Are you struggling with your finances? Do you know how to create a budget that can not only help you manage your finances but that you can also have the discipline to stick to?
A budget is merely a form of accounting that is geared to ensure that you have more money coming in than is being spent every month in the form of bills and other personal expenses. Creating a budget is an essential ingredient of financial freedom. It is an excellent way to ease stress and worries about your finances.
With a budget, you have peace of mind that money is allocated for various expenses and you can focus your energies on other important things. Unfortunately, many people have a hard time making a responsible budget. There are good and bad ways of making a budget. In this article, we present you the best way to make a budget.
Why Do You Need a Budget?
A budget is a personal financial planning tool. A monthly budget, for example, helps you to plan for how you will spend and save your money every month. It also ensures that you have an easy time tracking your spending patterns.
To make an effective budget, it is imperative that you keep your finances in order because budgets rely on balance. Namely, the money saved in one area can be spent on another area or be put in a savings or investment scheme for future use.
Before you embark on creating your budget, you should realize that an effective and successful budget needs to be as comprehensive and as accurate as possible. In the end, you should have a budget that helps you know where your finances are coming from, how much you have to spend, and where it is all going every month.
That said, let’s explore the various things to consider when making a budget.
If you aren’t a wiz with spreadsheets then you may want to consider one of the many budgeting apps on the market.
If you do not have a budgeting tool that you are somewhat comfortable with, I would suggest using Personal Capital. Not only can this app help you put together your budget, it also helps you monitor all your accounts.
This means all that you are doing with investing, budgeting, savings can all be seen in a single dashboard. While there are many top budgeting apps available, Personal Capital has been great for what I need and its FREE!
Determine Your After-tax Income
The first step into making a budget is knowing how much you have to spend. You have to figure out your after-tax earnings since that’s what you’ll be budgeting for, but how do you determine your after-tax income?
Just add up all your sources of income for the month. That may include your job, your side hustles, and even your spouse’s income. This income is the foundation upon which you will build your budget.
Calculate Your Regular Expenses
The next important step in creating a budget is determining how much you usually spend every month. You’ll need to check your receipts, banks statements, and financial files. Some expenses can change from month to month, like the electric bill.
With such expenses, it is advisable to calculate an average for at least six months to uphold accuracy. To do so, get a sum of the payments you have made for the last several months and then divide by the number of months. That gives you the average monthly expenses.
It is important to include every bill in this calculation. It’s also advisable to consider unexpected bills, such as car repairs or children’s random school expenses. We handled this in our first budget by adding an extra item labeled “We Forgot”. This allowed us to have that extra buffer while we figured out all of our expenses.
Figure Out Your Discretionary Expenses
Once you have your regular expenses figured out, you have to determine your discretionary expenses. Discretionary expenses are those expenses that you currently pay for, but you necessarily don’t need. Some examples of discretionary expenses are:
- Personal care
- Eating out
The primary benefit of discretionary expenses is that you can have them adjusted based on how much you’re willing to spend on them. It is worth noting that discretionary expenses usually are third in priority after regular expenses and financial goals. It’s important to give your financial needs a priority over entertainment and vacations.
Determine Your Debts
You need to know your monthly recurring debt repayments. You can easily do that, especially if you are no longer taking any short-term debt such as credit cards. However, you don’t have to worry if you are still struggling to break away from dependence on credit cards.
In fact, having a budget will help you gain financial freedom and stop depending too much on high-interest consumer debt such as credit cards. So, how do you determine your monthly recurring debt payments?
Get the sum of the amount owed on each debt account and the minimum amount you are required to pay each month. This may include mortgage, student loan, car loan, and credit card debt. Do not forget the debts that you owe friends, colleagues, etc.
Knowing what you owe makes it easy to determine your net worth, and hence the amount of money you have available to spend.
Prioritize Your Expenses
The primary purpose of making a budget is to help you reach your financial goals. Therefore, it is imperative that you have a clear idea of the goals you are trying to attain. You should write each of your financial goals down, whether they are short-term goals or long-term goals.
Then, you need to figure out what it’ll take to accomplish them. Maybe you are looking to purchase a home soon. In that case, you’ll need to determine how much money you would need for down payment.
You can then divide that figure by the number of months left until the time you plan to start looking for your ideal house. If your goal is to get out of debt, you can employ the same approach.
If you have a loan with a $200 monthly payment, for example, but you can pay it off a year earlier by making $300 monthly payments, make sure you factor in the additional $100 every month in your budget.
Getting your financial goals right will make a huge difference in the success of your budget. Therefore, you should not rush over this step. Otherwise, you may end up with more financial problems instead of accomplishing your desired financial goals.
Choose the Best Budget Method
There are several different budgeting methods, each with advantages and disadvantages. However, the most popular methods are:
- 50/30/20 budgeting method
- Envelope system
- Zero-based budget
Let’s take a more in-depth look at each method, so you can choose the one that fits your budgeting needs. You can even try all of them and see what works best for you.
50/30/20 Budgeting Method
If you are not into complicated stuff, the 50/30/20 method would be your ideal option. It is the simplest budgeting method to implement. All you need to do is to ensure that your spending doesn’t go out of the following main categories:
- Savings – 20 percent
- Wants – 30 percent
- Needs – 50 percent
The significant advantage of this budgeting method is that no one category is expected to remain constant. You can adjust your spending every month depending on your priorities. The trick is to make sure your spending fits into the limits specified by the main categories.
The 50/30/20 budgeting method may look simple, but it can be very effective in propelling you toward your financial goals. It is ideal for individuals who want a budget, but also want to keep things as simple as possible.
The Envelope Budgeting Method
If you tend to overspend your money and are looking for a way to be more disciplined with your finances, the envelop budgeting method will work well for you. The envelop method is quite rigid and can help curb overspending. So, how does it work?
Traditionally, you’ll need to withdraw all the money you plan to spend in a particular month. Then you divide the cash into individual envelopes for each of your expenses. The expenses may include groceries, gas, telephone, clothes, etc.
If you finish money in an envelope before the end of the month, you’ll have to move cash from another envelope. Otherwise, you’ll have to do without that item for the rest of the month.
Thanks to technological advancements, there are now apps you can use to create an envelope system without having to withdraw all the cash you plan to spend. You can simply use your debit or credit cards.
Some financial experts still recommend using the traditional envelop method. They believe it is more effective in instilling spending discipline.
Zero-Based Budgeting Method
If you want to be in complete control over every dime in your budget, then you need the zero-based budgeting method. The concept behind the zero-based budget is that any dollar not tracked will be spent mostly on something not worthwhile.
A zero-based budget helps you ensure that every dollar has work to do. If you make $5,000, for example, and your budget is worth $4,600, then your budget is not complete. You have to assign the remaining $400 a job.
You’ll need to create additional budget categories and assign values until the difference between your income, and the total assigned values is zero. Creating a zero-based budget can be time-consuming. You need to take your time evaluating the various expenses in your budget to ensure your spending reflects your financial goals.
Whichever method you choose, you should aim for always sticking to your budget. In that way, you increase the chances of reaching your financial goals. You can break your budget once in a while but make sure you don’t take too long to get back on track.
Track and Monitor Your Budget
Keeping track of your budget is essential. Depending on the budgeting method you choose, you may not need to track your spending throughout the month. It may only take about one hour a week.
Nonetheless, it will save you a lot of time and stress in the long run. Once your budget is up and running, it’s important to keep it in check. This will help grow your discipline and each day you’ll be moving closer to attaining your short-term and long-term financial goals.
Eventually, you’ll stop living a paycheck-to-paycheck kind of life and get to enjoy the long-term benefits of your disciplined spending and financial planning. It is advisable to capitalize on technology. Consider automating your expenses and savings, so the money you have allocated for a particular purpose gets to do the job with little effort on your part.
Review Your Budget Regularly
It is difficult to know exactly what your expenses will be every month. It is possible to forget about some items, such as payments that need to be made only once or twice a year. Sometimes you can make an impulse purchase that you did not include in your budget.
Emergencies can also arise that disrupt your budget. That’s why it’s necessary to review your budget from time to time to ensure you are always on the right track. At the end of each month, take some time to compare what you had budgeted for and the actual expenses. Then you can adjust your budget accordingly.
Keep it Going
The decision to create a budget and stick to it is one of the wisest you can ever make as far managing your finances is concerned. With a budget in place, you’ll have a clear idea of where your money is going. You will be able to identify wasteful spending and know exactly where you can minimize spending so you can save some funds or pay off some debt.
Making a budget can be a daunting task, but with tips shared in this article, you will have an easy time doing so. You can also take advantage of the many apps that are designed to help you budget and save money. It can take some time to get used to budgeting, but you will better off in the long run.
Don’t forget to evaluate your budget at the end of every month to see if you are on the right track toward your financial goals. You can also consider getting an accountability partner to hold you accountable for decisions that break your budget.