How to Budget Money 101 was written by Kristian Borghesan, and originally appeared on Wealth of Geeks. It has been republished with permission.
Budgeting. The nine-letter word in personal finance either excites you or conjures up images of torture. Regardless of whether you’re excited, terrified, or lost somewhere in between, there’s something we can all agree on here.
It’s that budgeting exists for one simple reason—because it works. But exactly How to Budget Money so you can reach your financial goals and enjoy life? This is the Way.
How to Budget Money: Common Roadblocks
So, we know and agree that budgeting works. We also know that we should be budgeting ourselves, even just a basic amount. Yet, a good amount of us doesn’t practice what we preach ourselves. This is usually either the result of one of two things:
1) A lack of commitment to being consistent with budgeting; or
2) Not fully understanding how to budget money or where to start.
If you’re here for either of those, you’re in good hands. But if you’re here, mainly because you’re not sure how to budget money and you’re looking to understand budgeting in more detail, then pat yourself on the back because you’re absolutely in the right place.
After reading this article, you’ll have a better understanding of how to budget money easily so that you can spend less, save more for your goals with sinking funds, and continue improving your money habits along the way! Here’s what you learn:
- What a budget is and why you should have one
- How to budget money and how you can easily create one
- Popular budgeting techniques used by some of our favorite personal finance experts
Ready? Let’s get to it!
How to Budget Money Part I: What is a Budget and Why Should You Have a Budget?
What type of ‘101’ article would we be if we didn’t at least include a basic definition of what we’re actually talking about, right?
What is a budget, seriously?
Cheques and bills.
Inflow and outflow.
Incoming and outgoing.
Income and expenses.
You get the point…
All of the above provides an extremely simplified view of how to budget money. It gives a snapshot of your income and expenses against one another over a period of time. But the above is still way too basic for our own good. So let’s try this.
Budgeting is a financial exercise highlighting your earning, spending, and saving habits. It provides you with an overview of exactly how much money you’re making, how much money you’re spending, and how much money you’re saving over a specific period of time.
While budgeting is commonly done monthly, it can be weekly, bi-weekly, quarterly, annually, you name it. You’re in the driver’s seat there, depending on how disciplined and committed you to want to be.
Do I seriously need a budget, and why?
In short… Yes, you do for several reasons.
Above all, here’s, at least in our view, the best part of any and every good budget; you gain an incredible amount of insight into your finances almost immediately by knowing right away if you’re bringing in enough income to cover your expenses and save money, or if you’re out of control and spending too much money.
You get value out of budgeting almost right away, which is why it’s always regarded as a ‘must-do in personal finances.
Your budget can and should help you identify where you’re spending too much of your hard-earned money. But, at the same time, it can also help you identify how you can better put your money to work for you. So what exactly does this mean?
Essentially, having a ‘budget’ makes it easy to create a spending plan so that you can make sure you’re staying within your limit, so to speak. It also allows you to understand better and have a clear view of how you can save more money, pay down debts such as credit cards or student loans, or even look at tucking away additional money for an upcoming family vacation. After all, you work hard for the money, and your money should work hard for you too.
It’s important to keep this in mind; A good budget provides as much detailed and accurate information as possible regarding your spending habits and income.
As is the case with pretty much everything else in our lives, budgeting requires commitment and practice. That’s the winning recipe.
How to Budget Money Part II: How Do I Make a Budget? What are the Steps Involved?
The good news is that creating a budget isn’t the hard part; sticking to it is where most people fall short. We’ll quickly spend the next few minutes going over the main parts of how to budget money so that you feel like you can finally do this.
Step 1: Totalling your income
While there’s no particular order for how to budget money, per se, this really comes down to personal preference. For me, personally, the first step has always been calculating my total income before even worrying about my expenses.
For these next sections on how to budget money, let’s assume we’re looking at things monthly.
The reason why I like to start with totaling my income is that it’s usually relatively easy. For the most part, there should be zero, or hardly any, surprises (both good and bad!), and you might even be able to accurately nail down your monthly income off the top of your head.
As you start adding up your income, keep in mind that any amount of money coming in from any source is considered your income. Most people add up their full-time employment earnings and then end there. But if you’re taking on side gigs or working part-time anywhere else, those are all important considerations that absolutely need to be included when calculating your income. Full-time income, part-time income, and anything related to contract-type work can all be considered active income.
Don’t forget to include passive income sources as well. These typically include money regularly coming in from real estate (investment properties) or even investments that have you regularly earning dividends every month, as an example.
Once you have all of your income added up and categorized based on the type of income, it’s time to move on to step 2 of how to budget money.
Step 2: Totalling your expenses
Now we get to the meaty part that most find stressful. In all honesty, this part can actually be enjoyable, even if you’re noticing that you’re spending way too much on meaningful things. The silver lining is that it’s often the start of knowing exactly how powerful and useful a budget can be. It’s eye-opening in ways you wish it weren’t at times!
One of the most overlooked outcomes here is not that totaling your expenses indicates just how much you’re spending, but that it provides actionable insight to help you understand how and where you should be allocating your hard-earned money.
Not sure where to start? No worries. When you begin examining your expenses, start by dividing them into two types of spending/expense categories: fixed costs and variable costs. You might commonly see others split this up into wants vs. needs. Again, however, this comes down to personal preference.
So what exactly are your fixed costs? Think of these as expenses that are just always there every month and are usually always the same amount or similar each and every month—your rent or mortgage, your car payments, phone and utility bills, and even student loans.
As the name suggests, your variable costs, on the other hand, are expenses that are variable or change from month to month. You’ll soon realize that it’s often your variable types of expenses that are usually (not always) the easiest ones to trim down or even eliminate altogether. For example, expenses like entertainment, travel, clothing, and dining are all considered variable expenses.
Now that we’ve got that covered, here’s how you can start calculating those expenses above. First, pull every bank statement, receipt, and bill from the last three months and start recording down any and every type of expense, breaking them out into those two categories above; fixed and variable expenses. From there, you can drill down into additional spending categories such as housing, travel, business, personal, etc., all of which give yourself even more insight into how you’re spending.
I’m suggesting three months to start with because it helps define a good baseline where you can take the average total spending from your most recent three months. By no means do you have to follow this; it just helps you get started.
Step 3: Let’s calculate!
And now… it’s time we’ve all been waiting for! It’s time for you to actually “calculate” your budget. Again, the calculation is quite simple. By minus your total expenses (calculated above in step 2) from your total income (calculated above in step 2), you’ll arrive at a number that’s either in green or red, so to speak.
You’re in the green if… your income is more than your expenses.
You’re in the red if… your expenses are more than your income.
Step 4: Create your spending plan
Based on the numbers above and whether you’re in the green or red, you’ll be able to create a spending plan according to your priorities.
The insight you’ll gain by knowing whether or not you’re in the green or red , along with exactly how or where you’re spending your money, can and will help you understand how and where you should be allocating your money.
For example, if you’re earning more than you’re spending, you’re in a good position to prioritize more money towards retirement or short-term savings. Whereas if you’re spending more than you’re earning, you need to assess how and where you can trim or eliminate spending in certain areas.
How to Budget Money: Make It Happen
Now that you’ve got the know-how when it comes to budgeting your money, it’s time to put the above to good use to reign in on your spending habits. Above all, you must remain consistent and stick things through so that you can continue to improve the relationship you have with your money now and well into your financial future.