How to Budget Your Money: 5 Step Guide to Create a Budget (2024)

Learning how to budget is an essential skill that few people learn in school. Health insurance, medical payments, grocery bills — the list goes on. Creating and sticking to a budget won’t eliminate your financial stress, but it will equip you with the tools to make better decisions.

Whether you’re trying to chip away at credit card debt or save to buy a home, knowing how to budget is the first step to meeting your financial goals.

Why is budgeting important?

Knowing your financial priorities means you can start taking the necessary steps to achieve them. And with 66% of Americans reporting money as a common stressor in a recent survey by the American Psychological Association (APA), sticking to a budget is important to ensure you make decisions in line with those priorities.

Here are five benefits of budgeting:

1. Helps you achieve financial goals

Setting practical financial goals is a positive extrinsic motivator. Clear goals guide you on how much to save for a down payment on a home, a nest egg for retirement, or an investment in your side hustle. And as you edge closer to your financial goal, saving money feels more purposeful.

Likewise, financial goal-setting develops other valuable soft skills like patience, adaptability, and seeing through an action plan.

2. Combats financial stress

Respondents of the same APA survey who reported financial stress described money as a source for family fights or tension, significant worry about properly planning for the future, and adjusted spending choices.

Being able to visualize your money situation can resolve financial uncertainty and help relieve that stress. Plus, creating a blueprint of your finances can help you make more confident personal or family decisions, rein in unnecessary splurges, and find where you stand on saving for future goals.

3. Leads to more informed decision-making

With a clear budget, you make decisions based on the information you have in front of you. If you don’t know the amount of money in your bank account, what to expect from your monthly credit card statement, or what your daily expenses add up to, it’s difficult to make sound financial decisions and avoid overspending.

Getting into the practice of recording your month-to-month expenditures will help you see your habits more holistically. When you have a clear picture of everything that comes in and out of your wallet, you can make better daily decisions that support your overall financial health.

4. Gives you a backup plan

Unexpected costs like sudden illness or getting laid off from work have the potential to derail your finances. Budgeting for an emergency fund helps you better prepare. The size of your emergency fund depends on your lifestyle and monthly expenses, but many financial experts recommend saving between three to six months' worth of cash.

While this amount may sound large at first, you can start by setting aside small amounts weekly, bi-weekly, or monthly until you reach your goal. Consider checking on and revising your emergency fund occasionally so it continues to meet your needs.

5. Breaks patterns of poor financial health

Financial responsibility requires both resources and education, two privileges that not everyone has. Not everyone has strong financial foundations, whether that’s because they never had to worry about money or have built bad habits over time.

A budgeting practice is a common missing link between financial wellness and distress, and it can make a big difference in your financial outlook. A study of millennials raised in low-income households found they were significantly better prepared for adulthood than their peers. They were:

• 171% more likely to afford an unexpected expense
• 182% more likely to have savings set aside for an emergency
• 34% less likely to carry unmanageable debt

How to create a budget in 5 steps

Creating an in-depth budget that works can be daunting, especially if you’ve never done it before. Here are five steps to learn how to make a budget plan:

1. Establish your savings goals

Determine which of your life goals require money and how much you realistically need to meet them. Start with 3–5 financial goals and prioritize them by what you want to achieve first. Here are some examples of financial goals:

• Down payment on a home
• New vehicle
• Debt repayment on student loans, credit card debt, or medical bills
• Retirement
• Emergency fund
• Vacation
• Investment fund
• Home repairs or upgrades

2. Track your expenses

Analyze your current monthly spending to gauge your needs and to what level you need to change your habits. You can review your bank statements, begin tracking your expenses with a worksheet template, or use a budgeting app to gather all the necessary information.

Here’s a common way to break down your expenses:

• Fixed expenses: Regular payments that typically don’t vary in cost from one month to the next. They include expenses like car payments, mortgage or rent payments, and insurance premiums.

• Variable expenses: Regular purchases that can be higher or lower each month. They include expenses like home or car maintenance, groceries, and clothing.

• Discretionary expenses: Regular or irregular purchases reflect your lifestyle habits. They include purchases you want but don’t necessarily need, like dining out, workout classes, and entertainment.

  See Also

  How to create a budget in 5 steps

3. Record your monthly income

Estimate your monthly take-home pay and extra streams of income if you have them. Your after-tax income is what’s important, since this is the money you can save or spend every month. Include all the extra money at your disposal in your estimate, like social security, disability, pension, or regular interest or dividend earnings.

If your pay varies based on tips, fluctuating hours, or commissions, try to create an average of what to expect. Record monthly income and expenditures over a few months to make more accurate estimates of your average monthly take-home.

4. Assess your spending

Write down and assess your average spending habits. Seeing everything written down can be an enlightening experience. Maybe you notice you’re spending a disproportionate amount of your monthly budget on discretionary expenses like takeout or subscription services. Or maybe you’re in better shape to reach your long-term financial goals than you imagined.

5. Create a budget

Subtract your fixed expenses —rent, food, and other necessities — from your income. Then you can assess how much you have left to put into savings or spend on the things you don’t necessarily need.

Rebuild your budget so that the money you set aside for variable and fixed expenses coincides with your monthly income. Categorize your spending and decide how much you can afford to budget for each item.

Try your best to stick to those amounts. You might not get it right the first time, and that’s okay. If you need to trim down, re-examine your discretionary expenses to see what to cut from your spending.

If you have stronger financial security than you anticipated, it’s a great opportunity to re-evaluate your goals and find ways to smartly invest your money.

7 tips for budgeting money

If you feel overwhelmed by budgeting your daily expenses, try saving more money with small, manageable daily practices. With time, budgeting will become a natural part of your routine.

Here are a few small steps that can put you on your way to better budgeting:

1. Separate wants from needs

There’s nothing wrong with treating yourself occasionally. But problems can arise when constant splurges push your spending beyond your means. Learn how to draw clearer boundaries around wants and needs. Car insurance and gas for your car are necessary, but going over your spending limit to buy the newest model isn’t.

2. Pay attention to small expenses

Everything adds up at the end of the month. Pay careful attention to smaller expenditures. A $5 coffee every day might not seem like much, but it ends up costing $150 per month, which might be more than you realize.

3. Catch your biases

Lifestyle inflation, or lifestyle creep, describes a common phenomenon — when you make more money, you tend to spend more. If you get a promotion, raise, or a higher-paying new job, weigh your desire to splurge. It might be more wise to use the opportunity to put more in a retirement plan or investment portfolio.

4. Prioritize your debt

Controlling debt isn’t just vital to your financial wellness. It also contributes to your mental health. The stress of debt has severe emotional effects, and it can trigger or worsen anxiety, stress, or depression. If you have debt, set aside as much as you can every month to pay it off.

Prioritizing debt payments over large non-essential purchases will benefit your life in the long run by limiting interest and stress.

5. Consult with a professional

Developing financial literacy and wellness is challenging for anyone, especially if it’s the first time asking yourself big questions about money.

Consider working with a financial coach who can give you the budgeting resources to establish and prioritize objectives, use financial tools, and contemplate planning for retirement, home ownership, and other life goals.

6. Swap out your debit and credit cards

Cashless payments can make you more reckless with your money. If you need help reining in extra spending, separate your discretionary budget into cash payments. Spending physical cash can help you weigh out the risks of a purchase to make better decisions.

7. Consolidate debt

Weigh out the pros and cons of a debt consolidation program to lower your interest rates and monthly payment plans. If making monthly payments on your credit card or a loan is beyond your means, speak with a financial professional to make the best choice for you.

What’s the 50/30/20 rule?

The 50/30/20 rule is a common budgeting framework that splits your monthly budget into three separate categories:

1. 50% needs, including fixed and variable necessities like rent, food, and car payments
2. 30% wants, including discretionary spending like trips to the movies, new clothes, or updated appliances
3. 20% savings, which includes an emergency fund

The 50-30-20 rule is one way to organize your budget, but it doesn’t work for everyone. If you need more help finding the right option for your financial situation, you can consider consulting with a professional planner.

The numbers add up

Learning how to budget is more than just adding and subtracting your income and expenses. It’s about building the ladder that lets you climb higher toward your life’s goals.

While getting started and crunching the numbers may feel overwhelming at first, there are plenty of tools and resources to help you along the way. And as you get closer to making that down payment or treating yourself to that well-deserved vacation, the work will pay off.

Published May 12, 2023