You know what a budget is and why it's important to have one, and you're familiar with tracking methods and different budgeting strategies. Now what about actually applying all of it? If you're feeling the crunch of information overload, rest easy. We've combined all the details into six steps you can take to create a budget that works for you.
1. Gather Financial Documents
Set yourself up by corralling all your financial info first. Taking a minute to get things together now will save time later in the process. Items you'll need to reference include:
- Tax forms such as W-2s and 1099s
- Bank statements
- Statements for all of your monthly bills
- Receipts (preferably from the past three months)
It helps to have one place in your home and/or on your computer where you store all these documents. You don't need a home office — a simple folder labeled with the year will do. Keep it in a kitchen drawer, your bedside table, or anywhere else within easy reach.
2. Research and Select a Budgeting Strategy
For example, try one budget strategy for a month to see if you'll be able to keep at it. If not, try different strategies until you find one that you can feasibly implement for the foreseeable future.
It's important to choose a budget that you know you can maintain. If your budget always falls short of your ambitions, you're going to feel defeated as the months drag on, and that's going to hurt your motivation.
And don't worry too much about what everyone else is doing — your life, your budget.
3. Determine Your Income
Once you've settled on a strategy, use your documents to add up all of your monthly cash inflow, which may include full-time paychecks, side-job earnings, and any other sources of income.
Your net income — the final take-home pay listed on your paycheck — is the amount you'll use when calculating your income. This is the amount left after deductions for taxes and Social Security.
Part-time workers, freelancers, and others who earn an irregular income may have different factors to consider when budgeting — you might need to look at your monthly average from three months of pay or go by your lowest monthly income to start with.
4. List Out Your Monthly Expenses
Dividing your monthly expenses into fixed and variable costs is an easy way to categorize your spending. Fixed means the expense is the same every month (rent, mortgage, car insurance) and variable means the expense may be different from month to month (groceries, electric bill).
To review, some common fixed costs, which stay the same month-to-month, include: rent or mortgage, loan payments, and insurance.
Common variable expenses, which may increase or decrease monthly, include: groceries, utilities, transportation, and entertainment.
5. Stick to Your Goals
While figuring out your budget preferences, do keep your eye on the prize. Working toward your goals can help build your financial security and know-how.
Short-term goals generally take between one to three years to reach and may include saving up to:
- Pay off student loan debt
- Open and fund a 401(k) or IRA
- Take a vacation
- Complete home improvements
- Fix your car
- Take a course or go back to school
Long-term goals don't necessarily have a time frame, but require continual contributions toward investments such as:
Reaching your goals is not only exciting and rewarding, but also opens up space for you to set new ones.
6. Adapt Your Budget as Needed
If you find it hard to meet your budget goals each month, try dividing your goals into smaller steps and working toward one small step at a time. Follow the old contractor's adage: under-promise, over-perform. Adjust your budget as you complete each smaller goal.
Setting a slightly less ambitious goal (even just temporarily) means you're more likely to exceed your own expectations, which in turn will boost your confidence, leading to better focus and determination in general.
If and when your income increases or your expenses decrease (like once you finish paying off a credit card or loan), feel free to adjust your budget again.
In general, staying fluid will help you ride the ups and downs with grace.
If, after budgeting, you don't have any extra funds, examine your variable spending to see if there are ways to cut back or make adjustments. Do you have subscriptions or memberships you could cancel? Could you cook at home more often? Maybe you could walk or bike to work or school instead of driving? If you have the time in your schedule, add a side-hustle and direct those funds to one specific goal, like saving for a trip.