A budget is a straightforward plan for managing your earnings. It ensures you have the funds to cover essential expenses like housing, groceries, utilities, and monthly debt payments, while also helping you work towards your financial and savings goals.
Why Budgeting Matters
Budgets help you maximize your paycheck. Without a budget, there’s a risk of running out of money before your next pay date.
How to Budget Your Money
Budgeting is crucial for staying on top of bills, paying off debts, and saving for the future. There are several effective methods to achieve this.
“Building a budget doesn’t have to be overly complicated or time-consuming,” says Brittany Castro, former in-house CFP for Mint. “It’s actually the first step in taking control of your finances because it shows you where your money goes each month.”
Steps to Plan a Budget
Starting a budget can be intimidating, but these steps can help you create a personal finance budget for the first time:
- Examine Your Income and Expenses: Understand how much you earn, how much you spend, and if you’re spending more than you make.
- Choose a Budgeting Approach: Consider methods like the 50/30/20 rule or the envelope system to determine your monthly savings goals.
- Identify Areas to Cut Back: Look for ways to reduce spending and develop strategies to maintain these cutbacks.
- Automate Savings and Investments: Set up automatic transfers to savings and investment accounts to grow your extra income effortlessly.
- Track Your Budgeting Process: Use budgeting apps or create a budgeting spreadsheet to monitor your progress and stay on track.
Examine Your Income
To start budgeting, understand your net monthly income after taxes. You can find this on your pay stubs or bank statements. Next, estimate your monthly expenses, including rent/mortgage, utilities, groceries, insurance, gas, and debts. Compare your total expenses to your income. “If your expenses exceed your income, you’ll need to earn more, cut costs, go into debt, or use a combination,” says Todd Christensen, an accredited financial counselor at Money Fit. If your income is higher than your expenses, you can save, build an emergency fund, or pursue other financial goals.
Choose Your Budgeting Strategy
The next step is to create a budget, a plan for how you’ll use your earnings each month to achieve your financial goals. Here are a few strategies to consider:
50/30/20 Rule
This popular rule suggests allocating 50% of your income to necessities (housing, transportation, utilities), 30% to discretionary spending (dining out, recreation), and 20% to savings and investments. It’s simple and flexible but may not work well in high-cost areas.
70/20/10 Rule
Similar to the 50/30/20 rule, this method allocates 70% of income to wants and needs, 20% to savings and investments, and 10% to debt payments or donations. It’s straightforward but less precise.
Zero-Balance Budget
This method aims for your income minus expenses to equal zero, ensuring every dollar has a purpose. It’s thorough and maximizes your earnings, but it can be time-consuming and difficult with unpredictable incomes.
Pay Yourself First Budget
Start with your financial goals and work backward. For example, if you want to save $500 and pay $500 towards your mortgage each month, subtract that $1,000 from your income first. This method prioritizes goals but can be stressful if it leaves too little for other expenses.
Envelope Budget
Created by financial author Dave Ramsey, this method involves placing cash into envelopes for each expense category (housing, utilities, food). Withdraw cash as needed, and adjust the budget if you run out or have excess. It’s visual and tangible but can be time-consuming and impractical in a digital economy.
Some tips to help cut down your spending
- Increase Friction: Make spending more difficult. For example, remove saved credit card information from your favorite sites, so you have to re-enter it each time. This can help curb impulsive purchases.
- Wait Before Buying: Implement a 48-hour waiting rule for purchases. If you still want the item after two days, go ahead and buy it. This helps avoid unnecessary impulse buys.
- Audit Subscriptions: Review your subscription services and cancel any you’re not actively using. This includes streaming services, apps, subscription boxes, and Amazon’s Subscribe and Save.
- Refinance Loans: Refinancing your mortgage, car loan, or student loans can lower your interest rates and monthly payments, freeing up cash for other important expenses. Shop around with several lenders for the best rates.
- Meal Plan: Plan your meals for the week to avoid last-minute eating out and stay on track at the grocery store. Include all meals and snacks in your plan.
Cutting back even slightly can free up more cash for paying down debts, achieving financial goals, or reducing overall financial stress.
Automate Savings and Investments
No matter which budgeting method you choose, including savings in your plan is crucial. Automating deposits into your savings account reduces hassle and keeps your goals on track. A high-yield savings account can maximize your savings by earning a higher interest rate than standard accounts.
After automating your savings, consider investing any leftover income. Consulting a certified financial planner can help you choose the best investments for your goals.
Budgets are dynamic tools that require regular tracking and adjustments, especially in the beginning. Adjust your spending habits as needed to stay aligned with your financial priorities.
“The key is to identify your spending trends and ensure they match up with your spending priorities,” says Christensen. “If you’re spending $50 a week on soft drinks but would rather save for a new gaming console, it’s time to change your purchasing behavior.”
While you can manually monitor your budget, using a budgeting app connected to your bank account can streamline the process. For example, Rocket Money helps create a budget, negotiate bills, and reduce spending, offering a free plan.
Some budgeting apps also provide credit monitoring services. Tracking your credit score and credit card use alongside your budget can give you a comprehensive view of your financial situation.
Alternatively, create an expense tracking spreadsheet in Excel, request receipts for all purchases, and total them weekly or monthly.
How to Budget on a Low Income
Budgeting is particularly important if you’re struggling financially. As Lisa Fischer, chief growth and lending officer at Mission Lane, explains, “Keeping a close eye on spending is crucial for all consumers, especially those living paycheck to paycheck.”
Budgeting helps monitor spending habits, stay on top of bills, and prioritize savings, improving your financial outlook over time.
Consider applying for rental or housing payment assistance, food pantries, and health care sharing plans to reduce costs. Financial, debt, or credit counseling might also be helpful. The nonprofit National Foundation for Credit Counseling is a good starting point.
Why Budgeting is Important
Budgeting is essential for making the most of your income and achieving long-term financial goals. “You need a solid budget and financial plan to set yourself up for long-term financial wellness, avoid problems like racking up credit card debt, and build your net worth over time,” says Castro.
There are many ways to budget, and you may need to try a few before finding the right fit. A financial advisor can help you choose the best budgeting strategy for your household.