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No matter how much disposable income you have at hand, budgeting is key to managing it successfully and making the most of your money. If your finances are tight, a realistic budget will alleviate stress and help you build a much-needed emergency fund or pay off your debt. If you’re feeling comfortable financially and want to focus on saving and investing to achieve financial freedom, it all begins with a realistic budget.
There are many ways to go about budgeting, but unless you have a background in money, such as a finance degree or business experience, you might be daunted by the prospect of budgeting for the first time. If you don’t know where to start, begin with these five steps.
1. Determine your income
Start by establishing how much money you have coming in by looking at take-home pay rather than gross pay. If you’re paid monthly, this should be very straightforward, but if you’re paid weekly or biweekly your monthly income will fluctuate slightly. In this case, figure out your average monthly income or be prepared to adjust your budget each month depending on how many paychecks you’ll be getting. If your wages fluctuate or you’re self-employed, calculate an average monthly income based on the past six months.
2. Determine your essential and discretionary expenses
The next step is to list all of your expenses by going through your bank statements and credit card statements from the last three to six months. Some expenses will be a fixed monthly rate, but for those that vary, such as groceries and gas, take an average.
Then, divide your expenses into two lists – needs and wants. Your needs are essentials such as rent or mortgage payments, utilities, car loan payments, public transport fares, groceries, and insurance. Create categories for your wants, such as dining out, entertainment and leisure, media, vacations, and personal grooming. You might start to realize right away where you could make savings when it comes to these non-essential expenses.
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3. Define realistic goals
Now is the time to ask yourself why you want to budget. Establishing your goals now will help you make decisions about your budget and motivate you to stick with it. You could have long or short-term goals or a combination of both. Short-term goals are things that are achievable within the next three years, such as building an emergency fund, saving for a big vacation, or putting away money for a deposit on a property. Long-term goals are anything above three years, but they may take decades to achieve. Examples include paying off student loans, saving for your child’s college fund, or building a pot for retirement.
4. Try the 50/30/20 rule
When looking to define limits on your monthly spending, you might find it helpful to try the 50/30/20 rule to begin with. This is where 50% of your income is assigned to your needs, 30% is assigned to your wants, and 20% is assigned to savings and debt repayments. This strategy ensures that your basic needs are met, you can bolster your future financial situation, and you can still have fun in the present.
You might find that the split needs adjusting depending on your income and goals. For example, if your current necessary outgoings account for more than 50% of your income, you have little choice but to assign a higher percentage to them, and to spend less elsewhere. If you have lofty goals for saving or repaying debts, you might be happy to reduce the amount you spend on wants.
5. Stick to your budget, track spending, and adjust as necessary
Check your bank and credit card statements at the end of each month to see how you’ve got on. Pay close attention to your unnecessary outgoings because overspending on wants is a common problem.
If you realize your initial budget was unrealistic, feel free to adjust it and see how you get on. For those having trouble staying on budget for their wants, try the envelope method. This is a cash-based approach in which you physically divide your money into individual envelopes that represent different categories of your wants. When an envelope is empty, you can’t spend any more on that category until next month.
Budgeting will help you achieve your financial goals
If you have financial goals in mind, no matter how big or small, budgeting is an effective way to help you achieve them. These steps are the perfect place to start when budgeting for the first time but be sure to keep tracking your spending to hold yourself accountable and reach your goals.
