Whether you’re a veteran of managing finances or just starting out, you’ve undoubtedly heard that you need to understand budgeting. When you create a budget you’re just deciding where your money will go – and if you mess up that’s okay! It may take a few months to tweak your budget just right and to start following it consistently.
Now, grab some paper & a pen, open a spreadsheet – any method you prefer to store this information – and let’s get started!
Step 1: Calculate Your Monthly Income
If the only sources of income in your household are run-of-the mill jobs, from which you receive a paycheck (with taxes already deducted), your monthly income is the sum of that. Generally, this is referred to as net income or take-home pay.
If, like me, you have multiple different sources of income, it might take you a bit longer to tally it up. Make sure your total is post-tax. If your income is a little sporadic, I would recommend taking a 3-6 month average. When in doubt, go with a lower estimation.
Step 2: Make A List Of Your Mandatory Expenses And Their Estimated Monthly Costs
This is a relatively straightforward step, so let’s make sure we don’t overcomplicate it!
Start With The Basics
• Rent/mortgage
• Utilities, internet, and phone bills
• Car payments and transportation costs
• Insurance (health, car, life, etc.)
• Childcare
• Groceries (food, toiletries, etc.)
• Minimum dept repayment
Be Sure To Add Anything Else You Can Think Of
Unlike your monthly income, for these estimations I suggest estimating a higher cost if you are unsure. Also, I listed minimum debt repayment, but if you have significant student loans or credit card debt you probably need to be much more aggressive on those payments.
Remember, account for the expenses you don’t incur every month, such as annual fees/renewals, taxes, car registration, maintenance, trash & recycling services, and other infrequent expenses. Some people budget for them specifically in the month in which they usually occur. I prefer to estimate my irregular expenses for the year and divide by 12 so I can set aside money for them every single month.
Step 3: Tally Up Your Discretionary Or Non-Essential Expenses
This generally includes things like entertainment, coffee/tea, subscription boxes, streaming services, gym memberships, gifts, dining out, vices, clothes, and other miscellaneous costs.
If you need to cut spending, this category is usually the easiest to do it in – just make sure that in your quest for financial security you don’t forget to enjoy the little things.
Step 4: Compare Your Income And Total Expenses
Now that everything has been calculated, how do your total expenses compare to your monthly income? Hopefully you spend a lot less than you make, if that is not the case the priority should be to cut your expenses drastically.
Here Are A Few Common Ways To Cut Costs Immediately
• Move to a smaller house or apartment
• Buy a used car or using public transportation
• No more (or at least limited) dining out
• Cancel subscription services
Step 5: Set Concrete Financial Goals
List your financial goals. A decent place to start is by looking at your vision of your financial future. What do you define as financial success? Do you want to be debt free? Be able to retire early? Compare your ideal (but realistic) situation with where you are. Now, make a list of how much you need to save in order to get to where you want to be when you want to be there.
Examples Of Concrete Financial Goals
• Get out of debt by paying $300/month extra towards loans
• Build a 3-6 month emergency fund by the end of the year
• Contribute the maximum to a Roth IRA
• Save $500/month for 5 years for a down payment on a house
Try to think about these goals as expenses that can’t be changed. By thinking of your financial goals as expenses, it will help you save for them monthly.
Step 6: Create Your Budget And Follow It
Hopefully by this point you have figured out your mandatory expenses, discretionary expenses, and how much you need to save to reach your goals – and at worst it isn’t significantly more than your income.
A common beginner’s budget is 50-30-20. With this approach 50% of your monthly income is allocated towards mandatory expenses and 30% is allocated for discretionary expenses. Lastly (and perhaps most importantly), 20% goes toward savings and investments. This system offers a lot of flexibility, but it isn’t as aggressive as I’d like, and individuals may still up overspending if they don’t keep a close eye on what they’re spending money on. However, this is a good spot to jump from as it is beginner-friendly and allows you to shift the percentages as needed.
For those who want a more in-depth explanation, check it out here.
Some Extra Tips
• If the financial goals you set aren’t possible given your current income, dial back until you can afford it – setting unrealistic goals will just lead to frustration and failure with your budget.
• Don’t disregard drastic measures – cutting fast food and subscriptions can save a decent amount of money, but the best way to cut a significant portion of your expenses are through changing your place of residence and buying cheaper or used cars.
• Never budget based on your pre-tax income (aka your gross income), this will lead to inaccurate income estimations and overspending.
• Try to automate as much as possible. Bills, savings, debt payments, etc.
• If you have issues spending less than budgeted in a specific category, try paying in cash only and see if that helps you keep track of where & how much you’re spending your money.
• Review the results of your budget every month. This will be especially important at first as you tweak the budget and learn to follow it. After some time, it is still important to monitor so you can keep track of your progress and update the budget after major life changes.
Step 7: Try More Advanced Tactics
Once you’ve been able to stick to a budget and consistently save money, you might be ready for more advanced approaches.
- Slowly increase the percent you save each month, whether it be from cutting expenses or increasing your income. I would recommend trying to increase the amount you save by a flat rate (e.g. $50) each month, as it creates a very focused goal.
- While increasing or maintaining how much you save, increase the amount you pay towards debt.
- Build a larger emergency fund.
- Make temporary cuts to hit short-term goals (e.g. cancelling cable and fast food for a few months).
- Create a buffer in your budget for unexpected expenses.
- Consider a zero-based budget, to make the most out of every dollar.
Conclusion
Remember, be patient with yourself and do your best to stick to it – results won’t happen overnight! If you have any budgeting tips for beginners, let us know in the comments. For more content like this, and a free budgeting template and financial goals worksheet, be sure to sign up for the Bitter to Richer newsletter!
