Most adults have a general idea of what a budget is but very few follow one. Most people don’t know how much money they spent in the last month. Many of us find the thought of creating and sticking to a budget overwhelming.
We may even create a budget then give up using it after only a few days. Usually, an unexpected expense crops up and throws us off our budget forever.
But budgets are an essential tool if you have financial goals to achieve. So how can we create a budget that works for us? Keep reading for the ultimate guide on how to create a personal budget.
Set Your Goals
The first step for how to create a personal budget that works for you is to set your financial goals. Budgeting is essentially an exercise geared towards achieving a money goal. Why do you want to budget?
Perhaps you want to live within your means and stop spending more than you earn. Your goal may be to achieve financial freedom and retire early. Or you may want to save enough to take your family on a vacation.
Whatever your budgeting reasons are, put them down on paper and attach a number to them. If it’s retirement, write the exact amount of money you want to save before you can retire. If it’s to live within your means write down the amount of money you’ll allow yourself to spend each month.
Find the Right Budgeting Tools
Once you have your goals in place the next step is to find the right budgeting tools for you. Creating a budget is all about balancing your income, expenses, and savings. So you need a tool that can track all these elements.
Most people use a simple spreadsheet to track their finances. But there is no point in creating a budget spreadsheet if you hate using excel. Perhaps a budgeting phone app may work better for you. Maybe you prefer a budgeting journal or ledger whereby you can handwrite all transactions.
We are all different so our preferred budgeting tools will differ from person to person. Choose a tool that you will be happy to interact with at least once a day. Modern budgeting apps automate your finances such that budgeting becomes a no-brainer. You can connect them to your bank account and they will update your budget anytime you make a transaction.
List Your Income and Expenses
Now that you have your preferred budgeting tool you need to feed it with your financial information. Start by adding all your sources of income. This might include your salary, income from side hustles, and any passive income from investments.
Ensure that your budget shows your actual take-home earnings as that is what you can spend. You also need to list down all the expenses you expect to spend money on. How can you save up for retirement if you don’t know how much money you need every month?
Your budget should help you to have a clear picture of your financial situation so that you can plan for the future. Get old credit card statements and bank statements to help you identify your monthly spending.
Split up your expenses into mandatory and discretionary expenses. Mandatory expenses or fixed expenses refer to the costs of your basic needs such as rent or mortgage payments, food, and transport. These are the payments you will need to make each month without fail.
You can find a way to reduce your mandatory expenses by getting a cheaper home or car. However, you can’t cut them off completely. If you are in a financial fix, downsizing your lifestyle to reduce your basic costs can release a lot of funds on your budget. For instance, by moving back home with your parents you could eliminate rental payments.
The other type of expenses is the discretionary ones. Depending on your budget, you can pick and choose which ones to include in your budget. If you are living beyond your means and want to reduce your spending, the easiest way to do so would be to drop some discretionary costs.
A mistake many people make when they start budgeting is by cutting off all their discretionary expenses. This type of budget will fail as you do need to enjoy your life even when on a budget. The key is to choose activities that bring you the most joy and spend budgeted money on these.
If you love Starbucks coffee but don’t mind doing your own nails, you can cut off salon visits from your budget but keep your morning coffee. This will make your life enjoyable so that it is easier for you to stick to your budget. Also, remember to allocate a small amount of money for unplanned expenses or emergencies.
Set Your Savings Rate
One of the best indicators of financial success is the level of savings you have. As you budget, plan to save at least 10% of your take-home earnings for your wealth-building activities. If your budget allows you to save more, do so. The more money you can save, the faster you will achieve your financial goals.
Your priority with savings should be to create an emergency fund. Once your emergency fund is in place, clear off any unsecured debt such as credit card balances or personal loans. These debts are quite expensive in terms of interest charged so paying them off will leave you with more disposable income.
Once you pay off your unsecured debts, you can concentrate on building investment vehicles. These should help you will earn passive income and give you the freedom to retire. For instance, you can put the funds into a retirement account or use them to build a stock portfolio or to start a business.
Review and Adjust Your Numbers
Now that you have listed your planned income, expenses, and savings you can run your numbers to see if they add up. Are your expenses and savings amounting to more than your income? Then you will need to cut some expenses or reduce your savings rate.
Is your planned budget having a surplus of funds? Then you can increase your savings rate or allow yourself some more discretionary income. Once the budget balances out, you can give it a test run for one month.
Track all your earnings and spending as you will find expenses that you forgot to list down. This first month will give you a realistic idea of your finances. You’ll be able to adjust your budget and make it more practical.
Don’t be disheartened if you find yourself overspending and deviating from your budget. Creating the budget will bring awareness to your impulsive spending habit and help you reduce it with time.
Do a Monthly Summary
At the end of every month review your financial summary to see if your finances are improving. Check to see that your debt is less than the previous month and that your savings and investments have increased as expected. Seeing your net worth increase each month will motivate you to keep up with your budgeting habit.
In case your results are worse than expected you should analyze where you went wrong. Come up with feasible strategies to do better in the following month. For example, you may discover that you spent too much on eating out. To avoid doing so in the future you can start prepping your weekly meals over the weekend.
Make Budgeting a Habit
Another great tip for how to create a personal budget is to make budgeting a habit. You can’t create a budget once and then leave it. You must track how you are saving and spending money each month to ensure that you achieve your financial goals.
Remember that there will be changes to your finances. Inflation may affect the prices, your income may go up or down or you may get married or have a child. All these will need you to make changes to your budget.
If you can, use budgeting tools that automate your financial transactions. For instance, you can set up automatic transfers and payments from your salary account.
You can also have apps that are linked to your accounts. They typically update your budget tracker whenever you make or receive a payment. Making your budgeting tasks as easy as possible will make it easier for you to stick to your budget.
Learn How to Create a Personal Budget to Improve Your Finances
A budget is the most important financial tool you can use to improve your financial status. But most people shy away from creating a budget because they think it is complicated and time-consuming.
The benefits you will get from taking the time to learn how to create a personal budget are worth the perceived hassled. Modern financial applications also make budgeting a no-brainer so there is no longer any excuse not to have a budget.
If you don’t have a budget in place, start one today using the above budgeting advice. For more budgeting and finance tips, read the rest of our blog.