It’s not easy to get by these days. Many of us are still suffering the economic effects of the Covid pandemic. Currently, 40% of Americans need to borrow money for emergencies. And some of us have to help out friends and relatives who may be reliant on us for assistance for a while.
It may be tempting to hide our heads in the sand, but ignoring money problems always makes them worse. As with anything else worth doing, overcoming financial hardship requires hard work and discipline. But starting earlier rather than later will make the journey easier and quicker.
So, if there’s always “more month at the end of your money” in your household, it’s time to create a budget. Below, we will take a look at how to create a budget so you can keep your money in order so you are never left feeling stretched thin.
Budgets Aren’t Just for Accountants – Real People Need Them Too!
A budget may sound very technical – if the word alone has you in a cold sweat, relax. A budget involves nothing more than looking at how much money you have coming in and how it should be spent. There’s no complicated math involved.
But where accountants do have a trick up their sleeve, they understand that not all expenditures are the same. They categorize different types of expenses and think about each type differently. We’re going to help you do the same.
There are many innovative apps to help with budgeting and tracking your money, but take out a pencil and paper or open a spreadsheet on your computer for the time being.
How to Create a Budget: A Step-by-Step Guide
Step #1 – Gather your Paperwork
To prepare your budget, you will need records of your past income and expenditures. Get together your latest W-2 and last three months’…
- Payslips
- Bank, investment, and credit card statements
- Mortgage, motor vehicle, and other loan statements
- Utility bills and receipts
Once you have this information handy, set aside a couple of hours during which you can work privately and uninterrupted.
Step #2 – Calculate Your Net Income
What is your monthly net income – your take-home after-tax? Do you get other, non-salary income in the form of child support, interest, dividends, rental income, social security, or others? If you’re self-employed, remember to factor in your tax. And if you earn variable amounts, work on your lowest income in any one month to be cautious.
Step #3 – The Simple Bare Necessities
What are your basic needs, the things you can’t do without? List them, including compulsory loan repayments and expenses you have to incur to earn your income. For most households, these include:
- Housing – Here include your mortgage payments or rent and any other housing expenses like repairs and maintenance.
- Utilities – This should include your gas and electric bills, water, and your landline.
- Transport – Your vehicle payments, fuel, and repair, or transport costs.
- Insurance – Homeowner’s, motor vehicle, medical, life, and other.
- Groceries – Food, cleaning materials, and others.
- Debt repayments – Minimum repayments on credit cards, personal loans, and other debt.
- Schooling – Your own and your children’s tuition fees, extra-curricular activities, uniforms, stationery, books, etc.
- Dependent/child care – Any costs involved in caring for dependents, which leaves you free to earn your income.
- Medical – Medical expenses in addition to any insurance included above.
- Comms – Any broadband or mobile costs essential for you to earn your income
Add these up and calculate the total as a percentage of your income after tax. A good rule of thumb is that essentials should comprise 50% of your net income. If your total is significantly over this, revisit each item to see whether the cost can be reduced.
Get comparative insurance quotes. Consider ways to reduce your grocery bills by shopping at discount chains, buying bulk, avoiding prepared foods, etc. Can you take public transport instead of using your car to drive to work?
You may need to make some hard longer-term decisions about bigger expense items like housing and schooling. Can you afford to live where you currently do? Would a smaller, more affordable home or a house in a cheaper location ease your finances? Is private schooling putting your family into debt?
Step #4 – Those Little Extras Which Can Add Up
Now you need to list the additional items that you spend money on – these are the non-essentials and luxuries. For most people, these include (but are not limited to):
- entertainment (eating out, shows, cinema, and experiences)
- travel (local and international holidays and trips)
- gym, clubs
- clothing and shoes
- beauty and spa treatments
- vice purchases (cigarettes, alcohol, and others)
- gifts
- donations and tithing
If your essentials make up 50% of your income, your non-essentials should make up 30%. Where your essentials exceed 50%, the difference should come off your non-essentials.
What people consider essential versus non-essential will differ. For some people, charitable donations are essential; for others, private tuition fees are a luxury. However you choose to define them, together, the two should not exceed 80% of your net income. Balancing your budget means cutting back your expenditures until they fit within this.
Simple adjustments to your lifestyle can make a big difference to your financial situation. Try cooking meals at home for a month instead of eating out or ordering take-out. Not only will you be eating healthier, but your bank balance will be healthier too.
Step #5 – Savings and Debt Repayments
The remaining 20% of your net income should be reserved for savings and debt repayments over and above the minimum repayments required. The latter is effectively also savings because paying your debt off early will save you interest costs.
It may take time to get to the point where you can put aside 20% of your net income, but knowing what to aim for is a good starting point. Be sure to seek sensible investment advice for your savings so that your money works as hard as you do. At the very least, ensure that your saving interest rate is more than the annual price increase.
Step #6 – Using Your Budget
Now that you have your numbers, your challenge is to stick to them and not spend more than you’ve budgeted for the month. Tracking expenses can require meticulous recording. To help you get the hang of things with less effort, you can try the old-school “envelope budgeting” method. This involves putting the cash for each category into separate envelopes. When the envelope is empty, you can’t spend more on that for the month.
Alternatively, you can use one of the many budgeting apps on the market. That way, you’ve always got access to your budget on your phone. Some of our favorites include these apps:
- Mint – This app will help you prepare your budget if you let it link to your bank and credit card accounts. It will categorize your historical expenditure and use it to suggest a budget. Mint will also allow you free access to your credit score, give investment advice, and recommend debt consolidation measures. The app is free in exchange for drawing your attention to Mint products.
- Goodbudget – This app is an electronic version of “envelope budgeting,” which allows you to allocate your budget into separate envelopes. The free version allows you up to 10 monthly and 10 annual envelopes. The visual graphics make it easy to see where your money is sitting and how you are positioned for the remainder of the month. The premium version for $6 a month or $50 a year allows users unlimited envelopes and email support.
- PocketGuard – This app links to your accounts and tracks your spending in real-time to let you know what you have left to spend at any point. It suggests ways to save, negotiate lower bills, and create higher interest savings accounts.
- You Need a Budget (YNAB) – YNAB can link to your accounts but also allows you to enter transactions manually. If you are wary of allowing third parties access to your bank accounts and personal information, then this is the app for you. It’s pricey, though, at $84 a year. YNAB offers free financial workshops covering topics like budgeting, debt, and savings. They also give users library access to many educational resources.
Step #7 – Revising Your Budget
Your budget will need to be revised at least once a year, and if there are any significant changes in your income or expenditure. Use windfalls, once-off income such as bonuses or an inheritance, to pay off debt. But work salary increases into your monthly budget. Likewise, take account of price increases in any of your expense categories.
Final Thoughts
Taking ownership of your cashflow, controlling your expenditures, and being disciplined about saving are practical actions to take under any circumstances. In times of economic crisis such as we are experiencing post-pandemic, it is more critical than ever to live within our means and save for unforeseen eventualities.
Having a nest egg to call on in times of trouble can be a lifesaver. And savings give you options. Often paying upfront or in bulk comes with a discount. Allow saving to become a habit and the effects will snowball over time.