How to Create Your First Budget

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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-, mid-, 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.

Budgeting Tools

There are many programs and apps you can use to make the budgeting process easier. Quicken is perhaps the best-known budgeting software program, but relative newcomers such as Mint, Mvelopes, and You Need a Budget (YNAB) have many fans as well. Mint is free because its revenue comes from ads. YNAB charges a single rate ($83.99 annually) and is free for one year to students. Mvelopes and Quicken have different rates ($6-$59 monthly and $34.99-$89.99 annually, respectively) depending on the number of features you think you'll need.

You can also create your own spreadsheet, relying on bank and credit card statements to fill in amounts and categories of income and expenditures.

Budget Types

Zero-based and 50-30-20 are two common methods of budgeting. In a zero-based budget, all inflows and outflows for a specific period are accounted for in some manner, so there is zero money left over. That doesn't mean you blow every dollar of your paycheck(s) every month; it means you know exactly where every dollar has gone, be it a retirement savings account, a credit card payment, or a checking account.

A 50-30-20 budget assumes you spend 50% of your monthly income on necessities, such as housing, utilities, groceries, and transportation; 30% on discretionary items, such as premium cable, concert tickets, and restaurant meals; and 20% for savings and debt payments. This kind of budget was popularized by Elizabeth Warren, a U.S. senator from Massachusetts and Democratic presidential candidate for the 2020 election, and her daughter, Amelia Warren Tyagi, in their 2005 book "All Your Worth: The Ultimate Lifetime Money Plan."

If you choose this type of budget, your goal will be to keep what you spend on your needs and wants within their assigned percentages so you will have the remaining 20% to put into an individual retirement account (IRA) or make more than the minimum payment on a credit card, for instance.

A zero-based budget requires meticulous attention to detail, while the 50-30-20 method is easier to carry out.

Monthly Income

If your only income comes from a steady job, calculating your monthly income is as simple as looking at your latest paychecks. Calculate your monthly take-home pay. If you're self-employed, add your net earnings from the past year and divide by 12. For greater accuracy, add your earnings from the past three years and divide by 36.

Irregular Income

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

Necessary expenses are the bills you must pay each month, including: 

  • Rent or mortgage and utilities
  • Auto and home insurance
  • Health care costs
  • Minimum 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. That will give you the cost per month.

Discretionary Expenses

List your discretionary expenses like restaurants, entertainment, vacations, electronics, and gifts. You can review the past year of your credit and debit card statements to calculate your discretionary spending. Add everything up and divide by 12 to find a monthly average.

Total Monthly Expenses

Add up all of the monthly amounts and 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, you’re off to a great start.

Cutting Expenses

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. Shop around for lower rates for your different insurance policies. Stock up on non-perishable items when they're on sale at the grocery store, and choose perishables according to what's being offered at a special discount that week.

Savings Priorities

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.

A Savings Plan

Now you should figure out how much to put away toward those goals each month. A good rule of thumb is to save 15% of your income for retirement, so if you've adopted a 50-30-20 budget, that leaves you with 5% of your income to set aside for extra debt payments and your short-term and mid-term savings priorities.

Set actual dollar amounts and time frames (for example, $1,000 and six months for the car repair fund), keep track of your progress, and figure out whether you need to drop a goal or downscale it (maybe take a nice long weekend at a beautiful, nearby resort instead of a 10-day vacation in France).

Comparing Spending to Your Budget

Each month, compare your actual income and expenses to the budgeted amounts. You’ll see the areas in which you have shortfalls and the areas in which you have more than expected.