If you have a monthly combined salary of say $2,500 per month and you are unsure how much you can pay for food, housing, insurance, health care, debt repayment and having fun then you need a budget. You might be concerned about how you are going to pay for everything you need to – especially because a budget is a zero-sum game.
The answer? Make a budget and try to stick to it.
What is a budget you say? A budget is a plan for every single dollar that you earn, where it comes from, and where you will spend it. It is a plan to work towards financial freedom and to create a life that has less stress. In this guide we will talk about how to set up a budget, and then how to manage it.
How Do I Budget My Money?
There are a number of steps you need to do to budget correctly:
- Figure out what your individual or monthly combined income is.
- Create a budgeting method – there are different ways to create a budget.
- Monitor your progress on a month-by-month basis. It might change or you might have to adapt it.
- Start simple with the 50/30/20 approach to budgeting.
- 50% of your income is spent on needs
- 30% can be used on wants
- Try to commit 20% or more to savings and debt repayments
- Track and manage your budget through regular check-ins.
What is the Budgeting Process?
Determine how much money you’re paid after tax. If you receive paychecks automatically from your employer then the amount you are receiving is usually written out on it. If you have deductions that are made for your 401(k) savings, health insurance, or life insurance, then add these back in to give yourself an accurate idea of how much you are saving and spending. Your 401k contribution counts as savings which is why you want it included in your budgeting tool. If you make any other income (rental income or from side hustles) then include it and then remove anything that would reduce it like taxes and business expenses.
Choose how you will budget. Any budget that you choose will need to cover all of your needs, some of what you want to buy, and an important part of it – saving for emergencies and the future. There are a number of different types of budgeting plans which include the zero-based budget and the envelope system.
Track How You’re Doing. Track all of your expenditures using a budget template or an online budgeting tool.
Automate the Process. Budgeting works incredibly well when you can take your willpower out of it as much as possible. It also helps you remember what you need to do month-to-month. If your savings are taken out of your account automatically right after your paycheck comes in then you are much more likely to save. If you can add an accountability partner to this process then you’ll have an even better chance of succeeding.
Practice, practice, practice. What you want to save, and what you want to spend, will change over time, and that is ok. It is a good idea to create a regular check-in (monthly or quarterly) where you look at your spending habits and check-in with yourself to see how you are doing on your targets. If you are struggling to stick to whatever budget you have created then you can read our top 5 tips for budgeting.
FAQs for Budgeting
- How Can I Make My Own Budgeting Spreadsheet?
- How Can I Keep To My Budget?
- How Do I Determine a Budget?
Start by figuring out how much your take home net pay is each month then have a look at your current spending. Look back through what you have spent the last month and whether this is a standar month for you or not. Then apply the 50/30/20 principles of budgeting to this amount – 20% towards savings, 30% for wants and 50% to needs. This is a great place to start.
Effective budgeting all starts from understanding. To start you want to track your spending on a regular basis so you can understand where your money is currently going and where you’d actually like it to be going instead of where it is right now. To get started you should 1) check your current account statements 2) Categorise every expense in to groups 3) keep your tracking consistent so you can look at it month-to-month 4) look at other options to save money and then 5) Identify room for change. There are a number of free online spreadsheets that can make budgeting much easier.
First things first – start with a personal financial assessment. You can’t know where you’re going unless you know where you stand and what you hope to accomplish. Once you’ve figured out where you stand, pick a budgeting system that works well for you. The 50/30/20 system is simple and is a great place to start. You can choose a more complicated system in the future if you need to, but it’s much easier to be consistent when something is easy to follow.
Start With a Simple Budgeting Plan
We always say start small. Start simple, and start how you mean to go on. The 50/30/20 budget can belp maximize your money and is easy to keep in mind when budgeting. The goal of the 50/30/20 is that you spend approximately 50% of your net income on what you determine to be essentials, 30% on what you want to buy, and 20% on debt repayments and money to put in savings. These categories will help you stay on track month after month.
Simplicity wins over complexity in the long run and this is why we like this system.
What are your needs?
You should spend 50% of your net income (after-tax) on what you need. Needs can be defined as:
- Housing – rent or mortgage
- Food – groceries (not eating out)
- Utilities
- Transport
- Insurance
- Loan repayments (minimum) – anything that is beyond the minimum repayment goes in to the debt repayments and savings category.
- Child care (if it allows you to go to work
If you calculate all of these expenses and it goes over the 50% mark then you might need to dip into the 30% – the wants category. It’s not the end of the world if this happens once in a while but you should adjust your budget if it happens continually.
If you find your needs (or fixed costs) falling under the 50% cap you should still revisit them on a regular basis. You’ll never know where you can save money if you don’t look. You might find cheaper internet, you might find a better cell phone deal or a better plan for your insurance.
30% of your income is for wants
It can be difficult to separate your wants from needs. Typically we would define needs as something you require to live, and wants are things that you desire beyond what is needed – these could include gifts, travel, dinners out, and entertainment.
It isn’t always straightforward to decide where purchases sit. If you go and get a massage to help with a hurt back – is this a need because it helps you work more productively, or is it a want because it is something that you can in fact live without? What about buying organically at the supermarket – is this a need because you are helping the environment or is it a want because you could in fact live without it?
It comes down to personal preference in the end – if you really want to get out of debt quickly then you might decide that you don’t need organic groceries or can put off that visit to the massage – it all depends on what you’re trying to achieve with your money. The main thing is that you can cover the real essentials – the things that if you don’t pay will mean you won’t have the basic necessities in life.
Any budget, regardless of which one you choose, needs wiggle room. Especially the first couple of times that you do it you will definitely forget about key things. Make sure that you leave room for these, and also for unanticipated costs that you might not expect. And also leave yourself some money for fun – you might want to be spontaneous and enjoy your money – you should let yourself do this.
Always think of a budget as a tool to achieve your goals – not something that will bind you to a way of life that you’re not interested in. If it is a sensible budget, and it doesn’t mean you’re living like a pauper, then it should be easier to follow it.
Make sure 20% of your income goes to savings and other debt repayments
Once you’ve set aside 50% for your essentials, 30% for your wants, arguably the most important thing to get you out of debt is to maximize where you are spending the final 20% of your income. Make sure to keep in mind the big picture – you absolutely need a buffer if something goes wrong but over the long term paying off debts with the highest interest rates will have a bigger impact. This is called the snowball effect.
What Are Your Budgeting Priorities?
Priority 1 - Create a cash buffer for emergencies
Many financial experts suggest that you build up a cash fund that would cover a number of months of your key essential expenses. A good goal to start is an emergency fund of about $500. This should be enough to cover small unexpected expenses and bills. From there you can set yourself a goal to work towards – maybe you want $1,000, $1,500, or $2,500 in your emergency fund so you don’t have to use a payday loan to top things up.
It is impossible to get out of debt without a way of avoiding more debt at every corner. If you have to borrow money for every unexpected expense then you’ll keep getting yourself in more trouble.
Priority 2 - Make Sure Your Employer Matches Your 401(k)
There’s easy money and then there’s hard money. Saving after you get paid is important, but it costs more because tax and other costs have already been taken from your gross salary before it is paid to you. The easiest way to save more money is through a tax-advantaged account like a 401(k).
Check if your employer offers a matching 401(k) – if they do then you should try to contribute as much as you can to grab the maximum. This is free money!
You might ask why we put matching your employer 401(k) higher than debts? This is because you won’t find another chance like this to get free money, compound interest, and tax breaks. Ultimately this means you’ll have a better chance of building long-term wealth because it means you’re getting in the habit of saving regularly over the long term.
You know what they say about compound interest – it is the 8th wonder of the world. You’ll never get a second chance at capturing compound interest – if you start in your 20s you’ll get extra years to build wealth. Every $1,000 you don’t put away in your 20s and 30s could be tens of thousands of dollars less at retirement.
Priority 3 - Clear Debts That are Toxic
After you’ve set up your 401(k) from your employer (if you can) then go for the toxic debts that are in your life. A toxic debt could be a high-interest credit card, payday loans, personal debt, title loans, and any rent-to-own payments that you have. Every single one of these carries very high-interest rates that you’ll end up paying at least 2-3 x the amount that you’ve borrowed.
If either of the following two options applies to you then you should investigate options for any type of debt relief. This could be debt management plans or bankruptcy:
- If you can’t repay your unsecured debt (medical bills, credit cards or personal loans) within 5-6 years
- You have unpaid unsecured debt which is more than half of your gross income, then you
Priority 4 - Again, Retirement
After you’ve paid off any toxic debts (well done!) the next thing on your list is to get on the right track for retirement. You should aim for about 15% of your gross income (which includes your 401(k) match) to be put towards retirement. You should first look into getting a Roth IRA and once you’ve maxed this out go back to your 401(k) and try to max that out.
Priority 5 - Again, Emergency Fund
Once you’ve created your $500 buffer you’ll want to return to it again and try to get that number higher. If your needs/essentials equal $1,000 you should look to put $6,000 aside (6 months’ worth). You won’t always get steady progress on this because emergencies will happen and you’ll need to dip into it from time to time.
Priority 6 - Repaying Debts
These are debt repayments that are beyond the minimum required. If you’ve already followed these steps and paid off your most toxic debts then what is left is probably the debt at a lower rate. Examples of this are your mortgage (which is tax deductable). This should only be tackled after you get your other proverbial ducks in a row.
Priority 7 - Look After Yourself
Well done – if you’ve made it this far you’ve made huge in roads in to your debt. If you’ve followed steps 1 – 6 you’ve built up your emergency fund, wiped out toxic, and are contributing monthly to your financial future. And you’ve built a savings habit – very important. Don’t stop now!
Consider topping up your emergency expenses with money that can be used on a new car, or even a new roof. These kinds of expenses will happen no matter what you do so it is better to be prepared for this.
