Most everyone can agree—money is a stressful topic. It’s hard enough to think about managing your own money if you’re single, and bringing up money issues in a couple’s relationship can definitely be a mood-killer since it’s far from sexy or romantic.
Thinking about your monthly spending habits and planning areas of improvement are probably not your idea of ways to spend a fun afternoon. Because of this, thousands of Americans choose to remain ignorant of their overarching financial activity each month rather than face it head-on.
However, did you know that creating a budget can actually ease your anxiety about money and give you greater financial freedom?
Read ahead to learn more about budgeting, why it’s essential, and how to create a stress-free budget you can follow.
What is budgeting?
Budgeting is the process of planning your financial activity over a defined period, such as one week, one month, or one year. Good budgeting is spending less than you earn, leaving you with discretionary income to put toward savings or “fun” expenses.
Budgeting allows you to compare your income against your expenses so you can create a healthy balance between the two. It also enables you to keep track of your spending habits and make any necessary adjustments to your activity.
Although many people view budgets as restrictive—limiting your spending and penalizing you for overspending—budgets actually permit you to spend your money. Many budgets divide your income into “needs,” “wants,” and “savings”—and you can choose how much money goes into each category. You have total control over your budget.
Budgeting helps you feel more comfortable with your spending rather than restricting your financial freedom. Instead of feeling guilty about every shopping trip or fast food run, budgeting can give you confidence that your “wants” fit into your budget just like “needs,” and that your monthly credit card bill won’t catch you off guard.
Why do I need a budget?
If you don’t currently have a budget, you may be thinking that you don’t need one—after all, you’ve made it this far without putting too big a hole in your bank account. And perhaps you have a general idea of your spending habits and how your income and expenses align, so you don’t need to analyze that information too closely.
In reality, everyone can benefit from budgeting— no matter how much money they have, what kind of lifestyle they lead, or how careful they are with their spending. Creating a budget can have several advantages, both for your bank account and your well-being.
First, budgeting can help you feel more confident about your income-to-expenses ratio. Seeing your long-term financial activity may help you realize that you have more disposable income than you thought. It might also encourage you to change your spending habits in one category to reflect your income better.
Budgeting also helps you plan for the future. Intentionally putting money into a savings or retirement account provides you with a more ample cushion to fall back on once retirement rolls around, and it gives your bank account some leeway in case of an emergency.
“Surprise” expenses like car repairs or medical bills will no longer put a wrench in your account once you’ve factored them into your budget. You also will not have to sacrifice money from other expense categories when these unexpected payments come around—and trust us, they will come around eventually.
Finally, budgeting allows you to feel more in-control of where your hard-earned money goes each month, eliminating some of the stress that comes with checking your bank account balance. It ensures that you’ll always have enough money for necessary expenses, keeping you out of debt and traveling down the road to financial freedom.
For many people, creating a budget and sticking to it is intimidating. Whether they struggle to cut down their monthly coffee runs or have higher expenses than they care to admit, they’d rather not look their poor spending habits in the face.
But not wanting to create a budget is the same concept as neglecting to go to the doctor because you don’t want to hear them to tell you something is wrong. In reality, going to the doctor could ease your anxieties altogether, and if something is wrong, the doctor could catch the problem before it might worsen.
What is a good way to budget?
Financial planners have hundreds of contrasting opinions about how to budget well. In general, sticking to these tips will leave your budget in an excellent position.
Create a savings goal
Sticking to a budget is easier when you’re working towards a tangible savings goal rather than a general mindset of financial responsibility.
Perhaps your goal is to save enough for a down-payment on a house, pay off your student loans in one year, or buy that new car you’ve been eyeing. The goal may also be less exciting, like putting a specific amount in your retirement account each month.
Either way, research has shown that setting goals leads to higher motivation, self-confidence, and autonomy. Working goals into your overarching budget can help you feel better about your spending and be more likely to stick to your plan.
Keep it simple
Many people choose not to create a budget because they think it will be too complicated for them to understand. They picture complex spreadsheets, charts, and formulas filled with percentages and monetary amounts—which would be overwhelming to anyone.
However, because you control your budget, you can decide how complicated or simple to make it. We recommend starting on the easier side, dividing your income into a few manageable categories. You can always add more detail down the road.
Utilize an automatic spending tracker
No one wants to waste time inputting every dollar they spend into a spreadsheet or budgeting app. One primary reason that many people neglect to create a budget is laziness—budgeting feels like work, and it’s easier just to cross that chore off your list altogether.
We live in a digital world, and most of your spending is probably digital as well. One way to make budgeting less time-consuming is to utilize an automatic spending tracker that monitors your digital spending habits. These apps and programs link to your bank account and organize all of your spending into categories, comparing expenses to income.
Automatic trackers ensure that you do not overlook any area of your spending. They also prevent you from purposefully leaving purchases out of your budget.
Develop a designated “spending account“
An easy way to keep track of your discretionary spending is to designate a bank account as your “spending account.” Some people utilize their checking accounts for spending, while others open a separate account into which they transfer a predetermined amount each month.
Using a designated spending account allows you to see how quickly your money dwindles from your paychecks. It also makes it easy to check how much discretionary income you have left near the end of the month, preventing you from overspending.
Live below your means
Finally, although this is not a tip about budgeting in itself, this recommendation affects how easy or challenging your budget will be: Live below your means. If you can afford to spend 50% of your income on necessities, spend 40% instead. If you make enough money to live in a $1,000 apartment, look for ones in the $900 to $950 range.
No matter how much money you make, allocating your income into a budget can be stressful. Living below your means will allow you to create a cushion for months that you overspend and feel more confident about your financial activity overall.
What are the 5 steps to creating a budget?
Now that you’ve learned more about the importance of budgeting and a few tips to keep in mind, it’s time to break it down step by step. Here are the five easy steps to creating a budget:
Examine your income
Before you can understand how much you should be spending each month, you need to have a solid grasp on your total income. Your gross income is your total earnings before taxes, while your net income is your take-home pay after taxes (plus any other sources of income you may have). We recommend factoring your net income into your budget to leave room for taxes.
Most people prefer to plan their budgets for one month at a time, so you should calculate your net monthly income.
Incorporating salary or invariable hourly income into your budget
If you work a salaried job, your employer likely expresses your salary in terms of an annual gross figure. To calculate your after-tax monthly income, we recommend looking at past pay stubs. If you get paid weekly or bi-weekly, it might be easier to budget in four-week periods instead of full 30-to-31-day months.
If you work an hourly job with regular hours—meaning that each of your paychecks looks identical— you can also use past pay stubs to calculate your monthly income.
But if you have variable income—that is, you work a freelance position or an hourly job with irregular hours—calculating your monthly earnings may be more challenging.
Factoring variable income into your budget
To best understand your monthly income from an irregularly paying job, we recommend gathering all of the pay stubs and bank account deposits you can find from the past six months.
Add up your earnings from each full month, then identify your lowest-paying month. We recommend using payments from this month as your baseline income to ensure that you stay within your budget during future low-paying months.
Using your lowest-paying month as a baseline will inevitably leave you with extra earnings during most months. We recommend putting these earnings toward savings and financial goals rather than “fun” expenses.
You may also decide to put your additional earnings in a separate account that you can use to supplement your income during low-paying months or times of unemployment.
If your employer does not take taxes out of your paycheck—if you are a freelancer, for example—you should set aside 25% to 30% of your income to pay your taxes. The monthly earnings you use in your budget should be your after-tax earnings.
Adding additional earnings
Many people receive money from sources outside of their full-time jobs. This income may come from:
- Child support
- Side hustles
We recommend only factoring these earnings into your budget if they are consistent from month to month. For instance, if you receive a set child support payment each month, add this money to your monthly income. If you receive commissions based upon performance, leave those earnings out of your net income.
At the end of this step, you should have identified a fixed monetary amount representing your monthly income. To simplify the budgeting process, be sure to use the same number each month and only adjust if you receive a pay-raise, pay-cut, or a new fixed-income source.
Calculate your expenses
Now that you know your monthly income, the next step is to calculate your expenses.
Most people have both fixed expenses and variable expenses. Fixed expenses cost the same amount each month and include categories such as your rent payments, insurance, cable, utilities, and regular medications. Variable expenses are any other items you spend money on each month, ranging from groceries to restaurants to gas.
Identify fixed expenses
First, make a list of all of your fixed expenses. Look at your credit card statements and bills to identify each of these monthly costs, then write them down with the amount you pay for them.
Along with expenses like rent and insurance, you may also have recurring costs that fall into your “fun” or other spending categories—such as Netflix, subscription boxes, or meal services. Add these to your list as well.
Now is a great time to consider whether you can eliminate any of your fixed expenses from your budget altogether. Staring them down in one list may make you realize that you don’t really need three different streaming services, a weekly meal box, and two video game subscriptions.
Once you finish this step, you should have a comprehensive list of your fixed expenses that you will eventually incorporate into your budget.
Estimate variable expenses
Next, look through your credit card statements and begin listing your variable expenses from the past six months. Make one list for costs that tend to show up each month but vary in price—such as groceries, gas, fast food— and another list for one-off purchases.
Be sure to record the date of the transaction and the amount you spent on each expense as well.
Organize your expenses into categories
As you make your lists, you should begin noticing some trends representing what categories your spending often falls into. These categories may include:
- Personal items
- Surprise expenses
Do your best to separate all of your expenses into more manageable categories, even if you have to make an “other” section.
Now is also an excellent time to determine all of your debt—student loans, credit card debt, mortgage, etc.— so you can factor these payments into your monthly budget.
Then, add up the amount you spent toward each of these categories (including debt payments) every month over the past six months. You should have six total amounts for each category—one for every month.
Calculate your average spending for each category by adding the total from every month and dividing this number by six. Then add these category averages together to determine your total monthly expenses.
(Note: If listing your expenses from the past six months seems too overwhelming, focus on the past two months instead. Though six months will give you a more accurate average, two months will still provide you with a decent picture of your spending).
You should now have a basic understanding of how much money you put toward all of your expenses each month. Knowing where your money is going will put you in an excellent position to plan your future spending.
Compare your income against expenses and look for areas of improvement
The most time-consuming, tedious budgeting steps are over, and now it’s time to begin developing your spending goals.
First, let’s take a look at how your income compares to your spending. Grab your monthly income amount from step one, and your total monthly expenses amount from step two.
Is your income higher than your expenses? Great! You’ll have more flexibility when it comes to planning your budget.
Is your income about the same as your expense? Not bad! Your budget will help you lower your spending so you can start to save some money each month.
Is your income lower than your expenses? Okay, it’s a wake-up call that you need to alter some of your spending habits. A budget will help you adjust your spending to reflect the reality of your income better.
No matter what position your spending habits are in, there is always room for improvement. Now is the time to think about how you can adjust your spending to maximize savings and best allocate money toward needs and wants.
Think back to when you made your expenses list. Did any aspects of your spending surprise you? Maybe you spend more on fast food each month than you realized. Perhaps your grocery bills are much higher some weeks than other weeks. Or maybe you didn’t know how much money you spend on entertainment or impulsive personal spending each month.
You may also use this time to consider how you might optimize your debt repayment. If you’ve been making the minimum payments for the past few months, consider how you could adjust your spending to begin putting more money toward your debts and pay them off faster. Making only the minimum payment on debts will keep you in a vicious cycle rather than moving you toward paying those debts off.
Looking for areas of your spending where you want to improve. Pinpointing these will help you cater your goals to your specific financial needs.
Create realistic yet challenging financial goals
Now you can begin planning how you will budget your money to best suit your spending categories. You should take your total monthly income and divide it into your expense and savings categories to determine your spending goals.
One easy way to create spending goals is to determine a monetary amount to stay below for each of your expense categories. Look back to step two, where you found a monthly average for each of your spending sections. Perhaps your goal will be to decrease spending in each category by 10%, then put your excess funds toward debt repayment or retirement savings.
You may also consider trying to stick to the 50/20/30 rule of spending—we’ll talk about this plan more in-depth later.
At the end of this step, you should determine a spending goal for each of your expense categories, along with monetary amounts you will contribute to savings, debt payments, and retirement each month.
You want your spending goals to be both realistic—or easy enough that you know you can stick to them with a little work—and challenging, so that they encourage you to spend less and save more than you currently do. However, ultimately your goals are up to you—you know your habits better than anyone.
Put your plan into action and adjust as needed
Congratulations! You’re all set to begin following your new budget! Try it out for a month, and do your best to stick to each of your spending limits and savings goals. At the end of the first month, take time to readjust your plans as needed.
You’re now on the right path to financial freedom—you should be proud.
How do I make a monthly budget?
You now know all the steps to creating a straightforward budget, so the next stage is to put all that new knowledge into action. Follow along as we make a sample monthly budget for our imaginary pal Bill— you can switch out Bill’s expenses and income for your own.
Bill is a freelance musician who makes about $750 a week from performing at restaurants in his area. However, three months ago, he had a low-paying period where he averaged just $690 a week. We’ll use this amount as a baseline for Bill’s income.
Because Bill does not take taxes out of each paycheck, he subtracts 25% from his baseline income to pay his taxes in April. He puts that money in a savings account from which he pays his taxes. His new after-tax baseline is then $517.50 a week. Multiplying this number by 4 gives him “monthly” (i.e., four-week) after-tax earnings of $2,070.
Bill spends some time looking through his credit card statements and bills. He finds that he currently spends an average of $1,300 a month on fixed expenses and $500 on variable costs. His spending falls into these categories:
- Housing: $600
- Utilities: $100
- Food: $400
- Clothing: $30
- Debt: $100
- Transportation: $300
- Personal items: $70
- Entertainment: $100
- Gifts: $20
- Surprise expenses: $80
He currently spends about $1,800 a month, putting him just below his monthly income of $2,070.
Bill also examines his student loan debt and finds he has $10,000 left to repay.
Bill sets a goal of saving $400 each month, which is about 20% of his income. He decides to cut down his food budget to $350 a month, decrease entertainment to $70, and minimize his transportation costs to $250. Altogether, those changes will allow him to now save at least $400 a month (depending on his income), which he can put toward retirement and debt repayments.
His new budget looks like this:
- Housing: $600
- Utilities: $100
- Food: $350
- Clothing: $30
- Debt: $100
- Transportation: $250
- Personal items: $70
- Entertainment: $70
- Gifts: $20
- Surprise expenses: $80
He will try not to exceed these spending goals throughout the month.
Notice that Bill has no category for health insurance or medical expenses. If he should have an unexpected illness or accident, he would need to depend on his savings to cover those costs. His savings account would also be his emergency fund in case any other unexpected large expenses suddenly arose.
Of course, Bill’s financial situation is probably more straightforward than yours. But following these steps can help you make a rough monthly budget and begin saving more than you currently are, making it well worth your time and effort.
If you find yourself regularly spending less than you have budgeted in each of your categories, you may have “free dollars” leftover at the end of the month with no plan or purpose.
We recommend putting most of this additional money toward savings (see our priority savings list in the 50/20/30 section) and using a few dollars to treat yourself. You worked hard to stick to your budget, and rewarding yourself will make you more likely to stick to it in the future.
On the other hand, you may find yourself exceeding a few budget categories each month. Here are a few common pitfalls that may lead you to not meet your monthly budget:
- Spending spontaneously without referencing your budget
- Creating unrealistic spending goals
- Not tracking your spending as you go
- Not adjusting your budget as needed
If you frequently exceed your budget, try to identify the root of the issue. Are you spending too impulsively, or is your budget unrealistic? Make adjustments to your spending and your budget as needed.
How do I follow the 50-20-30 budget rule?
Many consumers follow the 50-20-30 rule of thumb when creating a budget. This rule allocates 50% of your post-tax income toward “needs,” 20% toward your financial goals, and 30% to “wants.”
Though this rule seems straightforward, categorizing your spending into “needs” and “wants” may be more challenging than you expect. What you currently view as a necessity may actually be an expendable purchase.
Let’s look at how you can utilize this rule to help meet your savings and spending goals.
50% on needs
Needs are bills and expenses that you must pay each month that are necessary for your survival and well-being. A few standard necessities include:
- Rent or mortgage payments
- Car payments
- Doctors’ visits
Some of the expenses you view as “needs” may actually be “wants”— for instance, although groceries are necessary for survival, frozen dinners and pre-packaged snacks are more expendable than meat and produce.
To best classify expenses into your “needs” category, narrow down your monthly bills to those that would drastically alter your quality of life if they disappeared. Your house and car are necessities, but could you live without a gym membership or music streaming service?
If you find that your “needs” exceed 50% of your income, you may be living above your means. Think about what expenses you could cut from this category, and if you can’t find any, you may need to dip into your “wants” to make ends meet.
If your “needs” make up less than 50% of your income, you can allocate the remaining percentage to other areas of your budget. We recommend putting the remainder toward savings rather than “wants.”
20% on financial goals
Next, you should allocate 20% of your income toward your financial goals. These may include:
- Debt payments
- Emergency funds
- Major purchases
Financial planners recommend contributing funds to your financial goals in this order each month:
- Starter emergency fund: Having money set aside in case of an emergency is crucial to living a financially sound life. Start with a goal of saving $500 for emergencies, then contribute a bit more each month until you have saved the equivalent of three months of income. Unfortunately, layoffs are common, and you want to feel confident that you could get by for a few months on no or limited income.
- Toxic debt: Once you set aside a chunk of your 20% toward emergencies, your next priority is to pay off toxic debt. Toxic debt is any loan with an incredibly high interest rate that limits your ability to pay it off in full. Prioritizing these payments is essential, as procrastinating on them can require you to pay double or triple what you borrowed.
- Retirement: Many people, especially those in their 20s or 30s, fail to prioritize retirement savings in their financial goals. However, putting money toward your retirement is a crucial way to invest in your future. Begin by matching your employer’s 401K contributions each month, then consider investing in an Individual Retirement Account (IRA). In total, financial planners recommend setting aside 15% of your gross income toward your retirement.
- Debt repayment: If you have student loan debt, a mortgage, or low-interest credit card debt, you may decide to use some of your 20% to make payments above the minimum monthly requirements. However, because debt repayment is lower on the priority list, be sure to contribute the most money to the above categories.
- Personal savings: Once you have an adequate emergency fund, are debt-free, and contribute regular amounts to retirement, you are in an excellent position to begin setting money aside for personal savings goals. Major purchases, like home renovations, a new car, a home gym, or vacations fall into this category.
It’s not enough to just plan your financial goals to utilize 20% of your income—you should sit down and allocate your money into your goal categories each month.
30% on wants
“Wants” are any expenses that do not fall into “needs” or your financial savings goals. But take caution—”wants” are not only fast food runs, toys, and shopping trips. They may also include expenses like
- Cable or streaming services
- Gym memberships
- House renovations
- Optional clothing expenditures
- Unnecessary grocery or household items
You may be spending more money on “wants” each month than you realize, and perhaps your monthly fun expenses surpass the 30% mark.
Think about how you can cut down some of your wants to meet this goal better. Perhaps you can switch to a more affordable streaming service or gym membership, eat at home more often, or purchase cheaper grocery choices.
If you find yourself spending less than 30% on “wants,” place any excess income into your savings category.
Should I use a budgeting app, a spreadsheet, or a physical notebook?
Apps, spreadsheets, and physical notebooks all work well to keep track of your budget. Whichever method you choose, we recommend keeping your budget within reach so that you can easily reference your spending goals and track your progress throughout the month.
How often should I update my budget?
We recommend updating your budget in two instances: if you are consistently overspending or regularly underspending. If you struggle to stick to your budget, adjusting it slightly may help. And if your budget is too easy to follow, you should challenge yourself to save more each month.
Do I need to have a consistent income to make a budget?
If you do not have a consistent income, you can still make a rough budget based on your lowest monthly earnings from the past six months. However, you will likely have to be more flexible with your savings goals to reflect your income from the month.
Budgeting may seem like a scary, stressful topic, but in reality, it can make your life a whole lot easier.
Remember, you are in control of your budget. Every financial decision you make either benefits or hurts you (and your spouse or family members). You get to decide where your money goes each month, and a budget is simply an illustration of that plan.
Finally, exceeding your budget is not the end of the world. It happens to everyone. But the best budgets leave room for financial mistakes or the occasional overspending. If you find yourself exceeding your budget, forgive yourself and try to do better next month—your account probably will not suffer too much.
It’s time to take control of your finances and start down the path toward financial freedom. Start planning your budget today to experience the peace of mind it can bring you tomorrow—and for the rest of your life.