I used to dislike the idea of budgeting. Following a budget seemed restrictive — even a little obsessive. I had no interest in tracking my income and expenses every day.
As it turns out, following a spending plan actually helps you stop worrying about money. Instead of playing a guessing game, you’ll know exactly where you stand.
Budgeting opens up a new sense of freedom by making you more aware. Even though everyone’s plan will look different, there are several features the best budgets have in common.
Here are some essential tips on how to create a budget and take control of your personal finances.
How to create a budget that works
1. Adopt a proactive mindset
If you’re turned off by the idea of budgeting, shift your mindset. Budgeting isn’t about feeling confined by your money. Rather, it’s about gaining control over your finances so they don’t control you.
Without an awareness of how you spend, it’s easy to make bad choices. You might spend more than you earn or get into high-interest credit card debt. When unexpected expenses pop up, you’ll have no way of dealing with them.
But if you have a budget, you’ll be prepared for the unexpected and you’ll know how to follow the golden rule of personal finance: Spend less than you earn. By following this rule, you’ll be able to handle your debts and save for the future.
If you’re living paycheck to paycheck, creating a budget can help you break free of this cycle. With an effective budget, you can gradually build up your emergency fund. If the worst happens and you lose your income, you’ll be covered for a few months while you figure out how to bounce back.
Ignoring your money makes you vulnerable to overspending and debt, and you may need to rely on others to help you out of a financial hole. But a proactive approach to budgeting will help you achieve independence.
2. Identify your major financial goals
Some lucky people learn about money management at a young age. Others only realize they need a budget after getting into debt. Whatever your motivation, take some time to identify your financial goals.
Maybe you want to stop living paycheck to paycheck, you’re eager to pay off your student loans, or you’re ready to start saving for retirement.
By setting goals, you’ll increase your motivation to create and stick to a budget and you’ll know exactly what you’re working toward. Once you start budgeting, you’ll be able to measure whether or not your efforts have been successful.
3. Ask yourself some tough questions
As you think about how to budget money and set goals, do a self-assessment. Look at your spending history and current habits. What are you doing well? What are you doing that stands in the way of your financial goals?
Identify any areas where you spend past your means and try to root out the cause of these poor habits. Do you shop to relieve stress? Are you trying to keep up with your friends? Do you spend money on a lot of little expenses that add up over time?
Ask yourself these questions to gain a deeper understanding of what you do and why you do it. By analyzing your habits and motivations, you’ll be one step closer to making lasting change.
4. Track your monthly income
Once you’ve done some self-reflection, it’s time to get into the nitty-gritty of budgeting. Your first order of business is to track your monthly income.
For those with a consistent paycheck, this task is straightforward. Just write down your take-home pay so you have a clear sense of your monthly income.
If your income is irregular, add up your typical earnings. You could calculate an average monthly income or keep tabs on it from month to month. Some apps, like Level Money and Digit, will look for patterns for you.
Besides expense tracker apps, which you’ll learn more about below, you could simply record your income on an Excel spreadsheet. By writing your income down, you’ll know exactly what you have to work with every month.
5. Categorize your expenses
Now it’s time to record your expenses. Write down all your recurring costs and put them into categories. The most common categories are:
- Health insurance
- Credit card payments
- Student loan payments
- Car payments
- Retirement savings account
After recording your recurring expenses, take a look at your non-essential spending. Common categories include:
- Restaurants and Dining
Food pops up in both categories, as it’s not always a consistent expense. You may find yourself spending more some months if you eat out at restaurants.
Some people try to track their spending in lots of specific categories, others lump all non-essential spending altogether into one big category. I prefer the latter, as it lets me use my spending money however I want. I don’t care if I’m spending a lot on lattes, for instance, as long as I don’t exceed my “non-essential spending” limit as a whole.
6. Try the 50/30/20 rule
Once you’ve recorded your income and expenses, it’s time to set some boundaries. The 50/30/20 rule is one way to approach your spending. It gives three guidelines:
- Use 50 percent of your income on essential living expenses. These include rent, utilities, food, and transportation.
- 20 percent of your earnings should go toward monthly savings goals. These might include paying off debt and saving for retirement. This isn’t to say that repaying loans is optional, but you must cover your basic living needs before you can pay back debt.
- Finally, the remaining 30 percent of your income is flexible. You might spend it on travel or going out to eat.
All of these percentages represent the maximum in each category. If you can spend less, you’ll have even more money to set aside in your savings account.
Of course, if you live in an expensive city, it could be tough to limit your living expenses to 50 percent — some people spend that much on rent alone. If your essentials cost more than 50 percent of your income, adjust the other categories. You might also consider what you can do to lower your cost of living or add to your income with a side hustle.
Remember that the 50/30/20 rule offers a general guideline for your budget. You may need to adjust the percentages to match your specific situation.
7. Use the envelope method
Even if you create a meticulous budget, you still need the self-discipline not to overspend. That’s where the “envelope method” of budgeting comes in. If you’re struggling with financial self-control, you might benefit from this technique.
With the envelope method, you spend primarily in cash. When you shop with credit cards, it’s easy to remove yourself from the transaction. With cash, you see exactly how much money you’re giving away.
For this budgeting technique, gather envelopes for each of your spending categories and fill them with the exact amount of cash you need that month. You can only spend that much and no more.
Once the envelope is empty, you can’t refill it until the following month. If you have any cash left over, put it into savings.
This method sets physical limits on your spending. Plus, it helps you become more aware of exactly how much you’re spending.
You don’t have to use the envelope method forever. Sometimes, it can be what you need to kickstart your budget and adopt healthier financial habits.
8. Automate your savings and bills
Another useful way to meet your saving goals is to set up automatic withdrawals. That way, you won’t have to think about setting money aside. After you do the initial set-up, your savings will slowly grow without any work from you.
Plus, automatic withdrawals will ensure you don’t miss important payments. You won’t go into default on your student loans or let your credit card balance carry over from one month to another.
This method can even save you money. Most student loans give you a 0.25% interest rate deduction when you set up automatic monthly payments. And credit card debt doesn’t accrue interest if you pay off your balance in full each month.
There are incentives for automatic payments, and it takes all the work of how to budget money out of your hands.
9. Start an emergency fund
It’s always a good idea to set aside money in an emergency fund. You need to prepare for an unexpected expense, such as a medical emergency or job loss.
A good rule of thumb is to save enough to support yourself through three to six months without an income. If an emergency comes up, you’ll have enough to cover it without derailing your budget.
Setting up a savings account with automatic withdrawals can help you build an emergency fund. You won’t really notice the money missing, but your savings account will grow over time.
10. Only spend with a credit card in real time
If you want to stick to your budget, be careful with credit cards. Credit cards can be excellent financial tools if used wisely, but overspending could trap you underneath high-interest debt.
If you don’t pay your balance in full each month, it will start to accumulate interest. Credit cards have high interest rates; the national average is around 15%. Even a small unpaid balance could grow astronomically in a short amount of time.
The way to avoid credit card debt is to spend only what you can reasonably pay off within the month. Just because you have credit to spend more doesn’t mean you should use it.
So pretend you’re spending money on a credit card in “real time.” Think about the money as if it’s coming straight from your bank account today. Don’t assume you’ll have any more money next month than you do now.
As long as you use the card wisely, you can reap the benefits of credit cards. You’ll build up your credit score and maybe even accumulate credit card rewards in the process.
11. Use apps
You don’t have to pore over a spreadsheet to track your income and expenses. There are several excellent apps that do all the math for you. Instead of learning exactly how to create a budget, you can rely on these apps to do the heavy lifting.
Expense tracker apps link up to your bank and credit card accounts to analyze your cash flow. They let you create a budget and track your progress. Here are three of the most popular tools for creating and tracking your spending plan:
- Mint: Connects to your saving, checking, and credit accounts and looks for trends in your spending. It tells you how much you have left to spend in each category as you progress throughout the month. You’ll see weekly summaries and can set up reminders to pay bills.
- You Need a Budget (YNAB): Connects to your financial accounts to track your budget. YNAB teaches you about money management and allows you to manually input earnings and expenditures. It costs $5 a month.
- Level Money: Connects to your accounts to tell you exactly how much spending money you have each month. Rather than dividing your spending into specific categories, Level gives you one monthly “Spendable” category. It tells you whether or not you’re spending within your means.
- Digit: Analyzes your cash flow to identify saving opportunities. Digit sets aside small amounts of money every few days in a secure savings account. You can transfer the money back into your checking account for no fee at any time.
Reflect on your progress and adjust as needed
Learning how to create a budget is the hard part. Once you’ve set it up, it doesn’t take a ton of work to maintain. Plus, expense tracker apps make budgeting especially easy, as they show you where you stand at a glance.
Don’t forget to review your progress every now and then. Take a look at your spending plan and make changes where needed. Perhaps you can take a more aggressive approach to paying off your student loans, or maybe you snagged a higher income and must work to prevent lifestyle inflation.
If you’re struggling with overspending, identify your shopping triggers. Often, you can find other means of stress relief without swiping your credit card.
Continue to look for areas where you can improve and try out new solutions. With this proactive approach, you’ll take control over your money — rather than the other way around.
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