Budgeting best practices are important, because they help you manage your money in the best possible ways. If you want to build wealth, reduce debt, and achieve your long-term financial goals, budgeting is essential.
Don’t worry. There’s no need to avoid budgeting. It isn’t complicated or highly restrictive. The best budgets simply help you allocate your money where you want it now and in the future.
Let’s start by looking at what a budget is and why you should consider creating one if you want to master your finances.
What is a Budget?
Simply put, a personal budget is a comparison of your revenue and expenses during a specific period. Revenue may include items such as your income, side gigs, and other methods that generate money. Expenses include everything from your car payment to dining out.
Creating a budget involves recording all this information to get a good idea of where your money’s going. You may be surprised how much you spend on certain items, but that can be a big wake up call too. In many cases, adjusting your spending habits is the easiest way to achieve your goals.
Don’t give up at the thought of recording spending data. Budgeting apps make this very simple since they automate much of the process. There’s more on that later on.
Why is Using a Budget Beneficial?
Why is budgeting important? Budgeting helps you strategize your spending and savings so you can achieve your short and long-term goals.
As an example, you may want to control your spending so you can get out of debt. You may want to save up for a house, car, or dream trip. Perhaps you need to set up an emergency fund for unexpected expenses. Whatever your reasons, creating a budget let’s you see where your money’s going so goals can become a reality.
A budget also lets you know whether you can afford something, or not. That great apartment or electric car may not be a good idea if your budget shows you it will put you under a lot of financial stress. If you want to improve your chances of loan approval, it certainly doesn’t hurt to crunch the numbers beforehand either. A budget lays everything out in black and white.
Another great thing about a budget is that it can be flexible. Once you get into the habit of spending wisely, you may find that you spend less on unnecessary things and put more towards worthwhile items. All you need to do is tweak your budget and carry on.
How to Budget Money
Generally, people create a monthly budget. It is a simple way to compare how much you earn with what you pay out in expenses since most are paid monthly.
Monthly expenses include costs such as your rent or mortgage payment, utility bills, transportation, telephone, internet, insurance, healthcare, groceries, entertainment, and more. If you pay yearly expenses, just divide them by 12 for a monthly amount.
Luckily, budgeting apps suggest almost every item you could possibly imagine when it comes time to input your information. Fill in the blanks and let the technology do the work for you. Of course, if you love to mess with numbers, feel free to do everything manually.
How to Make a Monthly Budget
Wondering how to create a budget? Here’s a step-by-step breakdown of how to create a budget.
- Calculate your net income – include all your earning sources, but only use the actual amount you take home after deductions.
- List fixed expenses – these are the bills you pay regularly every month such as your rent/mortgage payment, utilities, auto loan, etc.
- List variable expenses – this is a little harder, since these costs fluctuate. Examples include gas, entertainment, groceries, clothing, etc. If you haven’t got a clue, take a look at your bank and credit card statements and average the amounts over a few months.
- Set short and long-term goals – decide what is the most important to you now and what you would like to achieve in more than 5 years. Examples include paying off your debt within the next year and saving for your retirement many years down the road.
- Compare expenses to income – if you have money to play with after you’ve paid your expenses, great! You can start pouring that money into one of your goals. If your expenses are higher than your income, you have to adjust your spending habits or earn more money if you want to achieve your goals.
- Review your budget often – as we said, your budget will change as your life changes. Definitely adjust your budget if you start earning more money or spending less. Even if everything’s chugging along as planned, you should review your budget regularly to ensure you’re on track.
How to Set Up a Budget
As you’ve read, the basics of creating a budget are pretty straightforward. However, some people like to follow a specific strategy that aligns with their lifestyle, spending habits, and tendencies to help them stick to their budget.
There’s no one-size-fits-all solution. Find a plan that resonates with you and give it a go.
50-30-20 Budget
The 50-30-20 budget provides a simple way to approach how you spend. Basically, you divide your monthly income as follows:
50% for needs – essential living expenses and minimum debt payments
30% for wants – non-essential items such as entertainment, clothing, and personal items
20% for savings – this money goes directly to a short or long-term goal such as an emergency fund or retirement account.
This budget is simple, but it’s not for everyone. You may need more money to cover basic expenses and may only be able to save 10%. Only adopt this budget if it feels like a good fit.
Zero-Based Budget
With this budget, you assign all of your income to specific spending categories based on percentages. The end goal is that you balance your income against your spending so there’s nothing left over.
The idea is that you’re putting every dollar to work for you. Your spending categories can change from month to month, but you can never spend more than you earn.
This can be one of the most difficult budgets to manage, but it is also a great way to stay on top of how you spend. It is a good option for anyone who has multiple savings goals too.
Savings-First Budget
For those that want to focus on savings, the savings-first approach could be a good fit. Basically, this method is a variation on the 50-30-20 budget, with a greater emphasis on savings. You pay essential expenses, but the majority of your remaining money towards savings instead of non-essential spending.
The obvious disadvantage of this budget is that you have less money to spend on your “wants”. This may mean less dining out, new clothes, or other indulgences. However, it also offers a great way to change your spending habits to direct more money into savings. It is also one of the simplest budgets to implement since you have fewer spending categories.
Spending-First Budget
This approach is only an option if you make more money than you spend. Essentially, you spend normally throughout the month. At month-end you put your remaining money into a savings option.
One disadvantage of this method is it is hard to remain consistent. You may spend more than necessary on non-essential items and put less than you should into savings.
Of course, it is possible to follow this approach if you’re disciplined and have already trimmed off excess spending wherever possible. In this case, this is one of the easiest budgets to implement.
Budgeting Apps
If you’re wondering how to create a budget, you have several options. You can put the data on a spreadsheet or just use pen and paper. However, technology has made budgeting so easy it doesn’t make sense to ignore this option.
A budget app tracks your expenses much easier and a good one provides instant access to your money situation at any given moment. Some of the best budgeting apps are free or at a low subscription cost.
Budgeting apps often work on iOS, Android, and desktop so you can track your money in a way that works with your life. Categories are pre-populated and much of the legwork is automated, making budgeting a breeze.
Nonetheless, no one can predict the future. If you’re just starting a personal budget and you suddenly find you must deal with an unexpected event, you can get loans for emergencies. Budgeting is meant to be flexible, so just add the payment into your budget to see if you can manage the expense.
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