How to Make a Budget

A lot of people, maybe even the majority, don’t use a budget. The main reason might be that they don’t know how to make a budget, at least not one they can stick to for the long haul.

That’s really the critical key to successful budgeting. Just about anyone can implement and follow a budget for a month or two. But where it gets complicated is keeping it in place in the long-term.

I know something about budgeting from my own rise from being broke to becoming a millionaire. Though I never had a formal budget in place, I learned early to keep my basic living expenses low. As a result, I was able to save an incredible percentage of my income – as much as 80% – just by living well beneath my means.

That’s what a budget can do for you.

If you’ve never had a budget before, let’s concentrate on how to make a budget. I’ll even provide several options so you can implement the one you think will work best for you.

how to make a budget

Creating A Budget Plan

A budget is essentially a process in which you implement a series of strategies to get control over your cash flow. It uses a process of gradually (or suddenly) reducing your living expenses, to make more money available for either savings or debt payoff.

Most people are accustomed to working and earning a paycheck, paying their bills, and buying the things they want. Absent a financial plan, that’s the natural order of human spending patterns.

In a real way, a budget interrupts that process.

Suddenly, you begin to account for both income and expenses. You also take stock of the importance of each, and how it figures into your overall financial goals.

There are of course different types of budgets. You can create a budget of your own, simply by listing your expenses, and making decisions about which ones to cut, and which to eliminate completely.

Using Online Budgeting Tools To Make a Budget

Alternatively, you can use one of the many online budgeting tools available. Two of the most popular are Mint and YNAB. Mint is a free app that will also provide you with access to your free credit scores. YNAB is a paid service, but is more comprehensive than Mint, and claims it will save you $6,000 in the first year.

Another is Personal Capital. It has limited budgeting capabilities, but is free to use, and also provides generous investment tools and advice. In a real way, it can help you understand what to do with your money as you accumulate it.

Any of these apps will aggregate all your expenses and accounts on one platform, giving you the high altitude view of your finances.

Any are worth considering if you’ve never had a budget in place before. They’ll provide you with all the tools you need to set up a budget, and even automate the process.

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How Do I Make A Budget?

At its core, setting up a budget is something of an arithmetic problem. Though you can choose the specific time periods covered, the most usual budget is set up on a monthly basis.

Here are the basic steps to creating a budget:

Determine Your Monthly Disposable Income

You’ll start by determining your monthly income. That will require your net income – which is essentially your take-home pay. It ignores payroll deductions, such as income taxes, health insurance premiums, or retirement plan contributions. This will give you an accurate picture of the disposable income you have available each month. It will also represent the upper limit of your budget. Your ultimate goal will be to spend less each month than your net income.

Now if you have an additional source of income, like a side hustle, you may or may not want to include that in your budget. If you include it, you’ll obviously have more room in your budget. But you may also want to allocate that additional income to specific goals, like building savings or paying off debt. It’s a decision you’ll need to make.

Analyze Your Expenses

Next, make a list of all your expenses. The best way to do this is by analyzing your monthly expenses for the past six months, or even a year. For most people, this can be done just by analyzing your checking accounts.

Make a detailed list of all expenses, then separate them into two categories:

  • Fixed expenses. As the name implies, these are expenses with a fixed monthly payment. They include your house payment, car payment, certain utilities, insurance premiums, mobile phone, and cable TV/internet, and other monthly debt payments.
  • Variable expenses. This group takes in virtually all other expenses. It includes both necessary expenses, like groceries, gasoline, and car repairs, and optional expenses, like restaurant meals and vacations.

You’ll need to decide whether you’re going to work to lower your fixed expenses, variable expenses, or both. Most people start with variable expenses, since they have greater control over those costs. For example, you can reduce your grocery budget as well as eliminate restaurant meals.

But if you’re already stretched tightly, you may also need to take a look at your fixed expenses. For example, your primary financial problem may be a house or a car you really can’t afford. You may have to consider trading down on either.

With my own informal budgeting, my choice was to target fixed expenses. I found that by keeping major expenses, like housing and transportation, to a low level, I have greater control over my variable expenses. That was easier for me, but it may not work for everyone.

Choose a Budget System

You’ll need to choose a budget plan that you feel confident will work for you. We’re going to discuss three specific budget methods in the next section, so you can choose among those. But you should also seriously consider using one of the budgeting apps listed in the previous section. It all depends on your personal preference.

Also, remember that any budget system you implement can be modified to your personal preferences. For example, you may decide to emphasize savings over paying off debt. If you feel that will better enable you to get control of your finances, it’s a change you should feel free to make.

Track Your Progress Going Forward

One of the unanticipated problems people face with a budget is learning that may not work the first time out. Expect the first month to be difficult. After all, if you’ve never had a budget before, it can be a lot like going on a diet, except that it involves money.

Since your goal is to create extra room in your budget each month, this is the number you need to focus on. For example, let’s say your net income is $4,000. In the first month, you reduce your expenses of $3,800. That leaves you with an extra $200 you can either put into savings or use to lower your debts.

Maybe the next month the extra comes to $350, and in the third month, it reaches $500. That’s an important number to track, and you need to do it on a monthly basis. It’s a way of providing feedback to yourself so you’ll know if your budget is really working.

In a successful budget, the extra left over each month should grow at least a little bit. But be patient, since budgeting does take time and effort.

Put Any Extra in Your Budget Towards its Intended Goal

As you begin to build a surplus in your budget, you may be tempted to spend it. Don’t. Make sure that the extra funds find their way into savings or extra debt payments, whichever you decide to prioritize.

For many people, the best way to do this is to automate the process. This is especially true when it comes to saving money. Set up a payroll deduction based on last month’s budget surplus, that directs the extra funds into a savings or investment account.

If you want to use the extra funds to pay off debt, set up an automatic debit out of your checking account. You can do that with either one specific credit account you want to pay off, or even two or more. Make sure the automatic payment includes extra funds from your budget surplus so you’ll accelerate the debt payment.

Automation will be particularly important if you had difficulty handling extra money in the past.

Make Adjustments in Your Budget as Needs Change

It’s important to understand that budgeting is not a static process. As you move forward, your financial situation will improve for the better. As it does, you can modify your budget to get even better results.

For example, once you’ve been on your budget for a while, you may find it easier to cut out certain expenses entirely. Eliminating cable TV, an unused gym membership, or increasing the deductible on an insurance policy to lower the monthly premium are possibilities.

And while you may have started out funneling extra funds into paying off debt, you may decide to begin shifting some of the surplus over to savings. If the extra funds in your budget are large enough, you’ll find yourself having the option to fund both savings and debt reduction.

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3 Most Common Types of Budget

There are probably dozens of different budget methods floating around out there, but below are three of the most common.

The Envelope Method

This one has its origins – literally – in paper envelopes. It comes from the idea of placing cash into individual envelopes earmarked for each expense in your budget. As you might imagine, this is a pretty extreme budgeting system, but it’s often the best solution if you’ve had difficulty controlling your spending in the past.

Now obviously this was easier to implement in generations past when people paid their expenses primarily with cash. But it’s still possible to do today. You’ll need to withdraw a sufficient amount of cash from your bank account, after your paycheck arrives, to cover your expenses.

But as you may already have guessed, there’s also a budgeting app called Mvelopes that uses the envelope method, without the paper envelopes. It works by allocating funds in each expense account by “giving a purpose to each dollar in your budget”.

One of the advantages it offers is budget flexibility. If you exceed in one expense category, you can make it up by removing funds from another.

Zero-Based Budget

As the name implies, this type of method puts every dollar in your budget into a specific category. It’s a highly controlled spending method that makes the assumption that any funds not allocated to a specific purpose will fall through the cracks.

In practice, if you have $5,000 in income each month, each dollar must be assigned to a purpose. In most cases, that will be to cover living expenses. But anything left over will be intentionally allocated to a financial goal, like saving money or paying off debt.

This is another method that can be particularly restricting in the early days of your budget. Though you can certainly trick the system by setting up a slush fund or two, it makes sure every dollar in your budget is accounted for. If you get carried away with a slush fund, you can undo the entire method.

That brings up an important point that applies to virtually any type of budget plan. To make it work, a budget plan will require your full cooperation. The best budgeting system ever devised will be ineffective if you don’t commit to it, and allow it to modify your financial behavior.

The 50-20-30 Budget

This method is gaining in popularity in part because of its simplicity, but also because of its overall effectiveness.

On the simplicity side, the method doesn’t get deep into line-item expenses in your budget. Instead, it concentrates on the big picture.

How Does The 50-20-30 Budget Rule Work?

The allocation works like this:

  • 50% of your after-tax income is spent on necessities. This includes housing, transportation, groceries, debt payments, insurance and other necessary expenses.
  • 20% goes for savings and/or debt repayment.
  • 30% is spent on “wants”. Those are things you don’t necessarily need but want to have. It can include spending money on clothing, restaurant meals, entertainment, and vacations.

The effectiveness of the 50-20-30 budget rule is that it puts you on course to allocate 20% of your net income toward savings and debt reduction. This is double the 10% that the typical saver allocates for this purpose. It’s easy to see how if you follow the plan religiously, your finances will improve pretty quickly.

I like this budgeting plan, but the obvious weakness is that it may be difficult to cover your necessary expenses on 50% of your net income. This will be especially problematic for lower income earning households.

But the workaround is to reduce the 30% you’ll allocate toward wants. It may be that you’ll have to dedicate 70% of your net income toward necessities, and limit wants to no more than 10%. The critical part is to maintain the 20% allocation toward savings.

But that also demonstrates the flexibility of this method. You can move money from one allocation to another. And it eliminates the need to carefully track each expense each month. As long as you’re staying within the designated percentage allocations, this budget method will work.

How to Make a Budget That Works For You

If you don’t have a budget, and you’ve been struggling to get ahead financially, the time to put one in place is now.

It may be difficult, especially at first, but every worthwhile venture in life always is. Train yourself to focus on the positive and result, rather than the inevitable sense of self-denial that budgeting brings.

If you can commit to it, you can make it work.

Grant Sabatier

Creator of Millennial Money and Author of Financial Freedom (Penguin Random House). Dubbed "The Millennial Millionaire" by CNBC, Grant went from $2.26 to over $1 million in 5 years, reaching financial independence at age 30. Grant has been featured in The New York Times, Wall Street Journal, BBC, NPR, Money Magazine and many others. He uses Personal Capital to manage his money in 10 minutes a month.

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