How to Make a Budget

If you want to learn how to make a budget, you’ve come to the right place. I’m not only going to teach you how to create your budget from scratch, I’m going to show you how to stick with it. Making a budget doesn’t have to be a painful process. I think you’ll find it to be fun – give it a chance!

Before You Make a Budget . . .

There are a few things you need to know before you start the process of making a budget. Lay the groundwork first and you’ll have a solid budget that will last you for months on end, if not years; requiring very little adjustment.

1. Understand why you need a budget.

The thing you need to do before you begin to make your budget is understand why you would do such a thing in the first place. Beyond the reason of “it’s a good idea to manage your finances,” let’s take a look at a few bullet points on why budgets are so important:

• A budget will force you to pay attention to your money and see new opportunities. If you’re not paying attention to your finances, you’re missing all kinds of opportunities to raise your income, lower your expenses, invest more money, and the list goes on and on. Budgets provide a tangible, visual reminder that you are on a financial trajectory and compels you to adjust that trajectory based on what you see.
• A budget will encourage you and your spouse to be on the same page. If you’re married, one of the most advantageous benefits of a budget is that it will give you both spending perimeters. This will dramatically cut down on money fights and help you deal with finances in marriage.
• A budget will dramatically lower your stress level. Trust me, once you have your budget in place you will have a sense of relief because you will finally know what’s going on with your money. Face your fear and make a budget! You’ll feel much better afterwards. Promise.

2. Schedule a day to create your budget.

If it’s your first time making a budget, I’d encourage you to mark a day on your calendar where your primary goal is to build and refine a new budget. You need to make this a priority and turn off all distractions. The longer you can focus on this one task (of making a budget) the better your budget will be (and the less you’ll have to modify it in the future).

If you feel that you’re ready to make your budget now, at least block out an hour or two to get everything headed in the right direction.

3. Gain access to your online financial accounts.

Does your spouse alone have access to online banking? Ask them for access. Don’t have online banking set up yet? Do a Google search for your bank and gain access – it’s easy to do.

How to Create a Budget

Alright, now you’re ready to make your budget. Whether you’re making your budget for the first time or want a refresher, this section is for you. So pull out a sheet of paper (or open a new document on your computer), write “budget worksheet” at the top, and let’s get started!

1. Make a prioritized list of expenses.

Begin by writing out all of your expenses. They don’t have to be prioritized yet, simply write down whatever expenses come to mind. You may choose to write them on sticky notes so that you can prioritize them easily later! Here are a few types of expenses to jog your memory:

• Monthly expenses. Think about anything that is a monthly expense. What do you pay for each and every month? This might include utilities, housing, cellphone bills (yes, even prepaid cell phones), etc.
• Annual or semi-annual expenses. What about those expenses that come once a year? Consider birthday or special occasion gifts, Christmas or holiday gifts, etc. Also consider some semi-annual expenses like auto insurance payments.

Another great way to jog your memory is to open your online banking accounts and look over the transactions. Where do you spend your money? The more transactions you look at the better; you’ll be more likely to find oddball transactions that don’t happen every month.

Once you’ve been staring at your list for more than five or ten minutes and can’t think of another expense, you can stop brainstorming.

Now it’s time to start prioritizing your expenses. Look at your list and ask yourself what the most important expense is on that list. Write a “#1″ beside that (or just rearrange the expenses if you’re using sticky notes, but create a master list after you are done arranging). Then ask yourself what the next most important expense is and write a “#2″ beside that. Here are some expenses that are at the top of my list to get you started:

• Tithing (Giving)
• Groceries
• Utilities
• Housing
• Transportation
• Clothing

2. Decide how much money you should allocate monthly toward these expenses.

Once you have your prioritized list of expenses, you’re ready to figure out how much you should spend in each of the categories. Here are a few things to consider when trying to decide how much you should spend . . . .

Think about your income. How much money are you bringing into your household every month (on average)? If you don’t consider yourself a high-income earner, perhaps you need to limit your entertainment budget and spend a greater percentage of your income on the essentials. Once you know how much money you’re going to need to allocate every month into your budgeting categories, add them up and see if your income can handle those expenses. If not, you may need to reconsider some of your allocations.

Think about your debt. If you’ve dug yourself into a deep hole of debt, you should probably get out before you take that cruise you’ve been thinking about. That’s just common sense.

3. Add a “cap” (limit) to your rollover categories.

Some budgeting categories you’ll deplete every month. Others will have a “rollover” balance moving from one month to the next. Consider having a “cap” on categories that rollover. Caps ensure that you don’t build up unnecessary amounts of money in any one category.

For example, you might consider capping your Insurance category at $1,000 because you know you wouldn’t spend more than that every six months. In addition, you might add $170 per-month into your Insurance category and let that build (up to your $1,000 cap) until you need to use it for an insurance payment.

Your budget worksheet should now have three columns:

1. A list of prioritized expenses.
2. A list of monthly amounts of money you’re willing to spend in each of those categories.
3. A list of caps (if they apply) on the expenses so you don’t overfund certain categories.

If you’ve done these things, you’ve completed the backbone of your budget. Now it’s time to learn some best practices for making your budget work!

Making Your Budget Work

The beautiful thing about the budget worksheet you just created is that it will be flexible enough to support your lifestyle despite income fluctuations. So whether you have a fixed (or steady) income or are working on straight commission, you’ll be able to allocate your money down your prioritized list until you run out of money. But how exactly do you do that? That’s what this section is all about. Here are a few key principles I’d recommend following . . . .

Say “goodbye” to spending more than you make.

You and I both know that spending more than you make is unsustainable. Eventually you’ll max out your credit cards and be paying enormous amounts of interest. That’s why I recommend taking a responsible approach and eliminating the temptation of spending more than you make by using a debit card instead of a credit card.

PerkStreet.com has a great cash back debit card you can use to earn a few extra bucks (actually, we make over $300 a year with it!). Be sure to check out our full-length review of PerkStreet for details.

Spend this month’s income next month.

“Whoa, whoa, whoa, John! I can’t do that!” Yes you can! Here’s why you’ll want to and how you can . . . .

Spending this month’s income next month allows you to have a buffer of money so that you won’t have to worry about timing your paychecks with your bill due dates. That’s huge my friend. I find that too many people waste enormous amounts of time thinking through when they get paid and what bills they’ll be able to pay with that money. That’s complicated and not very time effective.

Okay so here’s how it works. Let’s say in January you collect two paychecks. Write down how much money flows into your bank account in January and add together each of those paychecks. That amount of money you’ll be able to allocate down your prioritized list of expenses (remember we made that earlier) next month in February.

“But what money will I have to live on in January,” you might ask. Good question! You should live on the money you made in December of last year.

“Okay, but what if I’m starting this plan in January?” Better question. My recommendation would be to calculate how much money you have in your checking and savings accounts, take enough to cover you in January, and spend what you earn in January in the month of February. If you don’t have enough money to start out like that, I recommend considering some quick ways to make extra money.

I know this can be a bit of a complicated process starting out, so please leave a comment below if you have any questions. Hopefully I can clarify this process for you there.

Track every one of your transactions.

There are some great budgeting tools out there that allow you to track your transactions:

• Mint is wildly popular and free to join, and can be a good way to keep the big financial picture in mind. It automates your budget nicely, but make sure you stick with the principles outlined in this article for the best results.
• You Need A Budget (YNAB) is one popular choice, and holds to many of the principles I’ve outlined in this article.
• Mvelopes is a great way to use the envelope budgeting system – virtually! You can get started for free and have access to your home budget from anywhere using your portable computer or smartphone!
• MoneyWell is one of my favorites for the Mac. You can create income and expense “buckets” to spend this month’s income next month.

Whatever method you use to track your transactions, just be sure you actually track them! When you run out of money in a certain expense category, stop spending! Duh, right?

Every time you make a purchase you should make sure to either keep a receipt, write down the transaction, or type it out on your smartphone. Then, when you get home, quickly add those transactions to your budget.

Review and reconcile your budget on a regular basis.

If you’ve spent an adequate amount of time figuring out your expenses and designing your budget, you shouldn’t have to modify it much month to month. However, I do recommend you sit down with your spouse (if you have one) once a month and make necessary adjustments before the next month begins. If you’re single, you might have a friend look at your budget to hold you accountable.

In addition, you should reconcile your budget with your checking and savings account transactions at least once a week. It’s always a good idea to check your bank account daily for fraudulent transactions, but don’t worry about the math every day.

Set up a reminder system for paying the bills.

Remember, if you’re spending this month’s income next month, there’s no reason you shouldn’t be able to pay your bills anytime during a given month. But if you’re like me, you’ll need some kind of reminder system to keep track of when your bills are due.

Manilla.com is a great (free) way to have bill reminders sent straight to your email and/or smartphone. Check out my review of Manilla before signing up to see if it’s right for you.

Consider starting a “Hill and Valley” fund.

If you’re on straight commission, it’s usually a good idea to set up a “Hill and Valley” fund (a Dave Ramsey tip) that will even out any low income or high income months. If you have a low income month, you can take some money from your Hill and Valley fund to cover your necessary expenses. If you have a high income month, you can put some money back into the fund for the future. Think of it like a “take a penny, give a penny” jar at the convenience store!

ING Direct has a high-yield savings account that is a great choice for this type of fund – not to mention your emergency fund! I’ve written a review of ING Direct if you want to learn more.

How to stick with your budget.

Okay, so you’ve created your new budget and are wondering how to not fall off the wagon again. Here’s what you should do to stick to your budget:

• Identify categories where you typically overspend and use the envelope system for those expenses. The envelope system simply means taking the amount of money you allocate monthly to a certain category in cash and putting it in an envelope. Label the envelope with the category name (Groceries, for example), and only spend money on groceries out of that envelope.
• Ask for accountability. Your spouse needs to hold you accountable, and you need to hold your spouse accountable! If you’re single, again, ask a friend or family member to ask you about how your budget is going – get them involved!
• Don’t put off reconciling your transactions. When your transactions pile up, you’re in danger of trashing your entire system and having to start from scratch. Don’t do that! Keep up with your transactions and you’ll thank yourself later.

Final Thoughts on Budgeting

Creating and maintaining a budget is one of the most rewarding things you can do for your financial health. It will encourage you to make more money, spend wisely, and alleviate many fears you might have about personal finance. I know that maintaining a budget has saved us thousands of dollars in the past few years alone. Everyone needs a budget. Are you ready to make one?

If you found this article to be helpful, please take the time to leave a comment, share it on Facebook or Google+, or suggest it to a friend you know who needs to start a budget. I appreciate it!

Have you started a budget as a result of this article? What other budgeting tips do you have? Leave a comment below!