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Step One: Identify Income

A budget is a simple equation: Income minus Savings minus Expenses equals Zero. Basically, every dollar you earn is either put into savings or is spent. The trouble comes when figuring out your expenses and trying to make sure they aren’t more than your income.

Budget is a Four Letter Word

Most people dislike budgeting. The main complaints:

  • “Budgets are complicated and take too much time.”
  • “Budgets are restraining and limit freedom to spend and do what I want.”
  • “I can’t solve my money problems unless I make more money.”

The truth of the matter is that, when done right, a budget…

  • May take some time to set up, but maintaining can be relatively painless.
  • Should be a reflection of how you want to spend your money.
  • Can help you find extra money on your current income.

This guide walks you through the four main steps to building a budget that will work for you and can be used with the Budget Worksheet.

Step One: Identify Income

Look through pay stubs or online statements to determine your income. Sources of income to consider include wages, child support, pension benefits, social security, rental income etc.

Tips:
  • Look at your net income. Net income is what you get paid after taxes and deductions are taken out, it’s the amount that’s deposited into your checking account.
  • Ignore inconsistent income. While it’s nice to consider tax refunds and bonuses as income, if they don’t occur regularly, don’t include them in your budget calculations. It’s better to set a rule for any irregular income. For example, “for any irregular income I earn, 50% will go into savings and 50% will go towards my goal of paying off my student loans.”

Step Two: Identify and Organize Expenses

Identify Your Expenses

The best way to figure out where you are spending your money is to track your spending for one month.

If you only use your debit card/credit card to make purchases, you’ll just need to gather your most recent month’s statements. If you use cash, you’ll want to carry a notebook or open a note in your phone to write down every time you spend money, no matter how much.

You can also use a personal finance management app, like myFinance, to track your spending. It takes some time to set up, but can make the budget building step even easier.

Organize Expenses

Once you’ve tracked your expenses, it’s time to organize. Your goal is to evaluate where you are currently spending money.

There are a lot of recommendations out there on how to categorize and build your budget. We like to keep it simple so we recommend breaking expenses into three categories:

Essential Expenses
  • Housing payment (rent, mortgage)
  • Transportation (loan, gas, insurance)
  • Groceries
  • Utilities
Financial Priorities
  • Debt payments
  • Retirement savings (after-tax contributions)
  • Emergency Savings
  • Other savings/goals
Lifestyle Choices
  • Anything fun, personal, or voluntary
  • Cable, internet, phone
  • Charitable giving
  • Entertainment
  • Pets
  • Personal care
  • Shopping
  • Anything that doesn’t fit in the Essential or Financial Priority categories

Go through your list of expenses from the past month. Next to each item, write an E for Essential, F for Financial Priority and L for Lifestyle Choice.

In the next step, we’re going to build your plan.

Step Three: Build Your Plan

Now that you have your income and your expenses, it’s time to build your plan. Remember, one of the main goals of a budget is to tell your money where you want it to go.

Evaluate

There are a lot of different ways to divide expenses. In Step Two, we broke your expenses into three categories: Essential, Financial Priority, and Lifestyle Choices. This is called the 50/20/30 method:

  • 50% (or less) of spending should be on Essential Expenses
  • 20% (or more) should be on Financial Priorities
  • 30% (or less) should be on Lifestyle Choices

Before you can build your plan, you need to see where you are currently. Use the Evaluating My Expenses Worksheet to total up your expenses into these three categories and see how they compare to the 50/20/30.

If you’re just starting to budget, your expenses may not fit or the 50/20/30 method may not be the one that fits you best. You need to determine what works best for you and for your situation.

Build

The next part, building your plan, may seem overwhelming, but you’ve done most of the legwork already.

When you follow the 50/20/30 plan, you have a guide for where you want your money to go. Use the Budget Worksheet to divide up your income to these three categories. For example, if you make $3,000 a month (after-tax), you would budget $1,500 for Essential Expenses, $600 for Financial Priorities, and $900 for Lifestyle Choices. Remember, this is just a starting point. You may find you need to make adjustments.

Now, using your past month’s expenses, start to fill in the Budget Worksheet.

  1. Start with the Essential Expenses – your housing payment, transportation costs, utilities, groceries.
  2. Now, add in your Financial Priorities – after-tax retirement savings, emergency savings, debt payments, and any other savings goals. For now, just enter the minimum payments for your debt payments.
  3. Finally, add in your Lifestyle Choices. Since this category covers a wide variety of expenses, start with your needs. You should use the past month’s numbers as a starting point, but also think back to past spending to make sure it’s accurate.
Fixed vs. Variable Expenses

When budgeting, it’s important to know whether an expense is fixed – costs the same each month – or variable – the cost changes each month. With fixed expenses, budgeting is much easier since the cost won’t change. But with variable expenses, it can be more difficult to predict the cost each month.

For variable expenses, take a look at the past couple months to figure out your average spending in that category. Use that as a starting point when building your budget. This number may change depending on the month or the season. For example, in the summer, electricity bills might be significantly higher than in the fall or winter.

Needs vs. Wants

When it comes to evaluating expenses, you should ask yourself if it’s a need or a want. In an ideal world, a need is something you must have to survive and everything else is a want. But in reality, to determine if something is a need, ask yourself: am I willing to sacrifice other things in order to pay for this item? If the answer is yes, it’s likely a need.

But remember – not everything can be a need!

Adjustments

As you build your spending plan, you may find that your expenses are nowhere near the 50/20/30 recommendations. How you adjust your budget will depend on your goals and priorities.

Step Four: Implement

Now that you have your plan, it’s time to put it into action. To hold yourself accountable, you’ll want to choose a system to keep track of your spending to make sure you’re sticking to your goals. You’ll want to choose the method that works best for you:

Paper and Pen

Traditional and simple, yet effective. Use paper and pen to write down your expenses and build your budget.

Envelope System

With this method, you have different envelopes for different categories of your budget. When you get paid, you withdraw cash and divide it into envelopes according to how much you have budgeted to spend for that time period.

For example, you’ve budgeted $200 for groceries for the month. When you get paid, you count out $200 cash and put it into the Grocery envelope. Throughout the month, you use the cash in the specific envelope for any grocery purchase. Once the money in the envelope is gone, you can no longer spend money on groceries.

While this is typically done with cash and envelopes, there are ways to set up an envelope type system in personal financial management apps and websites.

Spreadsheet

Another method to build a budget and keep track of expenses is using a spreadsheet. While it might require more time to set up and maintain, you have more flexibility and control in how you build your budget and track your expenses.

Personal Financial Management App/Website

Using an online Personal Financial Management (PFM) app or website, such as myFinance, is a convenient way to build and follow a budget. With a PFM, you allow the app/website to have access to your financial accounts. They will then aggregate your spending data and account information into one location.

You can set up specific budgets, sort and categorize expenses from across checking and credit card accounts, and set up notifications for when you’re reaching your budget limits.