, in 2022, 86% of Americans track their money. That’s up from the 80% Debt.com reported in 2021 and 2020. If you are new to creating a budget, don’t worry. This six-step guide will cover everything you need to know about making a budget.
What is a budget?
A budget is a spending plan that is specific to your financial situation. Budgets are set based on your income and expenses. Typically, creating a budget consists of documenting how much money you have coming in, where the funds need to be allocated, and where you need to adjust so that you can also save and invest money. A clear personal budget helps you organize your money, track your spending, plan for the future, and achieve your financial goals.
Consumers should prioritize necessary expenses and make sure they are covered. Setting minimum goals for saving and investing your money can reduce your discretionary spending, but it will give you more financial opportunities in the future and potentially lead to a better retirement. A good budget can make both of those outcomes more likely.
Why should you budget?
There is no financial downside to budgeting. People of all incomes have budgets in place for their personal and business needs. Corporations track their income and expenses to make sure their initiatives are sustainable. Budgeting presents numerous advantages that can meaningfully impact your finances.
1. Save for an emergency fund
An emergency fund is a critical component of financial well-being. It lets you cover urgent expenses that cannot wait, such as auto repairs and medical bills. Many consumers are vulnerable to surprise expenses. Some people take out loans to cover emergency expenses which results in extra debt and monthly payments. Building an emergency fund with good budgeting strategies can help you stay on top of your monthly expenses while covering an emergency expense.
2. Pay off your debt
Getting out of debt will minimize your expenses and help you build wealth. If you only make the minimum payments, you can end up in debt longer and pay more interest. An effective budget can help you exceed the minimum payment for your credit card debt. You may also have an easier time covering student loans, car payments, and insurance premiums if you create a budget.
3. Add money to your retirement accounts
Your retirement accounts give you the opportunity to increase your money and lower your tax bill. Some retirement accounts let you save taxes on contributions, while others let you save taxes on withdrawals. Regardless of which option you choose, it is important to consider contributing to retirement accounts. An effective budget can enable you to make the maximum contribution to your retirement accounts. You can reduce your discretionary spending and use the extra cash to grow your retirement accounts.
4. Grow your savings
When you trim your expenses through a budget, you get to decide where the extra money goes. Paying off debt will slow interest compounding, but once you pay off debt, you can put more money into your savings. Building up your cash reserves can help you save up for large expenses or strengthen your financial security.
Supercharge your budgeting by having your spare change* automatically go into your Investment account.
5. Have money to play
You can still spend your money on discretionary items, products you enjoy, and experiences. A budget can give you the best of both worlds. You can set aside a small amount of money each month for discretionary spending and also stay in control.
How to make a budget in 6 steps
Budgets help you get more out of your money. They allow you to become more intentional about how you spend money and can assist with long-term financial goals. You can follow this six-step process to create a personal budget.
1. Choose your budgeting strategy
Everyone’s financial goals are different. They often depend on income, investment strategies, and lifestyle. Choose a strategy that helps you meet your goals while allowing you to focus on what matters to you the most.
While you can choose from several budgeting strategies, these are some of the most popular choices to help you master your finances.
Cash envelope system: People who want to be meticulous with their spending habits should consider using the cash envelope system. Essentially, you’ll designate envelopes for each category of your spending. By adding the exact amount of cash that you’re allowing yourself to spend per month, you can avoid overspending. Only use the cash amount in the envelopes, and don’t use your debit or credit card. Once the money is spent, you’ll have to discipline yourself to wait until next month to spend more money in that category.
Bills that can be automated should be set on auto-pay, and the rest of your bills should be paid with cash. Typically, the cash envelopes will contain money for groceries, gas, eating out, essentials, and play money.
50/30/20 method: Another popular approach is the 50/30/20 method. Made popular by Elizabeth Warren’s book “All Your Worth: The Ultimate Lifetime Money Plan,” this method is flexible and outlines how to spend your money. The strategy involves allocating your money to three expense items:
- 50% of your post-tax income on necessities
- 30% on fun activities
- 20% into your savings account
You can adjust the percentages based on your financial goals. People who want to accelerate their savings may opt to put 30% into their savings accounts and 20% of their earnings into fun activities.
2. Collect your money trail
After you’ve decided on your strategy, it’s time to collect all your financial paperwork. This includes anything that tracks money coming in, money going out, credit card statements, past tax filing reports, receipts, and monthly expenses. If you pay for things in cash, keep your receipts. File them away in a shoebox or scan them into a receipt folder on your computer.
This process may take some time, but it gets easier over time. You can put your finances in a spreadsheet so you can easily revisit previous months and years.
3. Add up all budget categories
You can make your own budgeting sheet in Excel or Google Sheets, but you can also grab a free template online. Once you have your budgeting outline ready to go, gather at least three months’ worth of statements. Those statements will reveal your income levels and how much you spend on each expense category.
For example, to find your average monthly grocery bill, add up what you spent on groceries in the past three months and then divide that value by three. If you spent $1,500 on groceries over the past three months, your average monthly spend is $500 per month. You can use that number as your projected monthly grocery bill.
If your income varies because of commission-based jobs or side hustles, base your budget on the lowest amount of money you make. You can treat your more successful months as bonuses. During months when you make more, you can put the additional income toward debt, savings, or investments. Creating a budget based on slower months will result in less financial stress when you are in the slower months.
While you should use the lowest income amount for your budget, you should use the highest average amount for variable expenses. That way, you won’t end up being short when you’re paying bills. Don’t forget to factor in random expenses that don’t occur monthly, like your tax bill or vehicle maintenance payments.
To incorporate these bills into your budget, determine the figure you spend yearly, divide that by 12, and put that dollar amount aside in a savings account every month. When it comes time to get an oil change or pay your taxes, you’ll have the funds saved, and you can pull right from your savings account.
4. Adjust spending habits
Laying out your income and expenses can help you make meaningful changes to your finances. Adjusting your spending habits can help you achieve financial goals, such as getting out of debt or building an emergency fund.
Your budgeting sheet will help you isolate the areas where you’re overspending and reveal opportunities to cut back where needed. Alternatively, noticing that you’d be more comfortable with additional money can give you the motivation to seek supplemental income.
Some of the easiest ways to cut back on spending are by canceling cable subscriptions, pausing expensive gym memberships, skipping coffee runs, and eliminating the urge to get takeout. You can easily save hundreds of dollars by using these tips.
5. Create an action plan
Now that you know where your money is going, you can come up with a plan to support a better financial future. Set a time frame for your budgeting goals. For example, an aspiring homeowner who wants to make a $50,000 down payment would have to save $1,042 per month for four years to make the down payment.
With a budgeting plan in place, you get to decide where your hard-earned money is going. From investing your money in stocks or saving for your kid’s college tuition to taking that much-needed vacation, budgeting can make your dreams more likely to happen.
6. Put your money to work
Got your budget plan locked and loaded? Keep your budget at the forefront of your mind so that you don’t forget about it. You did the planning, so all that’s left is to implement your budget and move closer to your financial goals.
You can also use the MoneyLion app** to keep you motivated. See all your finances in one convenient place for better financial management.
Budgeting like a pro
Few people have flawless budgets. It’s OK to make mistakes along the way. Overspending one day may notruin your finances, but you can’t let the small mistakes add up. It’s OK to dine out every once in a while, but it can become problematic if you turn it into a daily habit.
Mistakes give you the opportunity to learn, strengthen your resolve, and commit to your budget for the long run. Now that you know how to make a budget and successfully execute it, it’s time to make it happen.
What are some common budgeting mistakes to avoid?
Not tracking your income and falling for temptations are some of the common budgeting mistakes to avoid.
How often should you review and adjust your budget?
You should review and adjust your budget at least once every three months. Adjusting your budget monthly can help you stay on top of your finances.
Is it necessary to include every little expense in my budget?
It is necessary to include every little expense in your budget. It takes extra time, but you will become more conscious of every dollar you spend. A little extra work can make a big difference in your long-term financial goals.