Making a budget is one of the best ways to understand where your money goes every month—and what changes you could make to help you reach your financial goals.
There are several approaches to making a budget, and the right way to do it depends on your priorities, preferences and goals. Here are steps you can take when making a budget to ensure that it fits your lifestyle and financial goals.
1. Determine Your Income
If you get paid monthly or twice a month, this first step is straightforward because you're earning the same amount every month. If you're paid weekly or biweekly, you may earn more in some months than in others. If that's the case, you may choose to adjust your budget each month based on how many paychecks you're expecting.
If you're self-employed or your wages tend to fluctuate, consider calculating your average income for the past three to six months. Focus on your take-home pay instead of your gross (pretax) income because that's the amount that actually winds up in your bank account.
2. Calculate Your Monthly Expenses
Once you understand your income, you'll want to similarly run the numbers for your expenses.
Start by taking a look at your bank and credit card statements over the past three to six months to get an idea of what you typically spend each month.
Then break down those expenses into categories such as necessities vs. discretionary spending:
- Necessities: You can create as many or as few categories as you like. For example, you can group recurring monthly charges together or split them out into groups like rent, utilities and insurance. Also, try to account for expenses that don't recur monthly, such as insurance premiums, car registration renewals and tax bills.
- Discretionary spending: With discretionary spending, it may be better to break down your categories more fully. For example, eating out and entertainment don't always go together, so you may want to calculate each amount individually.
The more comprehensive your expense categories are, the easier it will be to understand where your money is going and how to manage it better. At the same time, it can also get more complicated and challenging to keep track of each category. Find a good balance you can stick to that will keep you motivated and effective.
3. Set Realistic Goals
Once you know how you've been spending your money, take some time to set goals on how you want to manage your money going forward.
For example, if you're hoping to pay down your debt faster, set a goal for how much you'll put toward debt payments each month, then set goals to cut spending in certain categories to make sure it happens.
It's crucial to be ambitious yet realistic with your goals. If you set your sights too high, it could be difficult to stay motivated when things don't work the way you want.
Set specific, measurable, achievable, realistic and timely (SMART) goals that require you to stretch a little, but keep in mind that it can take time to develop the habits you want to have. It's easy to underestimate certain expenses, even if you have information to back up your assumptions. Make adjustments based on the reality of your budget as you get used to the process.
4. Track Your Spending
Tracking your income and setting goals for how you want to spend your money is one thing, but it won't do much good if you don't keep track of your spending.
Keeping track of spending can be tough, especially if you tend to make several purchases a day. Using a mix of credit cards, a debit card and cash can complicate the process even further.
Consider using budgeting software such as You Need a Budget to aid in the process. These programs link up with your financial accounts and can import your income and transactions into one place, making it easier to track and categorize each expense.
In addition to the added accountability, tracking your spending can help you test your assumptions and goals and give you an idea of how to adjust them in future months.
5. Pick a Budgeting Plan
Now that you have the basics down, it's time to start thinking about whether you want to use a specific budgeting plan beyond what's already been discussed.
As you read about each way to approach budgeting, think about how it resonates with your money management style and pick the one you think will be most effective for you.
Here are four common budgeting methods to consider.
- Envelope system: With this classic approach, you allocate your money for each spending category, then put that amount of cash in an envelope with the name of the category. When you've spent all your cash from a particular envelope, you're out of money for that given category for the rest of the month unless you shift money from another envelope.
- 50/30/20 plan: The 50/30/20 budget involves allocating 50% of your take-home pay to necessities, such as housing, utilities and car payments; 30% to discretionary spending; and 20% to your financial priorities, including savings and paying down debt. Depending on your situation, you can adjust the proportions to fit your needs and goals.
- Two-account plan: With the two-account plan, you add up your fixed monthly expenses and divide that amount by the number of paychecks you receive each month. Deposit that fixed-expense amount into one bank account when you get paid, and the remainder goes into a second account for your discretionary spending.
- Zero-based budgeting plan: With a zero-based budget, the idea is to assign a role to every dollar, essentially making your expenses equal to your take-home pay. This level of detail gives you an incredible view of where your money is going, but be sure to keep a flush emergency fund in case your costs go up or you're hit with a large expense.
6. Stick to Your Budget
Creating a budget may be the easiest part of budgeting. Keeping track of and limiting your expenses month after month so you can stick to your budget is usually the hard part. Here are some tips for staying with a budget:
- Be realistic. Again, setting realistic goals is crucial because it helps you avoid falling short. This is especially important when you're starting out and need all the motivation you can get.
- Plan ahead. It's almost a guarantee that life won't go as you planned, so it's important to keep emergency savings just in case. Also, keep in mind that some recurring charges don't happen every month. If you have any expenses that occur quarterly or annually—think car expenses and holiday shopping—make sure to plan for those.
- Be flexible. As your life, and, therefore, your expenses, change over time, create some room for flexibility so you can adapt. If your budget is too strict, a few expenses can throw everything off.
- Pivot when needed. If you notice that your budget isn't serving you well or your financial situation or goals have changed, don't be afraid to make adjustments to your approach so your budget can continue to help you manage your money effectively.
- Use credit cards responsibly. You don't have to use credit cards if you don't want to. If you do, though, it's critical that you use your credit cards responsibly. This includes tracking your expenses so you stay within your budget. Ideally, this means keeping your balances low and paying them off in full each month to avoid late payments and an accumulation of debt.
Above All Things, Remember Your Goals
Making a budget can be an important step in the right direction for you. It'll show you where your money is going and where you may have room to spend less so you can save for a car, a home or whatever your financial goals are.
But budgeting for the sake of budgeting isn't fun. As you work with your budget each month, remind yourself of the reasons why you're doing it. Also, evaluate your progress periodically to make sure you're on track to meeting your goals.
As you gain more control over your personal finances, it's also a good idea to keep track of your credit. Create an Experian account to access your Experian credit report and FICO® Score☉ based on Experian data for free. A robust credit history and high credit scores can open doors that can make the financial future you dream about a reality.
Learn More About Budgeting
- How to Budget if You Get Paid Once a Month
If you get a paycheck once a month instead of weekly or biweekly, track your spending, choose a budgeting plan and keep a healthy emergency fund. - How to Pay Off More Debt Using a Budget
Sticking to a budget can mean eliminating debt faster by helping you cut back on expenses and redirect that money to credit card or loan payoff. - 5 Types of Budget Plans to Know About
Using a specific budgeting method can help you stay better organized and work toward your financial goals in the way that works best for you.