If I have take-home pay of, say, $2,000 a month, how can I pay for housing, food, insurance, health care, debt repayment and fun without running out of money? That’s a lot to cover with a limited amount, and this is a zero-sum game.
The answer is to make a budget. Gives you the comfort knowing where your money is going, how much is being spent, and most importantly that income exceeds expenses. giving each dollar a purpose and living within your means, developing a sense of freedom with your money.
Creating a budget is an essential step in managing your finances and achieving your financial goals. Here are some steps to help you create a budget:
Determine your income: Calculate your total monthly income, including your salary, any additional income from a side hustle, or any other sources of income. The foundation of an effective budget is your net income. That’s your take-home pay—total wages or salary minus deductions for taxes and employer-provided programs such as retirement plans and health insurance. Focusing on your total salary instead of net income could lead to overspending because you’ll think you have more available money than you do. If you’re a freelancer, gig worker, contractor or are self-employed, make sure to keep detailed notes of your contracts and pay in order to help manage variable income.
List your expenses: Make a list of all your monthly expenses, including fixed expenses like rent/mortgage, utilities, car payments, and insurance, as well as variable expenses like groceries, entertainment, and dining out.
Once you know how much money you have coming in, the next step is to figure out where it’s going. Tracking and categorizing your expenses can help you determine what you are spending the most money on and where it might be easiest to save.
Begin by listing your fixed expenses. These are regular monthly bills such as rent or mortgage, utilities and car payments. Next list your variable expenses—those that may change from month to month, such as groceries, gas and entertainment. This is an area where you might find opportunities to cut back. Credit card and bank statements are a good place to start since they often itemize or categorize your monthly expenditures.
Record your daily spending with anything that’s handy—a pen and paper, an app or your smartphone, or budgeting spreadsheets or templates found online.
There are 3 main ways that you can categorize your expenses:
Fixed vs. variable
Fixed expenses are all of those that are known in advance and are consistent month to month. Examples of fixed expenses are rent/mortgage payments, vehicle payments, childcare, and monthly property tax payments.
Variable expenses are those expenses that vary month to month. You may know how much you spend in each category, but that amount can fluctuate month to month. Examples of variable expenses are food, entertainment, and clothing.
Needs vs. wants
Needs are all baseline expenses required to live. Examples of needs may be rent/mortgage payment, transportation, childcare, and food.
Wants are all of the expenses beyond your basic needs. Some examples of wants may be transportation, clothing, and entertainment.
Needs and wants may differ from person to person. If you live near public transportation, you may not need a car, but if you live in an area with no public transit, then a vehicle may be a need.
Even though needs and wants can differ from person to person, be careful not to classify your wants as needs. Needs are the necessities.
Personally, I think that detailed categories are the best way to categorize your spending. Not only do detailed categories include your fixed and variable expenses and needs and wants, but they also provide a clearer picture of your spending.
Set your budget. This is where everything comes together: What you’re actually spending vs. what you want to spend. Use the variable and fixed expenses you compiled to get a sense of what you’ll spend in the coming months. Then compare that to your net income and priorities. Consider setting specific—and realistic—spending limits for each category of expenses.
You might choose to break down your expenses even further, between things you need to have and things you want to have. For instance, if you drive to work every day, gasoline counts as a need. A monthly music subscription, however, may count as a want. This difference becomes important when you’re looking for ways to redirect money to your financial goals.
Subtract your expenses from your income: Subtract your total expenses from your total income to see how much money you have left over each month.
Adjust your budget: If you find that you’re spending more than you’re earning, you’ll need to make adjustments. Look for areas where you can cut back, such as eating out less, canceling subscriptions you don’t use, or finding ways to reduce your utility bills.
Now that you’ve documented your income and spending, you can make any necessary adjustments so that you don’t overspend and have money to put toward your goals. Look toward your “wants” as the first area for cuts. Can you skip movie night in favor of a movie at home? If you’ve already adjusted your spending on wants, take a closer look at your spending on monthly payments. On close inspection a “need” may just be a “hard to part with.”
If the numbers still aren’t adding up, look at adjusting your fixed expenses. Could you, for instance, save more by shopping around for a better rate on auto or homeowners insurance? Such decisions come with big trade-offs, so make sure you carefully weigh your options.
Remember, even small savings can add up to a lot of money. You might be surprised at how much extra money you accumulate by making one minor adjustment at a time.
Stick to your budget: Once you’ve created your budget, it’s important to stick to it. Use a budgeting app or spreadsheet to track your expenses and make adjustments as needed.