How to Make Your First Budget

How to Make Your First Budget

A monthly budget is perhaps the single most important tool that can help you make the most of your income and achieve your financial goals over the short, medium, and long term. Unfortunately, many people find the idea of making a budget overwhelming; so much so, in fact, that only about 30 to 40 percent of American households have a working monthly budget.

The good news is that creating a simple budget is less complicated than it seems. It takes a bit of time and preparation to get started, but the effort you put in is definitely worth it. People who budget are almost twice as likely as non-budgeters to report that they have no financial worries.

Read on for a look at the basic steps to follow as you create your first budget.

1. Determine why you want a budget.

This may seem like a surprising place to start, but in fact, psychology plays a major role in how we handle money. This means that delving into the reasons why you want a budget, before you even start crunching any numbers, can help increase your emotional investment in the process.

As a result, this step will boost the likelihood that you’ll stick to the budget you create. Some of the most common reasons why people work with budgets include getting out of debt, ending the paycheck-to-paycheck cycle, pursuing long-term financial goals, and resolving fights about money between couples.

2. Assess your current spending habits.

In order to create a realistic budget that you’ll actually be able to follow, it’s essential to get a clear and detailed picture of where your money is currently going. Experts typically recommend that you spend the first month of your budgeting process tracking all your spending and keeping a record of all your expenses. You can do this by manually entering figures into a spreadsheet or notebook, using an expense tracking app, or going over your bank and credit card statements.

3. Don’t forget about irregular expenses.

In addition to your regular monthly expenses, your budget will eventually need to include line items for irregular or one-off costs. These may include Christmas or birthday gifts, vacations, property taxes, and annual insurance premiums. To make sure you’re not forgetting about these, go through your calendar and past statements from the previous financial year and make a list of these irregular expenses.

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4. Add up your income.

Just as you need a clear picture of your expenses to create a budget, you also need a thorough understanding of your income. Make sure you factor in all your sources of income, including wages, business income, investment income, money from side gigs, and alimony and/or child support payments.

If you have a variable income—for example, if you’re a freelancer without a regular wage—it can be helpful to decide on a realistic monthly “salary” to base your budget around. You can estimate this salary by reviewing your total income for the previous year.

5. Identify specific financial goals.

In addition to covering your regular and irregular expenses, your budget is also there to help you achieve personal financial goals. Perhaps you are interested in buying a house or saving for retirement.

Making these goals as specific as possible can help you make sure you’re planning to set aside the appropriate amount of money. For example, instead of “save for a house,” a clearer goal would be “save $300 a month for a down payment.”

6. Include your partner if you have one.

If you have a spouse or life partner, it’s essential that the two of you work together to create a budget that works for you both (and for the rest of your household, if applicable). Money is one of the leading causes of stress in relationships. This means that both you and your partner need to be on board with the budget in order for it to be successful.

Even if you maintain separate finances, it’s still a good idea to discuss your budget with your partner. That way, he or she understands how your spending habits are likely to change and what actions he or she can take to support you.

7. Decide on a type of budget.

It might surprise first-time budgeters to learn that there’s more than one way to make a budget. Two of the most commonly-used budgets you might choose from are:

A zero-based budget.

This budget is based on the principle that your income minus your outflow should equal $0. In other words, every dollar of your income has a specific job to do, whether it’s going towards savings or a particular spending category.

This type of budget isn’t for everyone. It can be fairly restrictive and requires very careful tracking of expenses. However, it’s a good one to choose if your main financial goals include debt repayment or avoiding overspending.

A 50-30-20 budget.

With this budgeting approach, you’ll allocate 50 percent of your income to needs (which include rent, food, and minimum debt payments), 30 percent to wants (such as entertainment and travel), and 20 percent to savings (for retirement or other goals).

This budget offers more flexibility than the zero-based budget. However, you’ll need to employ some strategies, such as automating savings, to make sure you don’t shortchange yourself.