How to Make a Budget

Creating your first budget can be extremely overwhelming. So overwhelming, in fact, that only 40% of American families have a working monthly budget. But it’s worth the effort. Developing a budget you can maintain over the long term has been definitively linked to building wealth, while simultaneously helping you get out of debt and cut expenses.

When I built my first budget several years ago, I knew approximately how much money I was making annually. But I had never broken down my expenses by category to figure out what I could afford regularly or how much money I could invest regularly.

In short, I was spending money on the things I needed and wanted without determining first whether I could genuinely afford them. After overdrawing my checking account once or twice, and having to pay several bills with credit cards because of my lack of a working budget, I decided to get real and begin a budget.

If you’re a first-time budgeter, here are 12 steps to make the process as smooth and painless as possible.

1. Decide to Start a Budget

If you’re reading this article, chances are that you’ve already decided to begin a working budget. Congratulations! For many people, myself included, this is the hardest part. Read on to get started with next steps.

2. Know How Much You Have

If you have savings, checking accounts, investment accounts, or any other financial instruments, you need to know how much money is in each account, as well as the interest rates and expenses of each one. Make a note of this information. It will become important in determining your net worth and the best use of your capital in the future.

If you use Personal Capital, they will automatically pull in this data when creating your budget.

3. Figure Out How Much You Make

This is easier for some people than others. Those on a salaried pay scale can easily find their monthly income. For hourly employees or those who work in a business where income may rise and fall unpredictably, it can be much more difficult. The most important consideration, regardless of how you earn your monthly income, is to determine the average amount of income you receive monthly.

A good way to do this if you receive irregular income is to average out the last 6 to 12 months of recurring income and use that figure. If you want to be extra conservative, you can choose the lowest monthly amount you earned in the last year, which will hopefully provide you with a worst-case scenario.

4. Know What You Owe

Determining your monthly recurring debt payments should be your next step. This should be fairly simple as long as you’ve stopped incurring additional debt in the short term. If you haven’t been able to break your dependence on credit cards, that’s OK. Building a budget will act as the first step for your next financial priority: getting out of high-interest consumer debt.

To find out what your monthly recurring debt payments are, calculate the total amount owed on each debt account as well as the minimum monthly payment. That includes car loans, mortgages, credit card debt, student loans, and all other debt that your family pays monthly.

This will provide you with the first few line items in your budget and will allow you to determine your net worth.

Pro tip: If you’re currently paying off student loans, you might be able to reduce your interest rate by refinancing with Credible. Right now, they’re offering up to a $750 bonus when you refinance your student loans.

5. Determine Your Net Worth

Once you know how much money you have and how much you owe, you can easily calculate your net worth. Just subtract what you owe from what you have. The answer will tell you the value of your financial resources.

For me, this number was an eye-opener. When I built my first budget, I had a negative net worth. I assume this is relatively common in America, especially for young people just starting out.

Pro tip: When you sign up for Personal Capital, you can connect all your financial accounts, and they will automatically calculate your net worth.

6. Determine Your Average Recurring Monthly Expenses

This can be hard for many people. The best way to determine your monthly expenses is to make a stack of household expenses for one month. Keep your receipts, your utility bills, and documentation of any other expense that arises during a one-month period, then divide these bills into categories.

The categories can be as general or as specific as you like. I keep my categories broad (automotive/household), whereas you may prefer specific itemized categories such as (car wash/electric bill). Either way works as long as you determine an average amount of expenses for each category.

7. Enter This Information into a Database

Budgets used to be old-school paper ledgers. Things have changed for the better for new budgeters. Software programs like Microsoft Excel and online budgeting tools like Personal Capital, Mint, You Need a Budget, and Mvelopes make it much easier to develop a highly adjustable and sustainable long-term budget.

I use Microsoft Excel for my personal budget because it allows more flexibility than sites like Mint. However, many people swear by online budgeting sites. Whichever path you choose will ultimately help you build greater wealth and keep you out of financial trouble.

Pro tip: If you want the convenience of an online budgeting tool but like the simplicity of an Excel document, try Tiller. Tiller automatically updates a Google Sheet or Excel with your daily transactions.

8. Look at the Bottom Line

After entering all of the above information, you’ll discover the most important number in your budgeting process: the bottom line. This number will tell you whether you’re overspending or underspending.

Ideally, you’ll find you’re living within your means – and maybe even have a little left over every month. On the flip side, you may find you must make adjustments to your monthly expenses to live within your means.

9. Make Adjustments Accordingly

If the bottom line of your budget shows you’re overspending, you come to the most challenging step: making cuts to your monthly expenses. There are tons of resources here on Money Crashers to teach you to be smarter with the income you have, help you cut your recurring monthly expenses, and stick to your budget moving forward.

10. Adjust as Needed

Life is full of surprises. Food gets more expensive, gas prices rise, and rent is hiked when you least expect it. Each time you notice inflation creeping up on your expense categories, get a raise at work, or suffer a financial setback like a pay cut or job loss, you must adjust your expense categories based on your new reality.

11. Pay Yourself First

Based on your bottom line, you may want to add a few extra line items to your monthly expenses. These may be monthly contributions to a savings account from CIT Bank, Capital One 360, or Ally Bank; a Roth IRA; a 529 college savings plan; or another savings vehicle.

Moving money into savings and treating it like a recurring expense allows you to slowly build up your savings without feeling like you must scrape together money from what’s left at the end of the month.

Pro tip: Another savings option is a Chime bank account. Chime helps you pay yourself first by automatically moving 10% of every paycheck into your savings account.

12. Track, Monitor, and Be Disciplined

Keeping track of your budget takes an hour or so a week. But it will save you a lot of time in the long run. Once you have an established budget, be sure to keep it in check. Knowing you’re making good long- and short-term financial choices will provide you with a great deal of comfort. It will also take you from living paycheck to paycheck to being able to see the results of your disciplined savings and financial planning.

Final Word

If you don’t have a budget, now’s the time to create one. By following the above steps, you’ll be on your way to financial freedom and building wealth for the future.

Do you have a solid personal budget in place? What has and hasn’t worked for you?


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