How to Create a Budget

So you may be asking why is budgeting important and what the advantages of a budget actually are. The answer to both of these questions is tied the newly-increased level of control you’ll have over your finances. A budge will:

Put you in control of your money. Instead of worrying if you can afford something you want while still having money left for necessities, when you know how to set up a budget, you’ll know exactly how much money is available to spend, on your both your wants and needs each month. You’ll be in control of your finances, and the peace of mind that gives.

Stop you from overspending. Once you see how much you’re spending each month, you’ll probably realize you can cut back on some impulse or habit purchases and redirect that money to goals that are actually important to you.

Help you plan for the future. When you know where your money is going each month, you can start to come up with financial goals and figure out how much time it will take to achieve them. You can even come up with hypothetical scenarios that show you what happens if you increase or decrease spending in an area.

Help you stop worrying about your finances. If you’ve ever fretted about spending too much on a leisure item, you’re not alone. When you know how to budget, though, you can safely spend money on something you want, because you will have planned for it - even if you’re spending over a thousand dollars. All you have to do is stick to your preplanned amounts, and you can be secure in the knowledge that you have enough money for all your needs and wants.

If you’ve spent time reading the previous sections, you should now know what a budget is, and why the benefits a budget provides blows away any reasons you might have to avoid creating a budget. The only thing you need to do now is actually sit down and create the budget. Coming up with a budget plan sounds complicated, but it’s really not. It consists of three straightforward steps.

1. List your monthly income sources and add them up. For most of us, this consists of looking at last month’s paycheck stubs, or you can go online and take a look at all the deposits in the last month that came from your employer. If you receive regular income from other sources, like investments child support payments, or other government benefits make sure to include those too.

2. List your monthly expenses and add them up. These will include your fixed expenses, variable necessary expenses and discretionary expenses, like:

• Rent or mortgage payment

• Internet bills

• Insurance payments

• Credit card and loan payments

• Groceries

• Gasoline

• Utility bills for electricity, garbage, heat and water

• Cell phone bills

• Clothes

• Eating out

• Morning coffee

Remember, be accurate, and if you do realize that you’ve overspent in a category or two, DO NOT feel bad about it.

3. Subtract your expenses from your income and see what you have left. If your expenses are greater than your income, don’t panic. Look over your expenses and look for ways to reduce your spending, whether that means adjusting your day-to-day spending habits or renegotiating your monthly bills. On the other hand, if you do have money left over, figure out what to do with the remainder, such as:

• Putting it into your emergency fund

• Save it for a big purchase

• Deposit it to a retirement account

While the previous section should have provided you with the budgeting basics you need, some special situations deserve their own sections.

If you have an irregular income where you’re paid by the project instead of by the hour or having a salary, you’ll want to make a budget that you’re sure will cover your necessary expenses. Make a list of your most basic needs, the bills you absolutely need to pay each month. Compare this list against the least amount of money you’ve received in one month and make sure that amount is enough to cover your basic expenses. Plan how you’ll use any money above and beyond the least amount of money you’ve received in a month, either by taking care of variable expense, saving it for lean months or building up your savings.

If you want to save for irregular expenses that only occur once or twice a year, like vet expenses, insurance and property tax payments, Christmas shopping or even taking a vacation, you can factor those expenses into your budget.  Figure out your spending goals for the expense, then divide that amount by 12.  Put that amount on your monthly budget as a new expense. Get a separate savings account in which to keep that money. You might also want to look into opening a club account, which have a higher interest rate and won’t let you access the money you put in until the date of your event arrives.

If you split expenses with a roommate or are budgeting for a couple, you can still create a budget if you apply some minor tweaks. Split your fixed expenses and record that amount in your budget.  Look back through your expenses for the last two or three months to see how much you’ve paid for variable expenses, like food and electricity, then choose the highest monthly amount for each expense and list it on your budget

If you have debt, you might wonder how you can afford to budget when you feel like you have to put every dollar you can spare toward your debt. The answer is a method called “debt snowballing.” Create your budget, including the minimum amount you can pay on your debts.  Take the extra money you have in your budget and put it toward your smallest debt.  Once you’ve paid off that debt, use the extra money plus the minimum payment on the smallest debt to pay off the second smallest debt.  Repeat the process until you have paid off all your debts

Once you’ve put together a budget, take a moment and congratulate yourself. You’ve just taken a big step on the road to financial success.  Now comes the hard part—knowing how to stick with a budget you created. How do you make sure you’re not overspending each month? Here are some tips:

• Make a list when you go out shopping to cut down on impulse purchases

• Review your budget on a daily basis to see how much you have left in each of your categories

• Review your financial goals at least twice a week to remind yourself why you’re saving your money

If you really want to make sure you stay on budget, you can use the time-tested “envelope method”. Here’s how it works:

• Get a box of envelopes

• Take one envelope and write one of your expense categories on it

• Repeat the process until each expense category has its own envelope

• When you get your paycheck, divide it up between the envelopes

• If you’re like most people you receive a paycheck biweekly or bimonthly, so make sure that each envelope gets half of the amount you’re planning to spend that month

• Repeat the process each time you get a paycheck in order to stick to your budget

You can also use a variation of this method called the digital envelope method. To do this, set up multiple savings accounts that correspond to each of your budgeting categories, using them as your “envelopes.” When you get your paycheck deposited into your main account, you can access your account online and divide your money among the digital envelopes as needed.

To use these digital envelopes, all you have to do is transfer money from one digital envelope to your main checking account each time you want to buy something. You’ll see just how much you’re going to spend on those new shoes or that lunch and what you have left to get you through the month, and you can easily check your balances using a financial institution’s online banking or mobile app.

One of the biggest mistakes people make when creating a budget is that they assume it will be set in stone. The problem is that your expenses (and income!) will shift over time. The key to this is to know how to adjust a budget each month:

• Look at any areas in which you’ve overspent, and try to determine whether it was a one-time expense or if it might happen in the future

• Look at any budget categories in which you’ve underspent and figure out if you’ll need that money in the future or if you can transfer some of that money to a category in which you’re regularly overspending

It's worth pointing out that budgeting apps can make this process a lot easier. There are several apps out there, so do some research and find the best budgeting app for you. 

Adjusting your budget after a life event

If something financially significant happens, such as getting laid off, getting a raise or having to visit the hospital, you’ll want to adjust your budget to reflect your new financial situation:

If you find that you’ll be bringing in less income, it’s time to match your existing budget against your reduced level of income and start making cuts. You might have to find creative ways to cut costs or get rid of some luxury items entirely.

If you have a sudden large expense, you may have to dip into your emergency savings account or cover your expenses with a credit card. You’ll also want to look into what temporary cuts you can make to your budget to help pay down the expense. Depending on what course you take, you’ll want to restructure your budget toward paying off the expense or rebuilding your savings account.

If you get a raise, a bonus or any other kind of windfall, revisit your budget as soon as you get the money to figure out the best place to put the extra money to use. Consider adding this money to your savings account, your retirement or putting it toward an important financial goal, such as buying a house.

Once you’ve made your budget, stuck to it and adjusted it for future expenses, you should notice the benefits immediately. You won’t have to worry about what you’re spending, since you know where each dollar goes, and you’ll also know that you’re budgeting and spending the money you’re bringing in on the most important goals for you.

What do you do now?

• Add more money to your savings account. Build up your emergency fund first, then start saving for larger financial goals.

• Think about what your life goals are, and how much money you’ll have to save to achieve them. Then use your budget to start planning out how you’ll save for these loans.

• Look at where you’re storing your money and how you can take advantage of the interest it generates. You can put your savings in a money market account, a certificate of deposit it, or even invest it in the stock market.