Have you ever created a budget? It sounds scary. Figuring out how to build a budget for the first time can be so overwhelming, many people procrastinate until eventually giving up the idea altogether. Did you know that only 40% of American families actually have a monthly budget? It may not be easy at first, but one thing is for sure – it is worth the effort.
Developing a budget you can stick to for an extended period is linked to great things, such as getting out of debt (check out some key debt management tips), cutting expenses, and building wealth.
How to Build a Budget: First Steps
You can start realizing how to build a budget by looking at approximately how much money you are making annually and then break down the expenses by category. These include fixed costs such as rent, insurance, debt, as well as variable or flexible expenses such as entertainment. Figure out what you can afford regularly, and whatever money remains is used for investing and saving.
What many people do is spend money on things they want and need without thinking about if they could truly afford them. But after overdrawing the checking account several times and having no money to work with, it becomes clear how a budget can help.
If you want to gain more control over your cash flow and begin reaching your financial goals, you need a budget. A personal, family or household budget is a little more than a detailed spending plan — a summary of expected expenses and income for a certain period, usually one month.
Budgeting is associated with restrictions, but what a budget should really be is a tool for more efficient spending. A budget will show you all your expenses (fixed expenses and variable expenses) as well as how much money you bring into the household. Here you list things like rent, car payments, insurance along with discretionary expenses such as entertainment or anything you want but don’t necessarily need. Instead of seeing a budget as a negative, you can view it as a tool for achieving your dreams and financial goals.
We will discuss the benefits of keeping a budget, as well as how to create one step by step. It’s easier than you think, and it will give you a sense of control and peace of mind.
Why Do You Need a Budget?
Why do you need to know how to build a budget anyway? After all, life is carefree when you can buy anything you want. Well, if you want to make sure you have a carefree future, the best thing you can do is understand your finances.
A monthly budget is a personal financial tool that allows you to chart how much money you earn, spend, save, and invest each month. It also helps you track your spending habits and patterns.
Of course, making a budget may not seem like the most exciting activity. For many, it may even feel scary at first, but it’s vital for your financial success. The primary job of any good budget is creating a sustainable balance. If you spend less in one area, you can spend more in another. You could also choose to save the money for a future purchase, retirement, or emergencies.
However, before you begin creating a budget, you must be willing, to be honest with yourself. You must be prepared to utilize as much accurate and detailed information as possible.
If you take the time to do it correctly, you’ll have a blueprint each month telling you where your money comes from, and where it’s going.
Most Budgets Fail: How to Build a Budget That Works
If you think you’re going to get it down perfect right away, you better think again. We all fail on our budget from time to time. Maybe your laptop unexpectedly breaks down, and you need to pay to fix it. Or perhaps you accidentally spent too much of your paycheck, and forget about the spending limit you set in your budget. That’s understandable, and it happens to everyone.
A lot of people get frustrated with the restrictions in their budget once they start to run into any difficulties. Be it failing to reign in their spending, or just unavoidable emergencies, something always seems to break the budget. At times, budgeting may seem like a lot of work with very little reward. But if you manage to stick with it, you’ll be amazed at the difference it can make, guaranteed!
Budgeting can be a lot less stressful if you realize the main reasons why people usually fail.
Why Budgets Often Fail
You may have troubles with your budget if:
It’s too complicated – We sometimes tend to overcomplicate things, especially when it comes to budgets. The good rule of thumb is – the simpler, the better. The clearer your budget is, the more useful it will be for you.
It conflicts with your values – A budget should be a reflection of your values and help you achieve your personal goals. As such, it has to be personal. If you try to use somebody else’s template, you may find it more difficult than creating your own.
It’s unrealistic – When building a budget, you have to base it on your actual spending behavior and income. You can’t create a budget for the life you don’t have yet.
It turns into a chore – Don’t let anything distract you. Creating a budget has a clear goal, to get your finances in order. So, keep looking until you find a system that works best for you.
It has no goals – When your budget lacks well-defined, attainable long-term and short-term goals, it will most likely fail.
It lacks accurate information – If your budget is not detailed enough, or based on inaccurate spending, the results will be inaccurate as well.
To sum it up, the best way to minimize the risk of failure is for your budget to be simple and easy to use. It should reflect both your current financial state and your future goals, while also including the things that are important in your day-to-day life.
So, in other words, if you lie on your budget, you won’t get the value. By the same token, if you don’t follow it and appreciate its importance, you probably won’t stick with it.
How to Build a Budget Plan
The first step to a successful budget is to make one that you will stick to. So let’s see how you can create a budget in seven easy steps.
Step 1: Make a Budget Plan
There are many budgeting methods out there, and all of them have their advantages. What you need to look for is the method that works best for your situation. We will mention three of the most popular budgeting methods below to give you an idea where you can start.
Choose the one that sounds most fitting to you. Remember, there is no one perfect method, and finding the right one for you will take a little trial and error!
The 50/30/20 Method
The 50/30/20 method is one of the easiest budgeting methods, making it best for people who want to keep things simple. The 50/30/20 budget rule puts your spending in three main categories: 50% needs; 30% wants; 20% savings.
The benefit of this method is that spending can be different every month. However, since this method has everything fit into broad categories, you’ll likely have money leftover. This method will help you continue moving towards your goals.
The 50/30/20 budgeting method is simple yet powerful. If you follow it correctly, you’ll have your needs covered, be able to buy things you want, and you’ll still be saving for the future. Not too bad for a system requiring a ton of detailed work.
The Envelope System
This budgeting method is an excellent choice for people who need more discipline in their spending. If you are struggling with overspending, this method is a good option for you.
As a cash-based method, all the money you will need for the month should be in cash. You then split it into envelopes for each of your expenses – rent, gas, clothes, etc. If you spend all the money in an envelope, you will need to wait until the next paycheck.
If it’s an emergency, you can always exchange money from a different category, but you should avoid this whenever possible.
The Zero-Based Budget
The zero-based budgeting method is suitable for people who want full control of every dollar. The idea here is that every dollar not tracked will be spent.
The fun part about this method is that you assign every dollar a job. You give tasks to all the money you have even to the ones that are left after you cover your monthly expenses. Every dollar falls into a certain category until you reach zero dollars.
This method is the most time-consuming, and it requires you to look very carefully into your expenses. But if you like to work with numbers and you practice it well, you will find yourself with much more confidence, peace of mind and fewer unexpected expenses.
Step 2: Do the Tracking
Creating a budget will not change anything in your finances. For your efforts to have an actual impact, you need to make budgeting a habit. That means you have to track your spending and income all the time. To do that efficiently, you can use a budget worksheet, an app, or even a bullet journal.
The budget worksheet is excellent for beginners. They aren’t fancy, but they get the job done and make you carefully consider where you stand. If you like to use technology to simplify your life, there are numerous apps out there to help you track your budget. If you wish to get a little creative, take a bullet journal and creatively organize your budget.
Step 3: What’s Your Income?
You cannot start creating your budget before figuring out your after-tax income. You need to know how much you have coming in each month. The after-tax income is, unsurprisingly, the amount you see after you pay your taxes.
To calculate this number, start with the base. Add up all your sources of income, including any passive income and side hustles, and there you have it. After you have your base pay, subtract the taxes, and you’ve got your net, after-tax income. This figure is also known as your take-home pay.
Step 4: Be Honest About Your Spending
Where is your money going? What are you spending it on? If you’re an overspender, starting a budget can be tough. Remember, the goal here is not to beat yourself up for spending too much. Creating a budget should be a positive step toward financial independence and responsibility. Just be honest about what you are spending, and where.
Review your last three months of expenses and try to break them down into categories. Your credit card and bank statements will help you in the process. If you’ve used cash, try your best to remember what you spent it on. Keep your list of categories with you and track your spending. Don’t forget your debt payments or mortgage.
Step 5: Set Your Priorities Straight
Why are you creating a budget in the first place? What do you want to achieve? What are your long-term financial goals?
These are all questions you need to ask yourself honestly. Some people are saving for a new home, while others want to travel the world or pay off existing debt. To reach your goals, you will need to set your priorities straight. This step will minimize stress, and you will not feel helpless when you face unexpected expenses. You will know precisely how to handle the situation and ultimately stay on track.
These are a few of the priorities most people want their budget to tackle:
Saving for Retirement
Congratulations! You’ve covered your basic living expenses, and have a little extra money to get started saving for your retirement. Determine how much of your monthly savings you can allocate towards retirement and set up an automatic deposit. This way, every month, a set amount of money will go to your account, building your retirement fund over time. The younger you can get started, the larger impact even small savings can make.
Debt is a financial burden, an anchor that sets you back on your money goals. That is especially true for credit card debt, which has high-interest rates. Every dollar that goes towards paying off those high-interest rates is a dollar you cannot spend on your goals and dreams. Paying off your credit card debt will also affect your credit score.
One thing you can do to get started is organizing your debt by priority (credit card, mortgage, student loans). The sooner you can identify the biggest culprits of high interest and start paying them down, the better. By sticking diligently to this approach, you will begin to pay off your debt and eventually free up money for savings or investments.
Also Read: Oprah’s Net Worth
Building an Emergency Fund
Living paycheck-to-paycheck is frustrating and stressful. Having an emergency fund will give you peace of mind when life decides to sneak up on you. The best way to build an emergency fund is to open a high-interest savings account which guarantees safety and good returns. This way, instead of spending the money, it will be working for you.
Once you have reached your desired emergency fund amount, you will want to continue to add to it but maybe a smaller amount every month. Having an emergency fund will protect you from unpleasant financial surprises like a health issue or a job layoff.
Step 6: Play the Long-Term Game
Don’t forget to track your progress. Remember, budgeting is a long-term game. You need to check your spending regularly to ensure everything is within the limits you set in the beginning. Over time, you will most likely need to delete budget categories and add new ones.
In the beginning, you’ll want to check your budget every week. Doing this will allow you to turn it into a habit and make necessary corrections on time. If you are budgeting with your spouse, you both need to be involved and to contribute to the reviewing process.
With time you will get a feel for your spending patterns and will be able to track your progress more efficiently. At this point, you can start reviewing your budget once a month. Stay focused, though! If you lose focus, your money will slip through the cracks.
Step 7: Track, Adjust, Repeat
One of the reasons why budgets fail is that people don’t stick to them for long enough. Frustration kicks in every time people overspend, or an emergency expense sets them back on their goals.
Well, we have news for you. There is no such thing as a “normal” month or a perfect budget. Don’t label your budget “bad” and give up.
There are times when you need to power through and continue tracking and adjusting. The first budget you make won’t be final. The important thing is to continue monitoring and reviewing, then adjusting your habits and budget.
The whole idea of a budget is to make you more conscious of your finances. If you continue trying and don’t give up on your goals, this increases the chances to achieve them, even through the stumbles. Re-evaluate all the time, but don’t give up. You got this!
How to Build a Budget With Automation Tools
Frameworks can be very useful when it comes to adjusting your budget and wrapping your head around the whole picture. To build a working budget, you need a system, but a system on its own is not very useful.
In the past, before the internet, even basic budgeting was quite difficult. Luckily nowadays, things are much more manageable: apps and tools allow for budget automation.
Check Out: Best Prepaid Debt Cards
Budgeting Apps to Make Your Life Easier
There is a wide range of budgeting apps and frameworks to help you with your budgeting process. Personal Capital is a popular way to track expenses, for instance. This app helps with an integral part of budgeting. If you don’t follow what you spend, there is no way to know if you are sticking to your budget or not.
You Need a Budget (YNAB) is another good option when it comes to budget automation. It is designed specifically for budgeting.
Pros and Cons of Budget Apps
It’s important to remember, however, that apps like these have their pros and cons. Personal Capital is a free tool, but it is owned by a wealth-management firm, which attracts clients through the use of their budgeting software. YNAB comes with a small monthly fee, but it is worth it for everyone who needs a budget in their lives. Other popular free options are PocketGuard and Mint.
Still, there are many other options. You can buy a budget calculator, a desktop budgeting tool, or specialized software that helps you with the entire budgeting process. Another way is to build personalized spreadsheets which can be very efficient and useful for some people. If you like digging in the numbers a spreadsheet might be a good option. That said, if you are looking for something easier and more straightforward, YNAB or Personal Capital might be a better idea.
Ultimately, there is no single tool that fits everybody. But to find the one that works best for you and your budget, you need to test several options. What matters most is finding something which helps you reach your goals without unnecessary headaches.
How to Build a Great Budget
You now have the steps. It may seem like a lot of information already, but before we wrap things up, we would like to offer some final tips to make budgeting easier.
Perfection is the enemy.
Don’t worry about creating the perfect budget. You will likely not get your finances in a stable balance for the first few months. Your goal should be to get as close as you can to a balance of income and expenses. Test, adjust, and repeat, but never give up.
Focus on the big stuff.
Shopping at thrift stores and keeping an eye out for discounts is a great start. But you can save much more by being smart in critical moments like buying a car or home. Decreasing your major expenses like transportation, debt, and housing will make a big difference in your budget.
Do the reality check.
While budgeting, make plans based on your real situation and not on the one you wish it would be. Don’t budget for bonuses you haven’t gotten, or future salaries. This advice is especially true if you have an irregular income. By being realistic, it will reinforce your ideal spending habits and help you reach your larger goals.
If you’d like to get yourself a snack or a coffee every day, put it in your budget. If you did not receive that bonus, don’t count it in your monthly income. Do your reality check often and forget about wishful thinking.
Pro Tip: Build Credit Today
Simplicity is key.
This is another core principle of basic budgeting. Include detailed information in your budget, but only as much as you need. Find a way to track your spending, which doesn’t overwhelm or confuse you. When in doubt, keep it simple!
Weekly, monthly or yearly.
If you find yourself struggling to keep your budget, the reason might be the timeframe budgeted for is too long or short. If you make an annual budget, it will tend to be easier to predict spending than if you opt for a monthly period.
The reason why yearly budgets are more accurate is people consider more expense categories when they create them. If you are making a monthly budget, you may forget to include a category, such as taxes, which is essential. That said, yearly budgets are not very useful if you want to plan your day-to-day spending.
Our advice would be to start with an annual budget. People tend to do a much better job estimating their yearly expenses accurately than monthly. After making your yearly budget, divide the estimated spending from each category by twelve. The result will be a monthly number you can work with.
Don’t get over-confident.
Believing they’re immune to overspending can be a big problem for people. If you’re not responsible with your credit, it can quickly balloon into an enormous drag on your finances. Studies show people who are less self-assured about their budgeting make better financial decisions.
Budgeting Will Set You Free
For many people, “budget” is just a word. But not for those of us who want to master their finances. These people view their budget as a useful tool that allows them to build the life that they want. At the same time, it’s pretty clear that figuring out how to build a budget isn’t something you do once and forget about. It is a work in progress.
Even the simplest budget is in constant need of adjusting. However, once you get the most critical numbers figured out, it becomes a much easier process. Your rent doesn’t change much, and neither does your insurance premiums. The same principle is true for your savings – these are fixed expenses. Once you get used to saving a certain amount, it becomes a habit that’s hard to break.
Your goal then becomes to trim needs and boost your investments and savings at sustainable levels. If you keep these categories where they should be, you can spend everything else the way you’d like.
Spending on fun stuff is so much less stressful when you know you can afford it. There is zero guilt! Budgeting isn’t a prison; it has the power to set you free! It is your gateway to financial independence.
Also Read: Preparing for Recession
Learning how to build a budget can be overwhelming, and sticking to isn’t easy. That said, it’s still one of the most important habits to develop to improve your personal finance situation. There’s nothing magic about budgeting. It’s proven to work!
There isn’t a single method that fits everyone. From spreadsheets to apps, there are quite a few options to choose from, so there’s no reason you can’t find the budget that works for you!
Remember that persistence is vital. If one budget doesn’t work, try another one. Don’t just blindly use somebody else’s template, either. No matter how rich and successful that person is, an ideal budget will be unique to you. Use their ideas to start, but tailor them so that your budget fits your values and your life!
Are you ready to create your first budget? Tell us about your experience with budgeting so far. How many budgets did you fail with, and what were the lessons you learned along the way?