I like to budget in monthly increments because many of my recurring expenses are monthly. A month is also both long enough to be a meaningful period of time and short enough not to be overwhelming. You could budget weekly or yearly (or do all three!), it just depends what works best for you. Here, I’ll discuss how to build a monthly budget, but the same ideas apply to any time frame.
Does everyone need a budget?
A budget might not be for everyone. Maybe you’re like BF and as long as there is money leftover in your accounts at the end of the month you’re happy. Or maybe all your spending and saving is so automated that a budget isn’t useful. I won’t say that everyone needs a budget, but I will say that I personally find it to be an incredibly useful tool. It’s also easy and (for us personal finance nerds at least) fun to make a budget. I hope you’ll agree!
Budgeting one step at a time
Step 1: Income. If a budget is a plan for how to spend money, you have to start by knowing how much money you have to spend. This is where your income comes into play. Regardless of where your income comes from (be it a job, student loans, the bank of mom and dad, investment earnings, etc.), you need to determine how much money you are working with.
Step 2: Savings and Debt Repayment. Once you know how much you’re bringing in each month, you need to determine what portion of that you want (or need) to allocate to savings or debt repayment. This gets subtracted from your income, leaving the amount you have to pay for expenses remaining.
Step 3: Fixed Expenses. With your expense “limit” in effect determined by your income less your savings and debt repayment, you now know how much you have to spend on things like housing, food, transportation, etc. Some of these expenses are likely fixed (such as rent or mortgage payments), while others are variable (such as food). Make a list of all of your fixed expenses and the amount you pay for each on a monthly basis.
Step 4: Variable Expenses. Variable expenses are harder to budget, because by definition they fluctuate. You can take a number of approaches here. One option is to work with historical averages to assign a budget number to a specific category. This might work well for something like utilities, where you have access to information about past expenses and can reasonably expect that future expenses will continue the same trend. The other option is to assign a value that you feel comfortable with. This works better for something like eating out or shopping, where you have an ability to control expenses to meet your budget.
Step 5: Contingency. Now that your expenses are laid out, it is important to account for the unexpected and build a buffer into your budget. You could put in a 5% or 10% contingency to cover overages in any category. I like to lump together several expense categories into a summary budget, giving me flexibility to over-spend in one category as long as I under-spend correspondingly in another.
Step 6: Track It. Keep track of how you do on your budget each month (without driving yourself crazy if you go over sometimes). As you track your budget each month, you may start to notice trends that you can incorporate into future budgets (such as recurring but irregular expenses like car insurance or taxes). You may also notice trends that you don’t like (such as high spending on coffee shops or nail polish), and your budget can be a tool to help you change those behaviors.
Step 7: Re-evaluate. A budget is not a static document. Life has a way of changing as time passes and your budget should be updated periodically to reflect that. This can also be a good way to keep an eye of lifestyle inflation.
What tips do you have for building a budget?