Building a budget is one part diligence, one part creativity, and one part discipline - and all three components must be sustainable after the budget is complete and the hard work of making a budget plan stick arises.
That's not easy for Americans who may be cash strapped and unable to build a proper budget that allows them to pay all of their bills and still have money left over at the end of the month.
Yet if you build a solid budget, one that accounts for every dollar coming into your bank account and every dollar going out, your chances of a better quality of life increase, as you'll soon find that a good budget can be a game-changer in your personal financial life.
How does a normal household budget work? It's pretty simple.
Primarily, all budgets are divided into income and expenses, but most good ones now include a third component, savings. Items in the "income" section can include after-tax salary, part-time work pay, investments and tax refunds. Items in "expenses" can include rent, mortgage payments, food, gas, utility bills, childcare, entertainment, gifts and holidays.
A good "savings" section logs how much cash you stash away each month, after accounting for spending requirements.
How to Make a Budget
Let's face it. Building a household budget is about as much fun as a root canal. But like serious dental work, having a budget isn't a luxury. It's a necessity.
The key to getting your budget rolling is with a good step-by-step road map - get that job squared away with these seven steps:
Step 1: Get a Grip on Your Monthly Income
Step one here is critical - you'll need to collect all of your income and, ideally, pop it into a household budget spreadsheet. On that spreadsheet, list all of your monthly income, including take-home pay, any rental or investment income you've earned, tax payment returns, or additional income from a moonlighting gig. If your income varies from month to month, just use the average of your last three months of income. Once you have it all added up and have a final figure, set it aside for now.
Step 2: Add Up Your Debts and Expenses
The second step is part and parcel with step one - add up all of your expenses and monthly debt. This is the sum of money pouring out of your household budget each month. Typical expenses include the following:
- Rent or mortgage.
- Phone and cable.
- Groceries and toiletries.
- Health care expenses (including insurance.)
- Home servicing expenses (like housekeeping, lawn care, or other regular home and property servicing.)
- Any educational expenses, like college costs.
- Credit card debt.
- Auto loan payments.
- Gas, oil and regular auto maintenance, if applicable.
- Other transportation costs (buses, trains, Uber rides.)
- Entertainment costs (i.e., dinner, other meals out, cocktails, and movies.)
- Clothing and accessories
The idea with listing expenses is that you want to focus on a regular amount you're spending every month. In general, things like mortgages and health care insurance costs are fixed, while new clothes and groceries are not. If you struggle to land at a final monthly "expense" figure, once again, average out your expenses over the last 90 days and you'll wind up with a good ballpark figure on debts and expenses.
Now, take your final debt and expense figure and deduct it from your final monthly income figure. The leftover sum is your household net income, on average, every month.
Step 3: Establish Long-Term Financial Goals
Now that you know your expenses and your income, and have a final net income figure, the goal now is to figure how to improve that net income number and push it upward.
A concrete financial goal can be a big help. Let's say your net income on a monthly scale stands at $1,000. Setting a goal of $1,500 within a one-year time frame gives you a figure to aim at, and gives you the impetus to cut costs or add income to meet that one year figure.
Step 4: Figure Where to Cut Costs and Aim at "Discretionary" Income
The most rock-solid way to boost your household net income is to cut costs - especially discretionary spending. In a word, discretionary spending is the money you spend, but you didn't have to spend. Think about clothing, happy hours with your friends, spending too much on groceries, spending too much on pay-per-view cable movies - things like that. Discretionary spending isn't mandatory spending, i.e., fixed costs on big-ticket personal financial items like rent, mortgage, or health care spending.
Sometimes, you can move a mandatory spending item into discretionary spending or remove it from your household expense category altogether. For example, getting rid of a credit card, cable television or selling your car and using a bike instead can save you big bucks, and any of the above expenses aren't mandatory spending at all, as you didn't need the credit card, cable TV or an expensive vehicle in your daily life.
Step 5: Figure Out How to Add to Your Monthly Income Number
Just as you need to be creative in cutting debt and expenses, you need to be crafty about adding to your monthly household bottom line. Can you earn money in a sideline gig like driving for Uber or Lyft? Can you buy and resell items on eBay EBAY or Amazon AMZN for a profit? Can you take in a roommate or tenant? Can you downsize your home? Can you get a better paying job? Find another online job? Think long and hard about where you can add money to your budget, and act accordingly.
Step 6: Put It All Together
Once you've identified budget items that could and will be cut, and figure out ways to add income to your household budget, implement the plan and begin reaping the rewards. Meet with your spouse or family members and make sure you're on the right track and that you're on the way to meeting your budget goals. Make adjustments, as necessary, and don't get discouraged if the process goes more slowly than expected. Remember, the idea is to have a plan, set a goal, implement the plan, and keep moving forward on all budget improvement fronts. Do that and you'll see solid results sooner and later.
Step 7: Get a Financial Adviser
The last step? As you track and monitor your spending, gaze further into the future and have a trusted financial planner or adviser help you see 10 or 20 years down the road. As your budget begins to reap serious dividends, start steering more of your added net income to long-term savings for a comfortable retirement. Yes, there will be roadblocks and unanticipated expenses along the way, but a good financial professional can aid you in navigating any choppy financial waters, and help you land safely where you want to be a few decades down the road.
Why Should I Make a Budget?
Your budget allows you to track your expenses so you know exactly where you can cut and how much you can save to reach your financial goals. That helps keep your finances in line and sets the stage for major improvements in your financial life.
This is especially critical for younger consumers just getting started in life.
After all, 20- and 30-somethings can easily find themselves at a financial crossroads early in adulthood. Paying off student loans, starting new families, businesses, buying first homes, and trying to save for the future - all can put wear and tear on a household's financial fabric.
The formula for getting through that crossroad intact and thriving is a personal budget. Remember, achieving real wealth creation is not what you earn or how you invest - but what you spend and how much you save. And that means having a budget, even early in life.
For adults at any age, though, the key is to think of your budget as a three-legged stool.
- Leg #1 - Identify your spending habits
- Leg #2 - Identify the holes in your budget
- Leg #3 - Develop a savings and spending plan
The takeaway? Life's little extras are well within reach for those who know how to budget. But it's the big picture is where a budget counts.
Five Helpful Budget Tools
Use these digital financial tools to help build your budget.
- Mint. This online budget tool syncs all your expenses and debts and puts it all in one place.
- Acorns. This online tool automatically rounds up your purchases and invests in the spare change.
- You Need a Budget. This mobile app helps you learn how to live on last month's household budget. It does cost $6.99 per month, making it a tool for the serious budget user.
- PocketGuard. This personal financial app gives you a snapshot of what you're spending at any given moment, giving you the incentive to cut your spending.
- Prism. This digital savings tool specializes in organizing and paying your bills for you - all on one platform.
A Few Last Budgeting Tips
Use these tips to enhance your budgeting-building experience:
- Time is on your side: Create and manage your budget every month. Or better yet, build a budget that's based on how often you get paid.
- Keep cash to a minimum: Carry only as much cash as you need today in your wallet so you won't spend it. Also, leave your debit card at home if you don't see a need for it.
- Be an early bird: Pay bills on time - or before they're due. Your lender, creditor or service provider likely offers email or text-message services that alert you when a statement gets issued and when a due date's near. Set it up for automatic payment and avoid pricey late fees.
- Set limits on your credit card. Your credit card provider can lower your credit ceiling for you, thus limiting spending - and debt. A better bet - cut your credit cards up completely.
- Be realistic: Don't underestimate what you spend. Figure in lunches that you eat in restaurants, movies, Netflix (NFLX) downloads, and other "extra" expenses.