Did you know that one of the number one reasons that millionaires attribute to their success, is creating a budget and sticking to it?
The problem is, not everyone knows how to make a budget and aren’t aware of common do’s and don’ts that should be followed.
Here we’re going to walk through how to make a budget and provide a step by step guide to budgeting so you too can be among the many wealthy people benefiting from proper budgeting:
Step 1: Determine Your Actual After-Tax Income
First things first; creating a budget requires that you know what your monthly income is. And we’re not just talking your gross income, we’re talking you net income, or your after-tax income.
We use your after-tax income because that’s the actual amount of money that you are receiving in your pocket. No sense in working with your gross income, since you don’t see the money that gets taken out for taxes anyways.
Your after-tax income is simply the dollar among stated on your check or direct deposit. If you want to get into the nitty gritty, take a look at your most recent paystub. It will show your total payment amount, then it will subtract your state and federal taxes with a final dollar amount listed after deducted taxes.
Step 2: See What Your Current Expenses Are
Next, we want to determine our total living expenses. It’s important to list your living expenses in order of priority, so you get the important ones paid first. Food, water, heat and shelter are common top priorities to list at the top of your list of expenses.
There will also be fixed expenses and variable expenses. A fixed expense is something like your rent or mortgage payment, it’s the same every month and doesn’t change on a regular basis. A variable expense might be your electric bill, and varies each month depending on how much electricity you use.
Other expenses will include things like transportation, entertainment, debt payments, insurance payments, car payments, medical payments, etc. The important thing in this step is to list all your expenses and make sure to give priority to the ones that you can live without.
Step 3: Find the Best Budget Method for Your Needs
There are multiple popular methods used today for budgeting. Here we will list a few of the most common budget methods so you can decide which one best fits your situation. Among the popular budgeting strategies discussed are:
- 50/30/20 Budgeting Method
- The Envelope System
- Zero-Based Budget
Each are great options to use, and each will steer you in the right direction financially. Pick the one that best suits your lifestyle.
50/30/20 Budgeting Method
The 50/30/20 budgeting method is a popular strategy used to determine how much of your budget should be spent where. This method suggests that you divide your after-tax income and allocate 50% of it on your needs, 30% on wants, and 20% on savings.
For those analytical minded people out there, this helps you properly allocate your income so that you’re not overspending in any category. For example, if you make $3,000 per month after taxes, you would allocate $1,500 towards needs, $900 towards wants, and $600 towards savings.
Needs are bills that you cannot miss and must be paid no matter what, like shelter, food, water, heat, etc. Wants are things such as weekend dates, going to the movies, retail purchases like electronics, etc. Lastly, savings is absolutely necessary if you are to ever build wealth for the long run, and 20% of your income will add up fast over time.
For more information on details of the 50/30/20 rule, take a look at this in depth article about the 50/30/20 budget rule by Investopedia.com.
The envelope system is a popular budgeting method taught by financial expert Dave Ramsey. It’s based on old fashioned techniques using cash and envelopes to categorize your budgets for each category.
The first step to starting the envelope system is to list your budgeting categories and use an envelope for each of the listed categories. Examples are Food, Gas, Health, Entertainment, Personal, Gifts, etc.
Next step is to determine how much each of your envelops/categories should have for spending each month. Dave Ramsey suggests considering categories where you often overspend and be sure to limit those categories to break your habit of overspending.
Then, when you get paid, you will take out the determined budget amounts and put them in each envelope according to the budgets you set for each category. Lastly, you need to commit to only spending the money from each envelope on things that fall into that category. When the money is gone, you’re done for the month in that category. No cheating!
Zero based budgeting is simply giving every dollar you earn a place to go each month. There should be no money at the end of the month left over because it didn’t have a place to go. If you can give your money a place to go, whether it be savings, investing, expenses, etc., you have complete control of your financial future.
The problem many people have is they don’t budget for every dollar they spend, and then mis calculate their budgets. For example, you may have an extra $200 at the end of the month because you didn’t budget every dollar and end up spending that money on worthless junk.
Another common problem from not following a zero-based budget, is when you know you have extra money left over, so you think it’s ok to overspend in certain categories because you have an extra $200 anyways. You end up overspending way more than $200 and mess up your entire budget!
Step 4: Choose How to Track Your Budget
Once you’ve decided which budgeting method works best for you, it’s time to find out how to track your budget regularly. Just like different budgeting methods, there are also different ways to track your money that may be helpful.
The old-fashioned method is simply creating a budget worksheet or looking up a template worksheet online. Many people will create a worksheet using an excel spreadsheet, or by using popular worksheets from financial experts.
The worksheet should simply allow you to list your after-tax income, categorize your expenses, and allow you to update and track your daily expenses accordingly. Dave Ramsey has created a helpful budget worksheetwith instructions and categories for every situation. You can use this for an example to create your own, or follow it as is.
Best Budget Apps
Budget apps are perhaps more popular among younger generations. There are thousands available, making it difficult to know which are reputable. Some require that you pay for the service, others are offered completely free.
Here is a list of popular budgeting apps:
- Personal Capital
- You Need A Budget (YNAB)
Most budgeting apps offer a free version and a premium version should you want access to premium services. The four mentioned apps above are the top in the industry and the most reputable and helpful apps for users of all financial scenarios.
Bullet journals are customizable journals that are formatted with bullet points, or dots, rather than lines. They are helpful because you can essentially create your own layout of how you wish to organize your budget. When using a bullet journal, you create a budget worksheet similar to the ones listed above but make it your own for your specific situation.
Step 5: Revisit Your Budget as Needed
Last step in creating a budget is perhaps the hardest part that most people fail on. And that is revisiting your budget on a regular basis. By revisiting your budget as often as needed and updating your expenses as life changes, you are in complete control of where you are headed financially. If you want to be wealthy, then plot out a map to get there with your budget and update it regularly!
To make your budgeting even more helpful and efficient, here are a few recommendations to consider that will make life even easier financially:
Build an Emergency Fund
Your emergency fund protects you from going back into debt when unexpected expenses occur. Your emergency fund should be anywhere from $1,000 to a couple months’ worth of expenses.
Pay Off High Interest Debt
Paying your high interest debt first will save you money in the long run and allow you to exponentially pay off debt quicker. High interest debts include things like credit cards, payday loans, title loans, etc.
Get a Full Employer Match on Your 401K
Most employers today offer an option to contribute to a 401k. In most cases, they will even match what you contribute. So, if you contribute $100 per month, they will match it dollar for dollar or put in half of what you put in. That’s free money!
Automate Your Savings for Retirement
Automating your savings for retirement means setting up automatic transfers on a regular basis to contribute to retirement accounts like 401k’s and IRA’s. Pick an amount that won’t break the budget and put it on automatic. Before you know it, you’ll have a nice chunk of change growing for your retirement savings.