If you want to learn how to make a budget, you have come to the right place!
I’ve often mentioned that a budget is the first step to controlling your spending, but how do you get started making a budget?
You may be avoiding the exercise because it will expose your spending, and it will. You may think budgeting means you will never be able to have fun again. A budget will keep you honest about living within your means, and also help you not waste money. Identifying and cutting the excess means you finally free up money to use in a way that serves you.
The first step to making a budget is tracking your spending
First, you need to know where your money is going.
Track your spending in detail in whatever way makes sense to you. You can do it in real time over the next couple of weeks using pen, paper and receipts, or it may be easiest to look back at old statements and use a spreadsheet. Once you’ve captured everything—every Target trip, Amazon purchase, and that bottle of wine you picked up for a housewarming gift—your goal is to break up your spending into categories that make sense to you: groceries, rent, utilities, dinners with friends, birthday presents.
Don’t be afraid to get detailed. For example, you would rather have headings like groceries, dinners out, and work dinners, rather than lump spending into one “food” category.
Your groups should be personalized. If you frequently spend on pedicures and hair color, maybe you have your own “beauty” category. If you travel a lot to visit family, that may need it’s own category. Find the level of detail that helps you best visualize where your money is going.
While this is not a finger-pointing exercise, seeing a snapshot of your spending can be eye-opening and may make some in your family feel singled-out. But everyone has to be accountable for their spending if you are going to make changes that stick.
Follow the “50/30/20” rule when it comes to budgeting
If you have a regular paycheck, you probably know exactly what deposit to expect on payday in your bank account. (We will talk about less-regular pay later.) If you are a W-2 employee, deductions for 401K, insurance, social security and other taxes automatically come out of your check. The amount that you see in checking is your net income.
Add any retirement savings being deducted by your employer back to this number. This is the number you will use to budget.
You have probably heard of the 50/30/20 rule: 50% of your money should go to needs, 30% to wants, and 20% to debt and savings payments.
The essentials each month are rent or mortgage, transportation, food, utilities and childcare. Things you have to pay for to continue working and living.
When you subtract these expenses from your net pay, is it more than 50% of your net income? If so, this is a red flag because your basic monthly expenses are taking up too much of the pie.
Breaking down your budget: Fixed Expenses vs. Variable Expenses
Fixed expenses are the monthly expenses you can rattle off easily—the mortgage, the utilities, your car insurance, HOA fees. Variable expenses are different each month. They are usually easier to change, and your first target if you are trying to curb spending.
But fixed and variable costs do not necessarily equal needs and wants.
Just because you have a monthly payment due on something doesn’t make it a need. It’s easy to ignore your balloon mortgage because you need shelter, when your family would be comfortable in a smaller home.
And you have to spend money to eat each month, but this number can fluctuate depending where you buy that food.
If making adjustments to your variable spending each month will not create enough wiggle room, it may be time to reconsider your fixed expenses. It is nearly impossible to get ahead on debt and find enough money to boost your savings if you are carrying more house or heavier car payments than you can afford. I talk here about how to get out of debt when you are serious about making changes.
Budgeting for debt and retirement
Of course, the more room you make in your budget, the more options you have. If you have credit card debt, most of your 20% (or more if you can) should go towards an emergency fund and then debt payments before you increase your retirement savings. And remember any 401K savings you put into your IRA or other plan before taxes. You get credit for that money too!
If you pay off your debt and your needs are covered by less than half your income, your options open up because you have a lot more room for fitting in extras while still saving for your future.
Giving should be a part of this picture too, because giving back helps shape your perspective. Giving has always brought me joy. It reminds me of the way money empowers me to make changes beyond myself. It drives me to think of what good I can bring, not just what I can buy for myself, and it helps me want to be a better steward of my money.
Budgeting best practices when you have irregular income
So what do you do if your paycheck is different each month? You are a freelancer, or you are retired but bring in some money on the side.
Start by listing those essential expenses each month that we talked about. Add in any debt payments or savings goal you need to reach each month. This total is the bare-bones amount you must cover each month.
You should also make a list of discretionary spending, cable, sports leagues, shopping, and eating out. If you refer back to your statements from the last couple of months, you should be able to pull a picture of what you usually spend. Based on that number, come up with a realistic goal, an amount you will plan to spend on those categories each month.
When you put together your essential and discretionary totals, is this an amount you can minimally reach each month? If not, you are living above your means.
Each month, deposit that amount only into your checking account. If you do not have that amount, make sure essentials are paid first.
Make sure to plan an emergency fund into your budget
An emergency fund is a priority when you have fluctuating income. When you have any extra funds above and beyond the essentials and your discretionary budget amount, sock it away in your emergency fund! This way you have something to help you on months your income may not cover the basics.
Notice I said when your income is low…not on months when your spending is higher.
You should have extra most months if you are carefully controlling your spending and living within your means. This extra can be used to pay off any high-interest debt. You can also use this income to fully fund your emergency savings to 3 months of expenses, and to invest in your retirement or other savings goals.
When your income is irregular, budgeting is more of an ongoing process, but also even more of a necessity. If you cannot consistently cover your combined basic and discretionary expenses, you need to revisit them to trim any excess or consider where you can bring in extra income.