Yes, you need a budget. Just about everyone does.
And if you’re serious about understanding your finances — as you should be — then designing a budget is the first step. It can be scary to face the facts about your financial situation. You may not even fully realize how much your spending for some things in your life.
But getting an idea of how much money you’re earning, and what you’re spending it on is absolutely essential. And it will put you in charge of your financial future.
What’s a budget?
A budget is a game plan for your money. It provides a bird’s-eye view of your finances, and allows you to plan for your daily, weekly, or monthly expenditures.
A budget helps you figure out if you have enough money to cover your bills, and how much you have left over to save or invest for the future.
Budgets can be incredibly detailed or very general, but they all serve to provide you with two important pieces of information: How much money you make, and how much you spend.
Types of budgets
No two budgets are the same, and yours should be tailored to your specific situation.
Businesses and the government, for example, use budgets to plan their annual spending, and to make sure they have enough money to pay employees and keep operating.
Personal budgets are usually far simpler, however.
All you’ll need to do is grab a pen and paper (or open a new spreadsheet on your computer, if that’s your preferred method) and get to work.
What should be in your budget?
All budgets should contain two main elements: How much money you’re earning, and how much money you’re spending.
The trickiest part is figuring out all of your expenditures. But once you know how much income you have to work with, you can start digging into the details regarding your spending, saving, and investing goals.
The easiest budget you’ll ever make
Here’s how you actually go about creating your budget:
- Step 1: Write down your monthly income and expenses.
Most people have only one or two streams of income from their job or jobs. But income can also include money earned through hobbies or side-gigs, interest or dividends from investments, or any other regular, monthly inflow of cash.
For expenses, include housing costs (rent or mortgage), spending on food, utilities, transportation, credit card payments, student loan payments, entertainment, dining out–and anything else that’s a regular monthly cost.
You should also break down your expenses into two different types: Fixed and flexible. Fixed costs are the bills you pay every month, that generally don’t vary much — expenses like rent or student loan payments. Flexible costs are things that can be variable, like your grocery or entertainment expenses.
One popular method of budgeting is to follow the “50/20/30” rule. This stipulates that you should save or invest 20% of your take-home pay, appropriate 30% toward your flexible expenses, and put the remaining 50% toward your essential living expenses.
While that framework may not work for everyone, it’s a basic set of guidelines that can help you get in the habit of budgeting.
- Step 2: Monitor your expenses
Sometimes you can just set it and forget it. But remember that budgets are living things.
While there’s not much you can do about the cost of your monthly rent or your mortgage, you may find you’re spending more than you planned in some flexible categories–vacations or groceries for example. If that’s the case, you need to figure out why that is and either change your spending habits, or change your budget.
One popular method of budgeting is to follow the “50/20/30” rule.
For example, if you set aside $400 per month for groceries, and find you’re actually spending closer to $500, you need to monitor that. That extra $100 can soon wind up running you into debt.
On the other hand, if you’ve budgeted $200 for monthly dinners out, but you’re only spending $100, take note of that and maybe reallocate between the categories.
The goal is to keep all of your spending below your income, at all times.
- Step 3: Plan for the future
You should also put money aside in your budget for saving and investments, to set yourself up for a healthy financial future. An easy way to start is by building an emergency fund — or, money that you have in an easily-accessible savings account for a rainy day. The money you have left over each month in your budget should go to create this cash reserve.
Your rainy-day fund should have enough in it to cover a few months of expenses in the event that your income experiences a significant drop, for things like an illness or a layoff. It could also be helpful in the event that you need to travel due to a family emergency, or spring for car repairs.
You also should consider a budget for retirement savings — money that is going into an IRA or 401K, that you don’t plan to touch until well into the future.
- Step 4: Make sure it all adds up
The goal of your budget is to ensure that your expenditures don’t outweigh your income. If you’re spending more than you’re making, you’ll quickly find yourself in debt. A budget will help you keep track of your situation.
You should aim to maximize your income and minimize your spending. This will free up more money for savings and investing, depending on your goals.