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Now that the new year is here, many of you will be working on your New Year’s resolutions. If you’re like many people, saving money and paying debt might be at the top of your list.
One of the most important tools for reaching these goals is to create a budget. Yet only 33% of Americans prepare a budget each month.
The thought of budgeting sounds difficult and restrictive. But there are many reasons why creating a budget is important.
Wouldn’t you want to stop stressing about having enough money to pay all your expenses every month?
Wouldn’t you want to pay off all your debts?
Wouldn’t you want to take that dream vacation or buy a car without worrying how you were going to pay for it?
A budget can do all that and more!
Let’s take a look at the exact steps to create a budget that will let you achieve your goals.
Step 1 - Determine How Much Money You Have
You were probably expecting me to tell you to figure out how much you make every month, right? While that’s one way to start the budgeting process, it’s not the best way.
This is because you’re guessing at what your income will be in the future. This isn’t budgeting...it’s forecasting.
Forecasting might work if you’re on salary and receive the same amount every pay period. But it doesn’t work if your income is irregular.
And, even if you receive a steady salary, there are always things that could happen. For example, if you’re a federal employee and Congress doesn’t pass the budget, you could go without a paycheck for a bit.
To truly budget, you need to work with the money you currently have. So your first step is to see exactly how much money you have.
To do this, log into your online accounts to see how much is currently in your bank accounts. If you don’t have online banking, you’ll want to pull out your checkbook register. You’ll also want to make note of any outstanding items, such as checks you’ve written but haven’t cashed.
Then, open your wallet and count all your cash and coins.
Step 2 - Determine Your Expenses
Step 2 - Determine Your Expenses
The next step is to determine all of your expenses.
The best way to get an accurate listing of all your expenses and how much you spend on them is to track them. To learn exactly how to track your expenses, check out this post: How to Track Your Expenses Like a Boss.
Step 3 - Allocate Money Towards Essential Expenses
The next step is the fun part...starting to create your budget!!
First, you’ll want to allocate money towards your outstanding items. These could be checks you’ve written but haven’t been cashed yet or an online purchase that hasn’t cleared yet. These are items that you’ve already committed some of your money to and need to be accounted for. You don’t want to spend the same money twice!
Next, you’ll want to allocate money towards your essential expenses. These are expenses that you have to pay to keep your life running.
Examples of essential expenses are:
- Shelter (rent/mortgage and utilities)
- Debt (minimum payments)
- Commuting costs to get to work (gas, bus fare, etc.)
Now, before you start allocating money, ask yourself what you need to pay for before you get paid again.
Is your electric bill or student loan payment due this week? Do you need to buy groceries or gas? These are the first things that should be funded.
If you’re not sure how much to allocate for your monthly essential expenses, check out this post: How to Track Your Expenses Like a Boss.
Let’s take a look at an example.
When you look into your bank account, you see that you have $1,500 to budget. Here’s how you decide to budget for your monthly essentials:
- Rent: You decide to budget half of your rent ($800) from the money you have. When you get paid again (before your rent is due), you’ll budget the other half.
- Utilities: You know your water and electric bills are both due before you get paid again, so you budget for them.
- Groceries: You need to buy groceries before you get paid again, so you budget for it.
- Fuel: You also need to buy fuel before you get paid again, so you budget for it as well.
- Debts: You need to pay for your auto loan before you get paid again, so you budget for it. But your student loan isn’t due until after you get paid again, so you decide not to budget for it now.
Here's how our example budget looks with your monthly essentials budgeted:
Step 4 - Allocate Money Towards Your Irregular Expenses
Irregular expenses are those that don’t occur every month but will happen at some point. Because they don’t happen every month, it’s easy to forget to save for them.
Examples of irregular expenses are:
- Car insurance
- Car maintenance
- Gifts (birthday, Christmas, wedding, etc.)
- Life insurance
- Home maintenance
- Quarterly taxes
- Medical (copays, deductibles, etc.)
- Pet (vaccinations, emergencies, etc.)
Again, before you start allocating money, ask yourself what you need to pay for before you get paid again. Are any of your irregular expenses due before you get paid again? If so, make sure to allocate enough money towards those expenses to cover them.
After you’ve done that, you’ll want to try to set aside something each month for these expenses so that you’ll have enough when they come around.
If you’re not sure what your irregular expenses are, check out this post: How to Track Your Expenses Like a Boss.
If you’re not sure how much to set aside each month, check out this post: How to Utilize Sinking Funds to Improve Your Budget.
Here’s how our example budget is looking with your irregular expenses budgeted:
In our example, you know your renter’s insurance is due before you get paid again, so you budget $100 to cover that. For the rest of your irregular expenses, you budget something towards each.
Remember to only allocate money you actually have. Hopefully you’ll have enough money to allocate money towards all your irregular expenses (and continue to the next steps). But, if you don’t, stop allocating when you reach $0.00. Look for ways to cut your expenses or earn extra money.
Step 5 - Determine Your Financial Goals
The next step is to figure out your financial goals. It’s important to determine your goals because then you can align your budgeting and spending with these goals.
You’ll be more likely to allocate money towards goals you care and are excited about. And it’ll be easier to cut your spending in other areas when you’re putting that money towards your goals. It’s called “personal finance” for a reason!
Examples of financial goals include:
- Going out for dinner once a week
- Hiring a house cleaner
- Buying your dream vehicle
- Buying those new shoes you’ve been wanting
- Building an emergency fund
- Staying at home with the kids
- Paying off your debt
- Saving for a down payment on a house
- Renovating your house
- Going on a vacation
- Saving for your kid’s college education
- Saving for retirement
- Buying an RV and traveling around the country
Really, the sky’s the limit. Each person’s (or family’s) list of goals will be specific to them.
- Related Post: How to Knock Out Debt with the Debt Snowball
- Related Post: Why a Debt Avalanche is the Key to Getting Out of Debt
Step 6 - Prioritize Your Financial Goals
Now that you’ve got a list of financial goals, you’ll want to rank them in order of importance. Again, what is important to you (and your family) may mean something different than to another person.
One way to do this is to write them on a piece of paper in order of priority (with one being the most important).
Another way to do this is to write each goal down on a separate post-it note. Then move the post-it notes around until you have them in order. The advantage of this method is you can easily change your mind without having to erase or cross off an entry on the paper.
Step 7 - Allocate Money Towards Your Goals
Now that you’ve prioritized your financial goals, it’s time to allocate money towards them.
Depending on your financial situation, you might only be able to allocate money towards just one or two goals now. That’s where your order of priority comes in...you’ll want to allocate money towards your highest priority goals.
Here’s how our example budget is looking with your financial goals budgeted:
In our example, you came up with three goals: pay off your auto loan, go on a trip to Europe, and pay off your student loan. After prioritizing and accessing your finances, you decide to focus on the first two. Then, when you pay off your auto loan, you’ll focus on paying off your student loan.
Step 8 - Allocate Money Towards “Just for Fun” Expenses
You’ve worked so hard towards making sure all your monthly essentials and irregular expenses were covered. And you’ve started working towards turning your goals into reality.
Now, it’s time to make sure you get to have a little fun. See, you still get to have fun!!!
Example “just for fun” expenses are:
- Eating out
- Entertainment (music, movies, etc.)
- Fun money
Here’s how our example budget is looking with your “just for fun” expenses budgeted:
Step 9 - Put Your Budget Into Action
Now that you’ve created your budget, it’s time to put it into action.
Each time you receive money, allocate it according to the steps above. Make sure your monthly essentials and your irregular expenses are covered, especially anything you need to pay for before you get paid again.
Before you spend money, check the relevant category to see how much you have to spend. If you don't have enough money in that category, do some thinking before you spend. Ask yourself: Do I really need to buy this? Can I cut out something so that I don't overspend?
If you find that it's something you really have to buy, pull money from another category (or categories) so that your overspending is covered by money you already have. (Versus going into debt for the purchase.)
Each time you spend money, subtract it from the appropriate category (or categories). Don’t be afraid to adjust your allocations if necessary. As plans and priorities change, so can your budget. Make sure to keep this info updated so you can make informed decisions before you spend.
Here’s how part of our example budget is looking with some spending transactions added in:
Make Budgeting Easier by Using a Tool
One of the biggest complaints with budgeting is that it’s too difficult and takes up too much time. Using a tool to help you budget can make it easier and quicker to create your budget. And, certain tools even help you track your spending and let you know if you overspend. Below are a couple different options.
You Need a Budget (or YNAB) is an online program that allows you to create a budget based on the steps I've outlined above. You only budget and spend money you already have, plan for irregular expenses, and easily adjust your budget to handle overspending. It also has apps for iPhone and Android. I have used YNAB for years because it makes everything so easy.
Here's part 1 of our example budget using YNAB (I had to do two separate screenshots):
And here's part two:
If you’re interested in trying out YNAB, you can try it out for free for 34 days. (If you love it and decide to subscribe after your free trial, I’ll get a free month.)
Every Dollar is an online program that allows you to create a budget, track your spending, and better manage your money. It also has apps for iPhone and Android. I haven’t used Every Dollar, but I’ve heard good things about it.
Budgeting isn’t something to be feared. Instead, it’s a tool for creating a plan for your money. A plan that allows you to control your money (rather than letting your money control you).
By telling your money what to do, you can achieve your goals of paying all your debt, retiring early, or taking that dream vacation.
What goal will budgeting help you achieve?