Making a budget and sticking to it is one of the best ways to understand where your money goes every month—and what changes you could make to help you reach your financial goals. When making a budget, the ultimate goal is to avoid spending more than you earn. That sounds simple enough, but actual budgeting can get complicated fast. There are several approaches to making a budget, and the right way to do it depends on your priorities, preferences, and goals.
Here are steps you can take when making a budget to ensure that it fits your lifestyle and financial goals.
Determine your income
This first step is easy if your pay doesn’t change much from month to month. If you get paid monthly, that’s your number. If you’re paid every other week, multiply your net pay by two.
If your wages tend to fluctuate, consider taking the past three to six months and averaging what you earned during that time. Focus on your take-home pay instead of your gross income because that’s the amount that actually winds up in your bank account.
Calculate your monthly expenses
Once you understand your income, you’ll want to similarly run the numbers for your expenses. Start by taking a look at your bank and credit card statements over the past three to six months to get an idea of what you typically spend each month.
Then break down those expenses into categories such as necessities vs discretionary spending. Create as many or as few categories as you like. For example, you can group recurring monthly charges together or split them out into groups like rent, utilities, and insurance.
Set realistic goals
Once you know how you’ve been spending your money, take some time to set goals on how you want to manage your money going forward.
It’s crucial with this step to be realistic with your goals. There’s nothing wrong with being ambitious about your budget, but if you fail in the first month or two, you may lose interest.
Set goals that require you to stretch a little, but keep in mind that it can take time to develop the habits you want to have.
Track your spending
Tracking your spending can help you test your assumptions and goals, give you an idea of how to adjust them in future months, and also provide added accountability in your budgeting. Keeping track of spending can be tough, though, especially if you tend to make several purchases a day. Using multiple credit cards, making purchases in cash and throwing away receipts can even further complicate the process, so consider adjustments in these areas to help make tracking easier.
Pick a budgeting plan
Now that you have the basics down, it’s time to start thinking about whether you want to use a specific budgeting plan.
Here are four common budgeting methods to consider.
With this classic approach, you allocate your money for each spending category, then put that amount of cash in an envelope with the name of the category.
When you’ve spent all your cash from a particular envelope, you’re out of money for that given category for the rest of the month—unless you shift money from another envelope. Just keep in mind that not all bills can be paid in cash, so account for that.
The 50/30/20 budget is all about simplicity. Instead of creating several categories for each type of expense you incur, you allocate 50% of your take-home pay to necessities, such as housing, utilities, and car payments; 30% to discretionary spending; and 20% to your financial priorities, including savings and paying down debt.
The two-account plan
With the two-account plan, you add up your fixed monthly expenses and divide that amount by the number of paychecks you receive each month. Deposit that fixed-expense amount into one bank account when you get paid, and the remainder goes into a second account for your discretionary spending.
Zero-based budgeting plan
With a zero-based budget, the idea is to assign every dollar to something, essentially making your expenses equal your take-home pay. This approach is similar to the envelope system, but it doesn’t require you to use cash for everything.
The zero-based budgeting method requires you to be detail-oriented, and there is less room for error, so it may be best used after you’ve been budgeting for a while. This level of detail gives you an incredible view of where your money is going, but be sure to keep at least a small emergency fund in case your costs go up or you’re hit with a large expense.
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