Creating a budget is a great first step to take when looking to improve your finances. Learning how to create a budget and save money with your plan is easy, and you can get started today with this post about budgeting your money.
Are you looking to take control of your financial situation? Would you feel better with some more money in the bank? Do you want to win with your finances?
One way to take control of your personal finances and save more money is to budget.
While budgeting isn’t the sexiest or most fun thing to do with your time, setting a budget and sticking to your budget can be the key to reaching your financial goals.
In this post, I’m going to share with you how to create a budget in 5 easy steps.
How to Create a Budget in 5 Steps
To create a budget, all you need is a pencil and paper, but using a computer can help if you are a spreadsheet nerd like me 🙂
Creating a budget isn’t too hard if you know the right steps to follow.
Below are the 5 steps you can take to create a budget:
- Learn about the Different Budgeting Methods
- Identify What You Enjoy and Don’t Enjoy Spending Money on
- Track Your Personal Finances to Understand Your Income and Expenses
- Understand Your Spending Habits and Eliminate Any Spending Weaknesses
- Implement, Track and Tweak You Budget Over Time
Now, let’s dive into each of these budget creation steps in more detail.
1. Learn about the Different Budgeting Methods
Budgeting doesn’t have to be hard or complex, and there are a number of different ways to make sure you are spending your money on what brings you joy.
First though, it’s important to learn about a few budgeting methods, and figure out which one makes most sense for you.
The four budgeting methods I’d like to share with you are:
- The 50 / 30 / 20 Budgeting Method
- The 80 / 20 Budgeting Method
- The 60% Solution Budgeting Method
- The Cash Envelope Budgeting Method
Let’s dive into each of these in the next section.
Budgeting Methods to Learn Before Starting to Budget
The 50 / 30 / 20 budgeting method involves spending 50% of your take-home pay on needs, 30% on wants, and 20% on investing and/or debt repayment.
With the 50 / 30 / 20 budgeting method, you only have 3 line items to track every month – it cannot get much simpler than that!
What this method requires is for you to clearly define what is a need vs. what is a want in your life.
After defining your needs and wants, you just need to sort all your monthly expenses into a need or a want, and add up each category.
The 80 / 20 budgeting method is an even easier version of the 50/30/20 method.
If you don’t want to make the effort to discern between wants and needs, you can just lump them into one.
In this budgeting method, 80% goes to your wants and needs, and 20% goes to investing and/or debt repayment. That’s really all there is to it!
The next budgeting method is the 60% Solution. This budget has five categories for your GROSS income (ie. pre-tax) outlined below:
- 60% to “commited” expenses
- 10% to retirement savings
- 10% to long-term savings
- 10% to short term savings
- 10% for “fun money”
This budgeting method effectively suggests you can live off 60% of your gross income.
This budgeting method really simplifies expense tracking since all your “committed” costs are lumped into one category.
However, it carries the same challenges as the 50 / 30 /20 method since 60% may not work for your household.
Finally, the cash envelope budgeting method is the oldest form of budgeting out there.
In fact, the word budget originated from the Old French word for purse.
While the cash envelope method requires the most effort out of any method on this list, it is still relatively simple.
The cash envelope budgeting method requires you to go old school by using nothing but cash for all your purchases.
Now that you’ve learned about these different budgeting methods, let’s move on to step two.
2. Identify What You Enjoy and Don’t Enjoy Spending Money on
I have a few questions for you to think about when thinking about your budget.
These questions are more related to your life, than money, and will bring the answers you need to start improving with your finances.
The questions for you are:
- What are you passionate about?
- What do you enjoy doing most?
- Is there anything holding you back from doing these activities more?
The purpose behind these questions is to get you thinking about MATTERS to you.
For me, I’m passionate about spending time with my family, being healthy and active, and learning.
Since these are my passions, then I need to align my spending habits with these passions.
What does this look like in practice?
- For my health, I’m not afraid to spend a little more money on healthy food and supplements. I am finding spending some money on a relatively nice bike, a rock climbing gym membership, and equipment which can help me reach my fitness goals.
- With learning, I’m not afraid to invest in myself and buy a course, a book or seek help.
- For spending time with my family, I’m fine spending money at a golf course my dad wants to play, or taking my family out to dinner once in a while.
For you, figuring out what you like spending money on with make the budgeting process easier.
Also, you can then figure out what you don’t like spending money on to come up with ideas to eliminate through your budget.
3. Track Your Personal Finances to Understand Your Income and Expenses
Next, it’s time to get a complete picture of your personal finance situation.
The 4 metrics you need to know for personal financial success when it comes to tracking finances are:
- Net Income
- Gross Expenses
- Savings Rate
- Net Worth
Below we dive into each of these metrics and statistics so you will know how to calculate them.
Tracking your net income over time will give you a picture of what you are working with financially.
Let’s start off with an easy one: net income. What did you make in income, after taxes, for a given period?
The easiest way to do this is by just looking at a recent pay stub.
You’ll see your gross income listed out, which is what you made before taxes.
It should also list out all of your deductions, like FICA, federal, your state tax (if any), etc.
If you have investment income, or have any other freelancing or consulting income, you can find your gross income by adding up what you are paid each month.
Below gross income, if you’re looking at your pay stub, you’ll find your net income, which is the income remaining after all taxes.
Essentially, your net income is what you have to work with each month and year.
If you make $5,000 a month after taxes, then you know you have a maximum of $5,000 you can live on for all of your expenses and saving goals.
Hopefully, over time, this number will go up as you become more experienced and valuable to your clients or employer.
For me, I use income to judge how effectively I used my cash in a given period.
Tracking net income allows you to plan what to do with that income to best set yourself up for financial success
Next, we have gross expenses. Your total gross expenses is a very important financial statistic to calculate for yourself.
After income, calculating gross expenses – the total amount of money you spend during a month – will help you identify any weaknesses in your budget.
You can track your expenses however you find most effective. I split my expenses into some broad buckets, and then dive deeper to get a better understanding of where my cash is actually going each month.
- Discretionary Spending
- Food and Drink
- Home Improvement
- Cash Withdrawal
- Principal on Mortgage
- Interest on Mortgage
- Home Insurance
- Property Taxes
- Private Mortgage Insurance
- Auto Insurance
- Auto Loan Principal and Interest
- Other Insurance
- Health Insurance
- Dental Insurance
- Umbrella Policy
- Life Insurance
- ATM Fees
- Other random charges and fees
- Social Security
If I had kids, I can imagine having more line items for diapers, clothing, child care, sports, saving for college, etc.
Like I said, you can categorize your expenses anyway you’d like. Personal finance is personal! 🙂
For example, I lump food and drink together. Splitting them up makes sense as well, but I don’t drink as much anymore, and as a result, I simply have kept it as food and drink.
As part of your overall financial picture, tracking gross expenses can reveal areas of improvement (are you spending too much on a cable subscription when you rarely watch TV?).
Over time, you can make tweaks and grow to make sure you are on the path to financial success.
Savings rate is a very important personal finance metric to track.
Once we have our income and expenses for a certain period, we can move on to a slightly more complicated metric: savings rate. No, it’s not too complicated, just some division added to the mix 🙂
A person’s savings rate is the percentage of income which a person saves in a given time period.
Simply put, it can be calculated as (net income – gross expenses) / net income.
Let’s say a person makes $5,000 in a month. They spend $2,500 of it and the rest is saved in their savings account. Then, their savings rate for the month is 50%, or ($5,000 – $2,500) / $5,000.
Now, it gets a little bit more complicated once you start to factor in contributions to investment accounts and principal payoff of debt.
For me, I don’t count these as expenses. With contributions to investment accounts, you aren’t giving your money to someone else, rather you are putting it somewhere else for your future self.
For paying down a debt, I do consider interest to be an expense.
At a minimum, people should aim to save at least 10% of their income. Personally, I’d suggest aiming for 25%+ to help you become wealthy more quickly.
The final piece of financial information to track for your personal finances is your net worth.
What is your net worth?
It is your assets minus your liabilities.
What are assets?
Assets are things a person owns which have value. Typical assets include houses, cash, stocks, bonds, cars, precious metals (jewelry, etc.), currencies, businesses – and the list goes on and on.
Next, what are liabilities?
Liabilities are things a person owes, either to a bank, a financial institution, or another person or business. These include credit card balances, mortgages, auto loans, personal loans, liens – and the list here goes on and on as well.
To calculate your net worth, subtract your liabilities from your assets.
Knowing your net worth is crucial to tracking your finances. Focus on growing your net worth and you’ll be on your way to financial success.
“What gets measured, gets managed.” – Peter Drucker
4. Understand Your Spending Habits and Eliminate Any Spending Weaknesses
After you’ve started tracking your spending habits with step three, now you can look at your spending and identify any weaknesses.
One of my favorite quotes is “what gets measured, gets managed”.
After tracking your personal finances and figuring how much you spend on a monthly basis, you can then start to attack certain areas of your spending to save more money.
For example, if you see that you are spending a ton of money on food, maybe $1,000 a month, and you think this is too much, you can make note of this.
For me, I spend about $400 a month on food for myself. There are months were I spend $500, and when this happens, I know that the next month I need to reign in my spending.
For you, you should look about at all of your spending categories (housing, food, transportation, entertainment, etc.), and also look at the big picture to see if there’s anything you can change to reach your financial goals.
5. Implement, Track and Tweak Your Budget Over Time
No one can ever make a perfect plan – the world doesn’t work this way.
But with solid preparation, you can create a plan for your budget which will get you on the right path.
After a month, you can revisit your budget to see how you did. If you think there were certain categories which were too restrictive on your lifestyle, you can raise the spending limits on those categories.
For example, if you wanted to only spend $500 on food and drink, but ended up spending $600, then maybe you actually want your budget for food to be $600.
At the same time, you need to keep in mind your financial goals and to make sure that if you raise any spending limits, that you lower others (unless you are comfortable with saving less).
Over time, you can figure out a budget which makes most sense for you and get on the path to financial success!
Create a Budget Today to Save Money This Year
Taking control of your financial situation with a budget is the first step to financial success.
By following the steps above, you will know where your money is going each and every month, and better understand how to hit your financial goals.
Now, it’s time to take action and get your budget set for a successful financial year.
Readers: what’s your favorite budgeting method? Do you have any budgeting tips I missed here?