A personal budget is a great way to determine where your money is going every month. Whether you are using pen and paper, a spreadsheet, or an app, you need to understand money management and save for your short-term and long-term financial goals. The trick is to figure out a streamlined way to track your finances and spend less than you earn to build wealth and stay out of debt.
How a Budget Works
A personal budget is a strategic planning tool that tracks how much you spend or save every month. It also allows you to identify your spending habits so you can change them if needed. Creating a budget may not be the most exciting activity for many individuals. However, it is one of the best ways to keep your financial house in order.
Budgets give you control over your finances. If you reduce spending in one area, you can direct it to another. You can choose to save the money for a large purchase, increase your savings, build a “rainy day” fund, or even invest in building wealth.
However, a budget only works if you are willing to keep detailed and accurate information about your earnings and spending habits. It requires honesty, gathering accurate information, and facing facts. Ultimately, a working budget will show you exactly where your money is coming from, how much you have, and where it all goes each month.
Here are some simple steps to get you started on the right track:
Choose Your Method
Before you create a budget, find a suitable template you can use to accurately fill in the numbers for your income and expenses. While it is possible to use old-fashioned pen and paper to create a personal budget, it is much easier and more efficient to use a budget spreadsheet or a budgeting app.
These tools contain designated fields for your income and expenses in various categories. They also come with built-in formulas to help you figure your budget surpluses or shortfalls with minimal effort. No matter which method you choose, make sure it contains all the fields you need, as well as formulas.
Gather the Information
The more information you can collect, the better. It is good practice to gather several months’ worth of data and then figure out an average. Documentation that will help you get started include:
- W-2s and paystubs
- Utility bills
- Bank statements
- Credit card bills
- Three months’ worth of receipts
- Mortgage statements
- Loan statements
- Investment accounts
Calculate How Much You Make
The next step is to figure out how much money you earn each month. Be careful not to overestimate what you can afford to spend based on your gross income or total salary. Subtract your deductions such as Social Security, 401(k), flexible spending account allocations, and taxes when creating a budget worksheet. Your net income, which is your final take-home pay, is the number you should use when creating a personal budget.
Consider the amount from your lowest month over the past year as a conservative baseline if you have a variable income. Alternatively, you can average the last 6-12 months’ pay and use that number.
Determine Your Monthly Expenses
It’s essential to keep track of and categorize your monthly expenses, so you know where to adjust. It helps you identify what you are spending the most money on and areas you can cut back on.
Begin by listing all your fixed expenses, such as rent or mortgage, car payments, and utility bills. It’s unlikely you’ll be able to reduce these costs but knowing the portion of your monthly income they consume is helpful.
Next, list all your variable expenses (those that often change from month to month), such as gas, groceries, and entertainment. This category is where you will find the most opportunities to cut back. The best place to determine these expenses is your credit card and bank statements since they often itemize or categorize all your monthly expenditures.
Face the Music
Once you have documented all your income and spending, you will see where you have money left over or where you can slightly cut back to have some to put towards your saving goals.
Want-to-have expenses should be the first area to look for spending cuts. For example, you can skip movie nights in favor of watching movies at home or reduce the number of restaurant dinners and cook more at home. Try adjusting the numbers to see how much money you can free up. Next, you could reevaluate your spending on needs. For instance, having internet connectivity at home is vital, but do you need to spend more on the fastest available connection?
Lastly, if the numbers still don’t add up, you could look at adjusting your fixed expenditures. However, such decisions often come with huge trade-offs, so you need to weigh your options carefully. The final goal is to have more income than expenses so you can start saving for emergencies and the future.
Track & Monitor
It is necessary to continue tracking and monitoring your budget regularly to ensure you are staying on target. Few elements of your budget are set in stone. Over time, you may get a pay raise, your expenses may gradually increase, or you may have surpassed your goal and want to plan for a new level. Whatever the reason, keep reviewing your budget and adjusting accordingly.
Recording your income and expenses can help prevent overspending and identify unnecessary costs or destructive patterns in spending. Take time each day or week and update your entries or look for an expense tracking or budgeting app. If you can, automate your bills to ensure you don’t incur late fees due to simple forgetfulness.
Budgeting can help you achieve your goals faster and reduce financial stress. Identify your short-and long-term goals and write them down somewhere you can see them, so you always have the purpose in mind. Short-term goals usually take no longer than a year to accomplish. Long-term goals, such as saving for your retirement or your kid’s education, may take several years to reach.
No matter how often you need to change your budget, you should always have one. If you find it challenging to hold yourself accountable, partner with someone who can help you reach your goals.
Do you have any personal budgeting tips? Feel free to share in the comments below!