How to Create Your First Budget
Creating a budget is an essential first step toward taking control of your money. Many people discover that they’re spending far more than they realized, while a lucky few pat themselves on the back for saving more than they knew.
Once you make a budget, you’ll see the areas in which you can cut costs. You’ll also learn how much you can save each month toward your future goals, and you’ll understand how to divide those savings among your short-term and long-term goals.
Your Financial Future
Sometimes it's hard to remember why you wanted to budget until you think about all of the things you can do once you have enough money saved up. With money in the bank and control over your spending, you'll have cash on hand for emergencies, money for your next vacation, extra funds if you happen to find out about a great sale, and the chance at a well-funded retirement.
If your only income comes from a steady job, this step is as simple as looking at your last paycheck. Calculate your monthly take-home pay. If you're self-employed, add your net earnings from the past year and divide by 12. Want greater accuracy? Add your earnings from the past three years and divide by 36.
Add irregular or passive income, such as bonuses, commissions, dividends, rental income, and royalties. If you receive this quarterly or annually, average it to get a monthly estimate.
Necessary expenses are the bills you must pay each month, including:
- Rent or mortgage and utilities
- Auto and home insurance
- Health care costs
- Loan repayments, such as student loans and credit cards
- Groceries, gasoline, and other semi-fixed expenses
Divide the annual bill by 12 for necessary expenses paid annually, such as property tax and income tax. It will show you the cost per month.
List your discretionary expenses like restaurants, entertainment, vacations, electronics, and gifts. Review the past year of your credit and debit card statements to calculate your discretionary spending. Add it up and divide by 12 to find a monthly average. You can also buy software or sign up for an online service to keep tabs on your spending.
Total Monthly Expenses
Compare your total expenses to your income. If you spend more than you earn, you’ll need to make some changes. If you earn more than you spend, congratulations – you’re off to a great start. Now it’s time to budget your savings.
If you spend more than you earn, your discretionary costs should be the first and easiest to cut. Pack a lunch instead of eating out. Stream a movie at home instead of going to the theater.
Fixed costs are harder to cut, but you can save hundreds by doing so. Ask for a re-assessment of your home value if you think property taxes might be too high. Negotiate a lower insurance rate for your different policies. Ask for a special on your cable package.
Once your income is higher than your expenses, decide which goals are most important to you. Your savings priorities should fall into three categories:
- Short-term: a vacation, a fund for car repairs
- Mid-term: a wedding, a college fund for your kids
- Long-term: retirement
Divide your savings into different accounts dedicated to each goal.
Compare Spending to Budget
Each month, analyze your statements and compare your actual income and expenses to the averages predicted in your budget. You’ll see the areas in which you have shortfalls and the areas in which you have more than expected.