Budgeting Made Simple
No nonsense strategies for spending and saving.
If you’ve never made a budget before, it can be a little intimidating. How do you decide how much you’re going to budget for the fun stuff — clothes, restaurants, trips, etc.? Do you just… pick numbers out of thin air and hope they’re right? Once you have your budget, how do you stick to it? What if you overspend?
Here’s a step-by-step guide to setting up — and sticking to — your first budget.
Calculate Your Monthly Income
Before you can figure out how much money you’re going to spend, you need to figure out how much you’re earning. Add up your typical monthly income: salary, wages, side hustles. If your income is variable, calculate your average monthly income over the past year — or play it safe by building your budget around what you might earn in a lean month.
Once you have your number, write it at the top of a sheet of paper and/or spreadsheet. Label it “Monthly Income.”
Subtract Your Fixed Expenses
Below “Monthly Income,” make a list of all of your fixed expenses. Label each one: “Rent,” “Mortgage,” “Electric Bill,” “Car Payment.” If you’re paying off debt, add your monthly debt payment as a fixed expense.
Don’t forget about small fixed expenses, like gym memberships or Netflix® subscriptions. If you pay the same amount of money towards the same thing every month (or roughly the same amount, if you’re looking at something like groceries or gas) add it to the budget. This is often when people decide to cancel some of their subscriptions or cut back on their fixed expenses — which is a great way to save money!
Set Aside Money for Savings, Goals, and Retirement
Once you subtract your fixed expenses from your income, it’s time to set aside some of what’s left over for savings, life goals, and retirement.
Start with savings. Most people need a six-month emergency fund to protect them from major unexpected expenses. That money will help you if you get laid off, if someone in your family becomes ill, if you need to make car repairs, or if you need to replace something expensive like a washer/dryer. Set aside a little money every month to build your emergency fund.
You also want to save money for your life goals: a down payment, a wedding, that big trip you’re hoping to take next year. Keep that money separate from your emergency fund, and add a little cash to your stash every month.
Don’t forget about setting aside money for retirement! Even if you have a 401(k) through your job, you’ll still probably want to put money in an IRA (or a Roth IRA). Figure out how much you can afford to put towards retirement every month, and add it to the budget.
If you have any other big accounts you’d like to fund every month — a HSA, a 529 plan for your kids — add them to the budget as well.
Subtract Work-Related Expenses
Like it or not, most of us have to pay money in order to do our jobs effectively. Whether you’re keeping your wardrobe updated, going out to lunch with your coworkers, or simply putting a jar of candy on your desk, it’s time to figure out how much your work costs you — and add it to the budget.
Once you see how much money you spend on work, you may decide to pack your lunch more often, take public transportation instead of paying for parking, or stop providing the office with free candy. For now, just write down every expense.
Don’t Forget About Irregular Expenses
We all have a few expenses that only show up one month out of the year: birthday presents, Valentine’s Day, your annual Amazon Prime® renewal. Some people go to the trouble of adding up a year’s worth of irregular expenses, dividing by 12, and adding that number to their monthly budget. If you want to estimate instead, that’s fine. Just make sure you set aside a little money for these irregular expenses.
Use What’s Left Over to Budget Your Discretionary Expenses
At this point, you should know how much money you have left over after calculating your income and subtracting all of the expenses listed above. Maybe that number is higher than you expected it to be. Maybe it’s lower. (Maybe it’s negative, in which case it’s time to figure out how to cut some expenses.)
The money you have left over after subtracting your fixed expenses and your savings/goals/retirement expenses is your discretionary income. This is the money you can put towards dinner at your favorite restaurant or that new book by your favorite author.
Discretionary income is the hardest to budget, because we don’t usually spend the same amount of money on restaurants every month. Some people prefer to leave the entire category as “discretionary” and tell themselves they have $500 per month (or whatever the number is) to spend on anything they want; other people like to split it up: $200 on restaurants, $200 on entertainment, and so on. For now, try leaving the entire category intact until you know a little more about your spending habits.
Track Your Spending and Compare It to Your Budget
Congratulations — you’ve completed your first budget! The work isn’t done, though; in fact, it’s just getting started. Once you have your budget, you need to start tracking your expenses against your budget to make sure you don’t accidentally overspend.
There are plenty of apps and software programs that will help you track your expenses and compare them to your budget; you can also keep it simple and use a spreadsheet or even a notebook. The important thing is that you know how you’re spending your money — and whether you’re inadvertently spending more than you planned.
If you discover that you’re overspending your budget, you have a few options:
- Spend less on that category in the future. Is your restaurant habit eating up all your discretionary income? Time to get used to home cooking.
- Spend less on a different category. If that new pair of work shoes took you over your budget, maybe you can spend less on groceries next month — or get that book you wanted to read from the library instead of the bookstore.
- Find an expense to cut. Maybe it’s time to ditch that Netflix® subscription, switch to a lower-cost phone provider, or see if you can get a better deal on your car insurance.
Use Your Budget to Improve Your Credit
Once you’ve gotten your budget set up, it’s time to start using that budget to improve other areas of your finances — specifically, your credit. Sticking to a budget is a great way to boost your credit score, because you now know exactly how much money you should be putting toward your debts every month. You also know how much you can put on your credit card every month without racking up any new debt.
As your credit score improves, consider adding a few new credit cards to your portfolio. Believe it or not, having a lot of available credit is generally considered good for your credit score — as long as you don’t max out your cards. (It’s called a credit utilization ratio, and you get points for only using a small percentage of your available credit — Experian suggests keeping your ratio at 30% or less.) When you’re shopping for credit cards, it can be a good idea to look for cards that’ll get you rewards for everyday purchases. The PayPal Cashback Mastercard®, for example, gets you 2% cash back on everything you buy wherever Mastercard® is accepted. Other cards save their biggest rewards for travel, groceries, or restaurants. Find a card that fits your spending habits — which you should be pretty familiar with by now, thanks to your budget — and pay it off in full every month.
As you apply these steps to your own budget, remember that you’re creating a living document: budgets are designed to be reworked and revised over time as your income and spending habits change. Use tools like the Money IQ series to learn more about how to spend, save, and use credit effectively. If you overspend your budget, use it as an opportunity to adjust your budget and/or change the way you spend money in the future. That’s the real purpose of having a budget: to help you make positive changes in your spending and saving habits, and to make sure your money is going exactly where you want it to.
Money IQ is a publication that aims to provide simple, no-nonsense personal finance advice. We’re here to dispel myths and demystify personal finance for our readers.
