Read on to learn how to make a budget in three simple steps.
Why Create a Budget
There’s a lot you can gain from creating a healthy budget. It can help you:
-Easily save for your retirement
-Settle your debts faster
-Purchase a new and better home
-Invest in your dream business
-Plan well for a vacation
-Afford good schools and colleges for your kids.
How to Create a Budget
Step 1: Come Up With A Plan - Find Your Most Suitable Budgeting Method a Budget
Here are the three methods:
#1 The 50/30/20 Rule
Of all the budgeting methods, the 50/30/20 rule is the easiest. It’s one that anyone can use, although it especially suits people with a tendency to worry about money.
The 50/30/20 rule involves dividing your expenses into three categories:
But before you can share out the money, remember the income you should work with is the final earnings after tax. Of course, figuring this amount is easy because you only need to subtract the tax you pay from your salary to get your final income.
So, how do you divide the expenses? It’s pretty straightforward. 50% goes to your needs, 30% to your wants, and 20% to your savings.
Needs include things such as housing, expenditure on utilities, groceries, car, and mortgage. After calculating what each need requires, make sure the total doesn’t exceed 50% of your income.
The 30% on wants should cover the essential things you need like phone bills, shoes, clothing, and lunch outs. Just ensure you don’t get excessively lavish.
Lastly, the 20% on savings should go to your savings account or any investment that guarantees future profits.
#2 The Envelope System
The envelope system is another budgeting method that involves keeping cash for each specific item in an envelope.
If your bill exceeds the money you’ve set aside in a particular envelope, you need to reduce the expenses or get the excess from another envelope. Nevertheless, spending more than your overall budget should not happen.
This method is quite effective if you’ve been overspending and want to get more accountable and disciplined.
#3 Zero-Based Budget
This budgeting method works in such a way that you have to consider each dollar you spend. To elaborate, if after budgeting you’re left with $200, you have to assign the money to the next item in your list. Any other extra dollar should go to your savings or investments.
The term “zero-based budget” comes from the fact that after adding all your expenses and subtracting from your income, you should get a zero balance (Total income – Total expenses = 0)
Step 2: Know Your Finances
All the above methods will only work after you’ve established what your financial status looks like. In this step, you need to:
#1 Get All Your Financial Paperwork
Dig up as much information regarding your income and expenses as possible.
You can only get this from your financial statements such as bank statements, recent utility bills, mortgage or loan statements, receipts from several months, etc. This will help you come up with a monthly average.
#2 Calculate Your Income
Calculate the total income you get in a month. Don’t just consider your salary if employed, but also all other sources of income, including investments, social security, etc.
Remember to consider income after-tax only.
#3 Generate A List of All Your Monthly Expenses
Expenses come in two kinds: Fixed and variable. Fixed expenses are those where the amount you pay every month does not change at all.
Examples are rent, car payments, internet service fees, trash and collection fees.
On the other hand, variable expenses are the expenses that will keep changing from one month to the other. It includes expenditure on items such as groceries, eat-outs, gasoline, gifts, and entertainment.
List all these expenses down and assign them values starting with the fixed expenses. Also, have a rough value of the amount you’re likely to spend on the variable expenses. If you use the 50/30/20 rule, remember to start with needs, wants, and, lastly, savings.
#4 Compare your Total Monthly Income with Expenses
Total your expenses, and subtract them from the income. If the income is higher, good for you. You can take the rest of the money to your investments or savings. The 50/30/20 philosophy is really effective in this case.
If your spending exceeds your income, it definitely means you’re overspending. Make some adjustments to your budget to balance things.
Step 3: Make Adjustments Where Necessary
There is always room to make some changes to your budget if things don’t balance well. This is so, especially when your spending exceeds the income.
Try to reduce the amount of money allocated to your fixed variables, especially those wants that are not a must. For example, you can reduce the number of eat-outs.
If your spending is way above your income, reducing the variable expenses may not work. In that case, consider reducing your fixed expenses too. For instance, you can move to a cheaper home.
The bottom line is that your income column and expense column should balance. This means your spending plus the saving or investment totals the income and that you can account for every dollar.
Creating a budget is one thing, but sticking to it is another. Make sure you hold yourself accountable for how you spend your income. Many apps are available that you can use to track your expenses. Of importance, however, is to know how to make a budget and a healthy one that allows you to spend within your income and save something. You are more than welcome to explore our finance classes as well and learn more.