6 Simple Steps on How To Create a Budget
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I want to give some insight into how to create a budget. Creating a budget doesn’t have to be hard. While most people feel that budgeting means they have to miss out on things that they want, we have found that it doesn’t have to be the case. By creating a realistic budget, you gain control of your money, opening you up to greater opportunities. True, you will have to miss out on some daily incidentals, but you don’t have to cut out all of them! It is all about maintaining balance and setting your priorities.
When we started our first budget together, we were barely making anything. We had recently graduated from college and gotten married. Wendy had a full-time job, but it wasn’t paying her much. Meanwhile, I was searching for a job during a down economy and was only able to find temporary positions for our first year of marriage. Needless to say, money was tight, and having a realistic budget and sticking to it was pivotal to us moving out of that stage of life with savings and making progress on paying off our debt.
Steps on how to Create a Budget
- How to Create a Budget: Monthly Expenses and Incomes
- Resolve How you will Manage your Budget
- Group your Expenses
- Create your Budget
- Find Savings in your Budget
- Focus your Budget
How to Create a Budget: Monthly Expenses and Incomes
The first step in this process is to pull together a list of monthly expenses. In order to know where we are going, we need to get a benchmark of where we are. Below are common monthly expenses you may have.
- Savings (yes, this should be here)
- Debts (These are debts not covered by previous categories e.g. Student Loans, Credit Cards, etc.)
- Unexpected Expenses
Those are a few categories to get started with. You may have a few others to personalize this list.
Also, pull together a list of all of your monthly income after taxes, but before your pre-tax deductions have been taken out.
Resolve how you will manage your budget
First, decide what cycle you would like to use for your budget. Typically it will match with your pay schedules. We typically have been paid bi-monthly, so it has always worked to schedule our budget into two periods – one period starting on the 1st of the month and the other on the 15th. Scheduling your budget based on pay schedules allows you to ensure that you have enough cash flow to pay all your bills. It won’t work well if you have all your payments in the first two weeks of the month if you only have half of your income during that time.
Next, take some time to figure out how you are going to track your budget. There are several options: You can use Mint if you would like a more automated process or many banks have budgeting software built into your banking app. Perhaps you like to have a little less noise or are really comfortable with Excel or Google Spreadsheets. Whatever you feel most comfortable with. I would suggest starting with a simple spreadsheet. Mint is a great tool, but it can have a lot of noise if you are just starting to set up your budget.
Group your Expenses
Now we are getting to the difficult part of creating a budget, especially for couples! This is where your differing opinions on money are likely going to come out. Remember those expenses that we discussed earlier? Now we are going to group those into three different categories. Fixed, Variable or Luxury Expenses. To ensure you are clear on what falls under each of these categories I have provided some definitions.
- Fixed Expenses: These are set expenses that are the same every month. A good example is your rent or house payment. These should be expenses that are necessary! Your Netflix subscription doesn’t count.
- Variable Expenses: These are expenses that are going to vary month to month, and are still necessary. A good example of this would be utilities.
- Luxury Expenses: These are expenses that you could live without. Maybe you don’t have to have that cable subscription or perhaps you don’t have to go out to eat 3 times a week.
Start grouping all of your expenses under one of these three categories. As I mentioned, if you are creating this budget with a significant other you will probably need to compromise on where some of these expenses fall. For right now just group them into the categories, we will discuss what we need to cut later in this article. Right now, I do want to address one thing that I have hinted at previously and that is how should we handle savings.
Factor in savings when creating a budget
Savings should be a fixed expense when you create a budget. You should be paying yourselves first and foremost. To start, your top budget priority should be building up your savings. Most experts will say that building up your savings to $1,000 is enough to start out. I actually like to double that number and say $2,000 should be your goal. Costs have increased and I have found that if something big occurs you are usually looking at a price tag of more than $1,000. I have found that $2,000 typically covers most large expenses. This will also decrease the chance that you would need to use a credit card to cover a major expense. If you end up having to use a credit card it is a major step backward.
Create your Budget
Now is the time. We have taken all the prerequisite steps and we can now create your budget. Many financial coaches suggest that you use the 50/30/20 rule. Under these rules, your fixed and variable expenses would make up 50% of your budget while your luxury expenses would make up 30% of your budget. Finally, savings or paying off debt would make up your final 20%. I find that the 50/30/20 rule is not strong enough to make significant progress.
The reality is that life happens. If you are saving 20% of your income and make $3,000 a month that means you would be saving $600. However most of this money is split up into many categories at least 10% is going to savings plans where you cannot touch it like 401k’s, College Savings Plan, HSA’s. etc. That means that you are only saving 10% which is $300. That means in a year you would save $3,600. That’s not much progress. Now that we have paid off most of our debt, I try to focus on having all of our expenses total up to 60% of our income. This is a number I have come to after much trial and error. It is aggressive enough to allow you to get ahead while still allowing you to enjoy some pleasures in life.
For now, you need to focus on saving as much as your budget allows. When you are allocating your money you should be pulling your savings immediately. If your budget allows you to save $100 per pay period than you should pull $100 immediately every time you get paid. Continue this until you have reached your initial savings amount of $2,000. After that, you can re-purpose your savings budget towards paying off your debt.
Again, I understand that some readers may not be able to reach these levels when they start this process, but it is what you should be working towards. Don’t be discouraged. Just by creating a budget, you are on the path to success! It takes many steps to reach your goal.
Find Savings in your Budget
You have created your budget. Now we need to take some time to find savings in your budget. Budget according to last month’s expenditures and then try to focus on cutting your expenses. For instance, if you spent $500 on groceries last month try lowering your bill to $400 or $450 this month. We have a great post on saving money on your groceries. Another expense to look at would be the internet or cable. There are now a lot of options available. You may be overpaying or may not even need it. A lot of cable and internet providers will offer introductory rates to new subscribers. Part of successfully managing a budget is ensuring that you are maximizing your money by not paying more than you should.
Focus your Budget
Once you have accomplished your savings goal, you can start focusing your budget priority toward paying off debt. When you pay off debt, you are actually increasing your purchasing power! By having debt, you are making payments on purchases from the past and the interest on that debt. You really are a slave to your past purchases.
The only debt that we have is our house payment. To us, payments on a house make sense, since you have to live somewhere and a house typically appreciates in value. If you aren’t putting money towards a house, then you are probably paying rent, which is money that you have no chance of getting back. I have covered paying off debt in this post and will cover buying a house in a future blog. For now, remember that paying down debt should be the main goal of your budget until you are out of debt.
Once you get out from under debt, that money can go back into your budget for things that you really enjoy. All of a sudden you will be able to create a budget that focuses on savings and your interests at the same time! That is where we currently are, and that is why we will be traveling to England this summer! We now have the freedom to make choices based on what we love to do. We are still saving for our future, and try to save at least 30% of our paychecks, but we also have the discretionary funds to accomplish our savings goals and enjoy our life.
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