How to Build a Budget in Five Steps

When was the last time you looked at your bank statement? For some, the answer is never! In reality, knowing where your money is going and regularly setting financial goals for yourself is essential to achieving confidence in your money decisions and reaching key life milestones. Luckily you don’t need a financial advisor to build a budget for your lifestyle; you only need to follow these five simple steps.

Step 1. Start with your net income

Building out a budget should begin with seeing what you have to work with. That starting point is your net income, or how much money you actually take home after expenses. If your paycheck automatically deducts things like taxes, retirement, and employer-based insurance, then your net take-home pay is your net income. If those deductions aren’t already taken out, you’ll need to subtract them from your pay to determine your net income for the purpose of budgeting.

You’ll be creating a monthly budget, so be sure to calculate what your net income is per month (which may not be the same as per paycheck).

Step 2. Write down where your money is going

Next, you’ll need to set a baseline for your budget. Start by writing down all of your expenses you may incur during a month. If you’re not sure where all of your money is going, spend the next month tracking your spending so you can create a general picture. We recommend using a spreadsheet or application to track your expenses, but there are also free budgeting worksheets online that can help with this, too.

Some expenses may change each month, like utilities. If the change is not too significant month-over-month, keep it simple and use the previous month’s amount. If the expense varies quite a bit depending on the time of year, use the amount you spent on that item in the previous month, or look at what you spent on that item the same time of year last year, if you have that information available.

If you have an expense that you only pay once a year, divide that expense by 12 to see how much you’d pay for it on a monthly basis and use that number. Expenses may include:

  • Bills:
  • Rent or mortgage payments
  • Utilities
  • Insurance (car, private health, etc.)
  • Credit card debt
  • School tuition
  • Savings
  • Emergency fund
  • Other:
  • Food
  • Gas
  • Entertainment
  • Clothes
  • School supplies

Add up all your monthly expenses and subtract that amount from your net income. If the result is negative, you’re likely going to want to make adjustments to your spending habits. If it’s positive, you’ll still benefit from creating a new budget.

creating a budget

Step 3. Determine your goals and priorities

Great, you know where your money is going. Now it’s time to make changes! But where to start?

Brainstorm your financial goals. Is your goal to pay off your credit card debt? Have enough money to retire comfortably one day? Be able to go on a family vacation this year? Think about your personal goals and your family goals. Be sure to list these goals in order of priority to you. For each goal, write down the total amount needed to achieve that goal.

Estimate how much you’d ideally like to contribute on a monthly basis toward that goal and write that down too. Be realistic here and write down a number you could reasonably be able to pay. And don’t worry about sticking to this number: this exercise is more about quantifying how much a goal is worth to you more than anything else.

 

GoalAmount NeededAmount I’d Like to Contribute Each Month
  1. Pay off credit card debt
$10,000$100
  1. Build an emergency fund
$3,000$30

Add an emergency fund to your goals. This needs special emphasis, as most people don’t save enough for unplanned expenses. These could include medical bills, car repairs, losing your job, and more. Unplanned expenses can happen to anyone, no matter where you live, what your job is, or what your income is. Everyone should have an emergency fund. But how much should your fund have? Experts recommend you set aside the equivalent of three to six months of your expenses, just in case. Part of your budget should include giving money toward your emergency fund. You never know when you may need it.

Differentiate your expenses between need to have and nice to have. Take your list from step 2 and split those expenses into two categories: need to have and nice to have. For example, entertainment expenses usually fall under nice to have, while school supplies may be need to have. Split categories into two if needed: in the food category, going out to eat may be a nice to have expense, while the expense of buying groceries for home-cooked meals would be a need to have. These are just examples; your necessities and wants will vary based on your circumstances.

As you split your expenses, keep your financial goals in mind. Is buying new clothes each month more important than putting that money toward your credit card debt? Maybe, maybe not, but these are the hard questions you have to ask yourself to truly get a sense of what your priorities are.

Step 4. Build a budget plan

Did you know there are many different budgeting plans available? This is a good thing because everyone has a different lifestyle and different priorities. One of the most popular budgeting plans is the 50/30/20 budgeting plan. Here’s how it works: your net income is broken down into

  • 50% toward required expenses,
  • 30% toward discretionary spending
  • 20% toward savings

This formula has proven highly successful for budgeting beginners. And since you already separated out your need to have vs. nice to have expenses in step 3, this plan would be very easy to get started with.

Here are a few other budgeting plans that you may be interested in:

The Zero-Sum Budget. Every single dollar you receive gets used in a deliberate way. Some may be earmarked for gas, some for a specific vacation you have planned, and some for paying off debt. The rule is that the amount of money coming in minus the money going out must equal zero. This budget works very well for detail-oriented people.

The Envelope Budget. Label each envelope with a spending category, such as groceries or emergency fund. When you receive a paycheck, divide that money into each envelope based on your priorities in step 3. Throughout the next month, as soon as you spend all of the cash in an envelope, you’re not allowed to spend any more on that category until the next month. This is really helpful for people who work best with visuals.

You can also choose to create a customized budgeting plan based on your priorities; it’s really up to what works best for you. As long as you select a budgeting plan and try it out for one month, you’re already taking proactive steps to get in control of your financial future. If it’s not working well for you, experiment with a different plan until you find the one for you.

Step 5. Track and revisit monthly

Remember to set up a way to track your budget. If you’re an organized person, you may choose to do this yourself using spreadsheets, but why not take advantage of the free resources out there? There are many budget tracking apps available that can help you manage your money automatically, saving you time. And the good news is that many of these apps are free to use.

Once you’ve set up a way to track your spending, keep checking back. Experts recommend revisiting your budget at least once a month, because our lifestyles and priorities can easily change from month-to-month, and you’ll want to reflect those changes in your budget. Set an alarm on your phone for the same day and time each month so you don’t forget!

Get help if you need it

Even after completing the five steps above to build a budget, remember that there are thousands of free resources available to you online to help with financial planning. Don’t miss out on free financial planning courses, apps for tracking, and budgeting worksheets. The more you know about your finances, the more confident you’ll feel in making spending and saving decisions.

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