Featured Expert
Andy
Andy Smith Advisor & CPA, The Mutual Fund Store View bio

This guide was written by

Kelli Bamforth

Ah, the dreaded “b” word. If you’re in denial about your spending or think you don’t have time to track where your money’s going, the mere mention of budgeting can be overwhelming or downright scary. But budgeting is absolutely essential if you want to get out of debt and afford what’s really important (versus singlehandedly keeping your favorite retail store or coffee shop in business).

Simply put, a budget is a system to monitor how much money you save and spend over a given time period. A budget helps you stay within spending limits and accomplish your long-term financial goals. Do you want to finally pay off that credit-card balance? Start a college fund for your kids? Save for a down payment on a home? Afford your dream vacation? Maximize your retirement contributions?

Whatever your objectives, a budget can help you break down those goals and determine how much you need to save per paycheck.

How to Create and Use a Budget

Once you’ve identified your short- and long-term financial goals, creating a budget is the next step toward living a more organized financial life. Because budgeting is highly subjective, what works for your neighbor or best friend won’t necessarily work for you. However, there are certain steps to building a budget that are universal – regardless of the specific method or categories you select.

1. List Your Income and Expenses

Most people establish a monthly budget because a majority of bills follow a monthly schedule; however, evaluating your income and expenses depends on your life stage and current employment.

Whether you have fluctuating or steady income (or a combination of both), revisit your banking statements from the previous 12 months and calculate a monthly average based on how much you earned during that time. You could also look at last year’s tax return and adjust your current income accordingly. If you don’t know the exact amount for a particular income source (e.g. an annual bonus), use an estimate.

Tallying your expenses is the other half of the equation. Expenses typically fall into one of three spending categories:

  • Fixed expenses are bills that stay the same each month, such as rent, mortgage and debt payments. If you have a monthly savings goal, you should include it here.
  • Variable expenses include utilities, groceries and other obligations that change from month to month.
  • Discretionary expenses, like clothing and entertainment, are considered optional expenditures.

Some expenses, like holiday shopping, home repairs and property taxes, aren’t incurred regularly. To calculate monthly amounts for these items, divide the anticipated total by 12 and add it to the appropriate category (e.g. holiday shopping should be a discretionary expense).

2. Pick a Budgeting Method and Track Cash Flow

No single budgeting method works for everyone. Because a budget needs to be used every day to actually work, you should select the best system for your needs – and it may take some trial and error to find the right one.

There are four basic methods for tracking and monitoring your budget:

Pen and Paper

This old-school method is unbeatable in its simplicity. With this approach, you just write down all of your income and expenses for the month. You might want to carry a small notebook for recording expenses on the go.

Pros

Hands-on

Inexpensive

Cons

Easy to make mistakes

Time-intensive

Who It’s Best for

Beginning budgeters

The technology averse

Budget Worksheet

Using a spreadsheet in Excel or Google Docs lets you easily organize your information and make changes or additions to your categories as needed.

Pros

Does the math for you

Free samples online

Customizable

Easy to share

Cons

Excel isn’t free

Time intensive

Can be difficult to learn the formulas

Who It’s Best for

Beginning budgeters

Avid computer users

Get the budget worksheet

Envelopes and Cash

Use an envelope for each spending category that contains the funds allotted for the month. When the envelope is empty, you can’t spend any more.

Pros

No math

Easy to track

Automatic spending limits

Inexpensive

Cons

May not work for all budget categories

Some people don’t like carrying cash

Hands-on

Who It’s Best for

Beginning budgeters

The technology averse

Personal Finance Software/App

There are several web-based software programs or apps (e.g. Mint and Quicken) that can help with budgeting. These online money-management tools sync with your all of your financial accounts. Updates are automatic and each transaction is categorized for you.

Pros

Accessible from anywhere

Automatic updates

No math

Easy to track

Cons

Can be expensive (depending on program)

May not categorize transactions correctly

Not hands-on (for beginning budgeters)

Who It’s Best for

Avid computer users

On-the-go individuals

You may find a combination of budgeting methods is best for you. You could use envelopes for budget-busting categories, like eating out or clothing, but track your other categories with a personal-finance app.

3. Adjust Income and Spending to Meet Your Financial Goals

It’s important to remember that there’s no one-size-fits-all solution to budgeting. Rather, your attitude about money will inform how you direct your spending to meet your financial goals.

You might aim for a zero-dollar budget, in which you account for every single dollar of income and have no money left over at the end of the month. Alternatively, you could embrace the 50/20/30 philosophy, which says you should spend 50 percent of your income on essentials, 20 percent on priorities like debt and savings and 30 percent on lifestyle expenses such as vacations and entertainment.

Whatever you do, you’ll need to reduce your spending in one or more categories if your budget is in the red at the end of the month. Here are some options:

Category How to reduce spending
Fixed expenses

You may need to make major lifestyle changes to lower your expenses in this category:

-Consider downsizing your current home

-Trade in your newer vehicle for a used model

Variable expenses

Reducing spending in this category is a little easier:

-Cut your grocery bill by clipping coupons and shopping at more affordable chain stores

-In the winter, lower your thermostat by 10-15 degrees while you’re at work. The U.S. Department of Energy estimates this can save up to 15 percent on your heating bill

Discretionary expenses

This is the spending category where you have the most control. Some ways to save include:

-Skipping restaurants in favor of eating at home

-Swapping your gym membership for at-home workouts

-Eliminating cable for a streaming service like Netflix or Hulu

Don’t think of these spending reductions as deprivation, but as an interim realignment of your goals. By temporarily forgoing dinner with friends and other non-essentials, you can allocate more money to credit card debt or retirement savings. As your income increases and your debt decreases, discretionary expenses can be added back in.

4. Keep Your Budget Flexible

Managing a budget can be difficult if you earn irregular income or are going through an unexpected life change, like sudden job loss, an emergency expenditure or even a surprise inheritance or work bonus. But because a budget is a living document, having one can help you navigate those tricky times.

If you’re facing a reduced level of income, prioritize essential living cos ts such as your rent or mortgage, utilities and food. This is what’s known as a bare-bones budget in which you bring your spending in line with your lower earnings. Doing so immediately can make the difference between surviving a difficult time and facing financial disaster later.

When you have a surplus, increase your savings rate so that you’re better prepared for the lean times. It might be tempting to blow a sudden influx of cash on wants instead of needs, but getting into a spending habit during the better months will make the leaner months more difficult. The last thing you want is to end up relying on a credit card when your income is below average.

Example Student Budget

Living within your means as a college student is crucial to avoid taking on unnecessary debt. Your income sources may vary from what’s included in the sample budget, but every dollar you receive (such as that from a summer job or even a tax refund) should be applied to your monthly income. If you find yourself earning less than what you need, look into work-study programs or consider living at home for a semester or two. In the following example, tuition has already been paid in a lump sum at the beginning of the semester by student loans and is not shown in this monthly budget. The

Income type Expected income Actual income
Part-time job

$500

$450

eBay sales

$100

$72

Babysitting gig

$300

$225

Financial aid (monthly average per semester; disbursed after tuition is paid)

$500

$500

Parent contribution

$150

$150

Total

$1,550

$1,397

Spending category Expected budget Actual budget
Fixed costs:
Rent

$400

$400

Cable/Internet

$75

$75

Cell phone

$75

$75

Car insurance

$60

$60

School books/supplies

$75

$75

Variable/discretionary costs:
Utilities

$100

$112

Food

$150

$140

Gas

$40

$40

Laundry

$20

$18

Entertainment

$75

$97

Restaurants

$75

$85

Savings

$100

$100

Total

$1,245

$1,277

Monthly surplus $305 $120
Example Family Budget

With the demands of full-time work and supporting a family, creating a budget might be the last thing on your to-do list – but that’s exactly why it’s so important. When you face competing priorities, your discretionary spending is where you can make the most impact to your budget.

Income type Expected income Actual income
Full-time job

$3,500

$3,500

Part-time job

$800

$680

Rental income

$750

$750

Total

$5,050

$4,930

Spending category Expected budget Actual budget
Fixed costs:
Housing (mortgage + insurance)

$950

$950

Transportation (insurance + car payments)

$600

$600

Cell phone (x2)

$160

$160

Medical insurance

$400

$400

Cable/Internet

$100

$100

Child care

$600

$600

Credit cards

$200

$200

Student loans

$315

$315

Retirement savings

$200

$200

Emergency fund

$150

$150

Variable/discretionary costs:
Utilities

$150

$172

Food

$450

$420

Gas

$120

$115

Clothing

$100

$65

Entertainment

$100

$120

Restaurants

$150

$130

Car/home repairs

$100

$140

Kid’s activities (gymnastics, athletic leagues, birthday parties, etc.)

$100

$88

Total

$4,945

$4,925

Monthly surplus: $105 $5

Expert Q&A Interview: Tips for Successful Budgeting

andy-qa Andy Smith Expert

Andy Smith is a Certified Financial Planner and executive vice president of investments at The Mutual Fund Store in Indianapolis, Ind.

How can a person set reasonable budgeting expectations for themselves?

There are a few different things I like people to do:

  1. Be honest with yourself. You know your personality, and you know where you are in the process of setting goals and expectations and how successful (or unsuccessful) you’ve been with that in the past. There are some things in life that are pretty important, and getting your money and your budget under control is one of them.
  2. Write down all of your inflows and outflows – and not just for one week. You need more of a trend to really get a sense of what’s coming in and what’s going out.
  3. Go back a couple of months (if not an entire year) and try to get a sense of your tendencies there, too.
  4. Overestimate your spending and underestimate your savings. Unfortunately, people usually do the opposite. They think they won’t spend anything extra, or that they’re going to save more than they will.
  5. Consider inflation. I can’t tell you how many times I’ve looked at budgets that were built four or five years ago and the numbers don’t make sense anymore. Prices are going to change and you need to accommodate that appropriately.

What are the best ways to cut back on unnecessary spending?

It really helps to have a budgeting partner. If you’re in a relationship or have a spouse, that’s great; if you’re not, then do it with a friend who’s going through the same thing. It comes down to accountability, just like with diet and exercise. You don’t want to tell your workout buddy you didn’t run for a week or ate an entire chocolate cake, right? It’s the same with unnecessary spending. I also like people to give themselves some sort of “free” day once in a while. You’re not going to spend gobs of money, but it’s okay to buy yourself a little something extra.

With every purchase, you should verbally ask yourself, “Do I need this or do I just want it?” If you have a budgeting partner, you can do the same thing. If you think you absolutely need it, give yourself a week to rethink the purchase. If you can live without it for a week, chances are you don’t really need it – unless, you know, there are gaping holes in your shoes or you’re literally wearing a sack cloth.

What are some common pitfalls to budgeting?

Number one is lack of patience. Depending on where you are in the process, age-wise or dollar-wise, you could be reworking years of less-than-optimal behavior – so don’t think everything will suddenly be fixed. Number two is not admitting to yourself that you’re going to make mistakes, or thinking you won’t overestimate how much you can save or underestimate how much you’re going to spend. Number three is probably lack of communication, especially if you’re in a relationship. Hopefully you’re going through this together, but if you’re not that adds another layer of difficulty.

How should someone prioritize what they spend money on (e.g. debt versus savings)?

When it comes to savings, your two best assets are time and compounding interest. If you screw that up for too long, you’re going to get to a point in life where you won’t have enough time – mathematically speaking, the compounding will not work. So when it comes to prioritizing what you spend money on, your savings really have to be up there.

Resources

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America Saves is a campaign coordinated by the nonprofit Consumer Federation of America (CFA) and is dedicated to helping individuals save money, reduce debt and build wealth.

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Budgeting tips from the U.S. Department of Education can help students learn how to keep track of income and expenses, save for their goals and adjust their budget as life changes.

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Money Management International, the largest nonprofit credit-counseling agency in the United States, has a mission to improve lives through financial education.

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Duke University’s personal-finance website helps students learn the essentials of managing their financial lives, including their budgets and credit scores.

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Dedicated to protecting America’s consumers, the Federal Trade Commission operates consumer.gov, a website providing tips on money management, credit, loans, debt, scams and identity theft.

Updated: July 27, 2017