Imagine a life where the stress surrounding money begins to ease.
It feels nice, doesn’t it?
As much as I would love to believe that we could wake up one day and know how to manage money responsibly, we can’t. It takes a little bit of work.
That is where creating a budget comes into play.
If you have never created a budget before, it is not too late. Budgeting has become essential, and everyone needs one.
Yes, it can seem daunting. You might feel overwhelmed, but with practice and patience, it does get easier.
What is a budget?
A budget is a personalized plan that helps track your income and expenses.
This plan is unique to your definition of financial success; you can’t look at someone else’s budget and assume it will work for you.
Challenges of Budgeting
Budgeting comes with its own set of challenges, from not knowing where to start to having to shift your mindset about spending. And while some sacrifices are necessary, the goal is to identify where our money is going.
Many times, we fail to understand the purpose behind setting our budget, leading to it being too restrictive and not meeting our needs.
We don’t revisit the budget for months, leading us to feel guilty for not adhering to it.
While budgeting has challenges, it does more good than harm if done right.
Five Tips for Creating a Budget
Here are five practical and effective tips to help you create a budget that paves the way to financial freedom.
Step #1: Know Your Why
Simon Sinek once said, “Start with why.”
The first step is determining our goals and motivations.
Consider your reasons for budgeting:
- Saving for a future vacation
- Looking to cut expenses
- Paying off debt
- Purchasing a home
- Paying for college tuition
Everyone has different money goals. The general idea is similar, however. There needs to be an underlying reason why you want to create a budget.
Knowing what is going to keep you motivated month after month will give you the motivation to keep going.
Take a few minutes and identify what your reasons are for creating a budget.
Step #2: Track Your Income and Expenses
This is the most important and shocking step in the process.
Tracking your expenses gives you a high-level overview of where your money is going monthly.
This process is the reality check you need to make data-driven decisions when creating your realistic budget.
What you will need:
- 1-3 months of previous bank statements
- highlighters
- two sheets of paper
- pen or pencil
I recommend printing your bank statements out for easier highlighting.
On your blank piece of paper, create a list of categories that correspond to your monthly spending. Your categories could look something like this:
- Housing/Utilities
- Transportation
- Groceries/Eating Out
- Entertainment/Shopping
- Savings
Your list might look different than the ones I’ve listed.
You can define the categories to encompass whatever you decide they encompass. There is no right or wrong here, and there is no limit to the number of categories you have.
Next, you should sit down with each statement and assign a highlighter to each category you listed on your blank sheet of paper.
Highlight every item that fits within the categories you chose. Yellow can represent your groceries, and pink can represent transportation.
You might have to add more categories than you originally planned for.
After assigning a color and category to each item, calculate the totals. Make sure to do this in monthly installments.
Suppose you had two housing-related transactions: a $1500 rent payment and a $15 renter insurance expense. Your housing category should have a total of $1515.
All expenses should be accounted for.
An Example:
Let’s use the following calculations for the remainder of this article:
- Income: $3,500
- Housing: $1,515
- Utilities: $250
- Transportation: $200
- Groceries: $700
- Eating Out: $250
- Entertainment: $250
- Vacation Savings: $100
- Shopping: $400
Your total expenses for the month were $3,665.
Consider these questions:
- Am I shocked by any of the categories I created? If so, which one and why?
- Am I happy with any category? Why?
- Am I living below my means, or are my expenses greater than my income?
- If I could change anything, what would it be?
Keep these answers in mind as we move on to the next step of creating a budget.
These will help you identify where you want to improve and set small goals each month.
If you follow the steps I’ve laid out for you, you’ll come to understand the meaning behind the phrase ‘the truth hurts.’
Don’t give up, and if this process takes you a few days to complete, give yourself the time.
When I first tracked my income and expenses, I cried seeing how much money I spent in a month.
Step #3: Categorize Your Needs vs. Your Wants
Before we create our budget and after we have seen where our money is going by tracking our expenses, we need to distinguish what our needs are and what our wants are.
Define your needs as the essential expenses that you must pay each month. These expenses cover rent, gas, groceries, and minimum debt payments. These are the non-negotiable items that we will be prioritizing in the budget.
Then there are the wants, which are discretionary expenses that bring us joy but aren’t necessary to our survival.
We might think that a weekly Target run is essential, but nine times out of 10, it isn’t.
However, it’s essential to give yourself some grace and allocate funds for occasional treats, like a weekly Starbucks visit, as a reward for sticking to your budget.
Having a budget does not mean you can only spend money on your needs and not your wants.
It means making appropriate adjustments or sacrifices to prevent us from continuing on the paycheck-to-paycheck cycle.
Step #4: Create a realistic budget.
Now it’s time to create your budget.
Based on your previous month’s income and expenses, you can set a realistic budget that allocates funds for both needs and wants.
I will be focusing on the example calculations listed in the ‘Tracking Your Expenses and Income’ section.
Your budget might look something like this:
- Income: $3,500
- Housing: $1,520
- Utilities: $260
- Transportation: $220
- Groceries: $600
- Eating out: $150
- Vacation Savings: $200
- Shopping: $200
- Debt: $350
Your total projected expense for the month is $3,500.
Can you spot how it is different from the expenses we calculated earlier?
In the example of expenses above, we were overspending by $165. While we don’t want to overspend each month, we want to make sure our total expenses match our income.
This does not mean you need to spend the entire income for the month.
I will be writing an article about the concept of zero-based budgeting later.
In our essential categories, we were able to add a buffer in case the bills were higher than expected.
In other categories, we were able to lower groceries and eating out by $100 each and cut our shopping budget by $200.
By reallocating the money, we were able to increase our vacation savings and start tackling our debt.
With this budget, we are getting one step closer to our financial goals.
Step #5: Set small and achievable goals.
While I am a huge believer that we should be setting goals that scare us, aiming to save $10,000 in a month when you don’t have the income to support it won’t work here.
We want this first round of goals to be small and attainable.
Think of small wins. These are the wins that will give us the momentum and motivation to keep going month after month.
Let’s say your small goal is to save $500 for an upcoming trip to New York City in five months.
To do this, we need to find ways in our budget to save $100.
Where in your budget can you cut expenses and reallocate them to your New York savings fund?
So your small and achievable goal might look like reducing your grocery spending.
If your calculation over the past few months shows that you typically spend $700 on groceries, try cutting back by $100 on this month’s budget.
By saving $100 per month for five months, you will have money by the time the trip comes around. This will reduce the stress of finding funds at the last minute or relying on a credit card.
This creates a domino effect, allowing you to continually refine your budget while also giving you a small win.
Over time, you may find that you can cut out certain expenses entirely, further contributing to your overall financial goals and achieving them faster.
Conclusion:
Identifying what your motivations are and defining your needs vs. wants are critical steps in creating your budget. Although these steps serve as a guideline, remember that a budget should be flexible and adaptable.
A budget is not something you create once and never look at again.
Ideally, you should check in on it regularly throughout the month to project where your money has been going so far.
Find a cadence that works for you.
And if expenses aren’t as you projected, adjust them. Don’t be afraid if you get off track and have to get back on.
Acknowledge that you fell short of your budget and find a way to get back on track.
Do not think of a budget as a rigid plan that is going to take all the fun out of your life. You can still enjoy life but in a more responsible way.
Taking control of your finances doesn’t have to be overwhelming.
Budgeting is a journey, not a destination. Start small and stay consistent!
What are your thoughts on budgeting?
Comment below and share your experiences.
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