How to Create a Budget in 5 Simple Steps
While following a budget may sound painful, living according to a financial plan has serious advantages. Of the nearly 40% of Americans who never or rarely pay their credit cards in full each month, most tend to also feel socially isolated and dissatisfied with their personal lives. Taking back control by creating and sticking to a budget not only empowers you to make proactive choices with your money—decimating your debt and living within your means can simply help you feel better about your life.
If you’re ready to master your money, now’s the perfect time to create a budget that’s customized to your needs. And it’s easier than you think. Just follow this five-step plan to build a budget you can actually stick to.
Start with the big picture
When you’re creating a monthly budget, it’s easy to make the mistake of thinking just one month at a time.
The better method? Start by looking at a full year.
Why? Because there’s no such thing as a “typical month.” Some types of income and expenses simply don’t happen every single month. Thinking about your annual company bonus, your summer vacation, or your quarterly insurance payments as part of a year-long financial picture is crucial when budgeting your family’s income.
The best place to start is by putting together an annual budget, and then dividing that by 12 to get a better picture of what your monthly spending should look like.
Take stock of what’s coming in
It’s basic math. You can’t spend what you don’t have without going into debt. Where many families go wrong is by under- or over-estimating their yearly income. It seems obvious but getting a clear picture of exactly how much money you pocket each year is absolutely essential to building a functional financial plan.
Write down every type of income that you can reasonably expect to pocket during the upcoming year. Include not only take-home pay, but all sources of income that come your way—bonuses, commissions, tax refunds, Social Security checks, child support, and more.
For each category, check how much you brought home in the past 12 months, or come up with a solid estimate for the coming year. Add up your income streams to get your true annual take-home income.
List out your must-haves
Life is full of bills that need to be paid. Some of them go toward luxuries (like your cable package or morning coffee runs), but many of your expenses are clear necessities. For this step of the budget-making process, write down each of your non-negotiable costs:
- Rent or mortgage payments
- Basic utilities
- Childcare or school tuition
- Insurance premiums
- Minimum debt payments (credit cards, car loans, etc.)
- …and others
Some of these costs are fixed, meaning you know exactly how much your rent or car insurance will run you every month. Other amounts may be harder to pin down.
Take a look back over the past 12 months of records to estimate a cost. For example, review your electric bills over the past year to see how much money you spent powering your house—paying special attention given to monthly highs and lows. For undocumented expenses, like your trips to the grocery store, do a look back over the past few weeks to see how much you paid, on average, for food each month.
Feeling stuck? Often, distinguishing between true needs and wants can be a tricky task. If you need some guidance, check out Jean Chatzky’s podcast.
Plan for savings and debt repayment
At this point in a budget, plenty of people think that whatever money is left over after covering their must-haves is money that’s theirs to burn. So, only after spending on their wants, do they think about saving for the future or digging out of debt.
As a result, half of Americans unfortunately spend everything they earn—if not more—and wind up saving exactly zero from one month to the next.
The right approach to building a budget involves a strategy called paying yourself first. When you pay yourself first, you choose to put money toward your goals before you spend it on life’s luxuries.
What types of goals should you think about including in your budget? Some popular objectives include:
- Building an emergency fund
- Contributing to a retirement account
- Saving for your kids’ education costs
- Getting out of debt faster
- Purchasing a home
- Replacing a car
- Holiday gifts for the kids or a family vacation
What if savings sounds unrealistic? “Almost everyone can save at least 1% of their income,” notes J.D. Roth on his acclaimed blog, Get Rich Slowly. Once you make that adjustment you can slowly increase your rate of savings.
Allocate money for your wants
Once you’ve committed money toward your necessities and your financial goals, you’re free to focus on your discretionary spending—the “nice-to-haves” in life. Give yourself permission to budget for the fun stuff: sports or music lessons for the kids, eating out, a trip to the amusement park, or a new T.V.
But always remember this: The amount of money available to spend on your wants is no more than what’s left after you subtract the cost of your needs and savings from your net income. If you spend more than what you make, you’re setting yourself up to go deeper and deeper into debt every month.
Sure, budgets can seem intimidating at first, but building a plan to support your lifestyle doesn’t have to be complicated. Now that you’ve learned how to create a budget of your own, you can follow these five simple steps to construct a custom plan for your financial success.