Knowing how to create a budget is the simplest and most dependable way to get your spending and saving under control.
Whether you’re looking to start putting money away for retirement or simply want to feel more comfortable financially, creating a budget should be your first step. Here’s how to do it:
Step 1: Calculate Your Net Income
Your net income is your take-home pay after deductions for taxes, health insurance, and retirement plans. If you use your gross income instead, you’re likely to overestimate how much money is available to you.
If your income is irregular, keep detailed records of each contract and see if you can find an average net income for the last several years.
Step 2: Calculate Spending
Where is your net income going each month?
Start by listing your fixed expenses:
- Car payments
- Childcare payments
Next, make a list of your variable expenses:
See if there are any areas in your variable expenses where you can cut back. Check your credit card statements for a list of all monthly payments. You can use pen and paper or an app to track your daily spending.
Step 3: Create Budget Goals
What are your short-term and long-term goals financially?
Short-term goals fall in the next 1-3 years and could include paying down credit card debt, creating an emergency fund, or paying off a vehicle. Long-term financial goals span over decades and may include paying for a child’s education, saving for retirement, or buying a vacation home in the future.
It’s good to remember the 50-30-20 rule:
- Around 50% of your income should go toward needs (your fixed expenses)
- Around 30% of your income can go toward wants (your variable expenses)
- Around 20% of your income should go toward savings or debt
Step 4: Create a Plan
Compare what you’re spending each month in reality with what you’d want to spend each month.
Using your variable and fixed expenses, calculate what you’ll likely spend in the next few months. How does this compare with your goals? Now you can start setting realistic spending limits in each category.
Start with your wants (variable expenses).
For example, maybe you spend $300/month on eating out. If you made more meals at home, you might be able to cut that figure in half to $150/month.
Look at subscription services too: the average consumer spends $219/month on subscriptions, even though a survey found they estimated spending only $86/month on average — that’s a lot of money going toward entertainment.
Next, look at your needs (fixed expenses).
If you commute to work and count gasoline and car maintenance under fixed expenses, consider whether other options are available. Could you take public transportation or carpool with a colleague? How much money would this save you, and would it make it worth the change?
Step 5: Try Out Your New Spending Goals
You’ve come up with various savings ideas — most likely by cutting spending in the variable expenses category. Now it’s time to try it out.
Keep careful, cent-level track of your expenses for a month or two. How did you do when it came time to skip a night out at the restaurant in favor of cooking a meal at home? If any of your new financial goals worked out, great — keep them going. If any of them were too unrealistic, see where else you could cut spending instead.
It’s worth reiterating that your fixed expenses aren’t always strictly “fixed.” Even such a seemingly immovable expense as your mortgage can be refinanced to take advantage of lower interest rates. You can shop around for cheaper auto or home insurance.
Even small spending cuts can add up to significant savings over time. Saving $30/month adds up to $360/year — and if you can create that level of savings over multiple areas, you can wind up saving thousands.
Step 6: Review and Update
You’ve made your budget and taken it for a test ride — now all that’s left to do is keep it up to date.
If your finances change (you get a raise or change jobs, you take on more expenses, or you have a new financial goal), go into your budget and make the necessary change.
Get in the habit of reviewing your budget every couple of months to keep spending under control and stay aligned with your goals.