How to budget: 8 steps anyone can do

1

At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here’s an explanation for

No matter how old you are or what you do for work, there is one essential lesson you need to learn to navigate the financial twists and turns of life: how to budget. A budget helps you understand what’s coming into your bank account and what’s going out. That knowledge empowers you with the ability to prioritize immediate expenses while preparing for long-term costs such as paying for college, buying a home, retiring and other major financial decisions.

Despite the crucial role that a budget plays in one’s life, many consumers don’t have one. In May, budgeting app Mint surveyed 1,500 people, and the results revealed a shocking reality: 65 percent of them didn’t know how much they had spent in the prior month. If you fall into that category, it’s time to be a budgeter.

1. Determine your income

Before you think about how much you can spend each week or month, you need to have a concrete understanding of how much you make. If you have an annual salary with regular paychecks, that’s pretty easy to do. However, there are a range of situations that can make income fluctuate – if you receive commission payouts or if you’re a freelance worker, for example. In those situations, Eric McClain, CFP, co-founder of Alabama-based McClain Lovejoy, advises living frugally until you can get a better sense of your earnings.

“It’s often advised to make retirement contributions as you go, but it may be better to delay and build up a bigger cash reserve,” McClain says. “Accurately estimating your taxes throughout the year can help with cash flow. If you’re making less this year, your estimates calculated from last year’s income may be too high.”

2. Track your spending

Does thinking about how to make a budget feel daunting? Michael Sullivan, personal financial consultant at Take Charge America, likes to refer to the concept as a “spending plan.” Sullivan recommends starting with an analog approach.

“Take an index card, and write down every time you spend a dime,” Sullivan says. “Every time you spend cash, charge something on a credit card or pay through Venmo, make a note. That’s how you’ll see where you’re spending, and it’s how you’ll be able to start making changes.”

3. Think about your saving goals

Jotting down a note each time you buy a sandwich may not sound like fun, but Sullivan says that a budget is ultimately about doing something that should make you smile: Seeing your savings account increase.

“A spending plan should enable you to save money, to prepare for emergencies, to prepare for the future and to prepare for retirement,” Sullivan says.

Use Bankrate’s retirement calculator to get an idea of what you need to save to enjoy a post-work lifestyle.

4. Be ready for the unexpected

Before you think about all that you want to go well in life – saving for retirement or saving for a college education, for example – you have to focus on recognizing the potential for worst-case scenarios such as a big medical bill or a layoff. The need for smart savings has never been more clear than in 2020 when the COVID-19 pandemic has sent shockwaves through the economy.

“We always recommend that you have three to six months in living expenses set aside for precisely these kinds of events,” says Danna Jacobs, CFP, president and founding partner of Legacy Care Wealth.

5. Make your big expenses as small as possible

There is a common belief that around 30 percent of your budget should go to your housing costs. However, Sullivan says this benchmark gets people in trouble.

“A typical family wants to dedicate 30 percent on housing expenses and another 15 to 18 percent of their money to other household expenses,” he says. “That is simply too much.”

The same challenge happens with transportation, which is often the second-biggest line item in a budget.

“Car loans are very expensive,” Sullivan says. “People often spend up to 25 percent of their money on a vehicle.”

6. Consider the 50-30-20 approach

If you aren’t sure where to start with your budget, consider the 50-30-20 guidance included in Elizabeth Warren’s and Amelia Warren Tyagi’s “All Your Worth: The Ultimate Lifetime Money Plan” (one of the best personal finance books, according to the experts). This system breaks down your money into three categories: must-haves, wants and savings.

If you make $2,500 each month, here’s how that budget would look:

  • 50 percent or $1,250 goes to must-haves, which include housing, transportation, food, insurance, utility bills and anything else you can’t live without
  • 30 percent or $750 goes to wants such as the new stereo equipment you’ve been thinking about, an evening out with friends or other fun activities
  • 20 percent or $500 goes to your saving plan

7. Power up your phone

How do you monitor that your spending is staying in those lanes? Here’s one area where your smartphone can actually make you smarter. According to a Bankrate survey, 63 percent of smartphone users have at least one financial app installed on their devices. Those tools may include your bank’s app or a dedicated budgeting app like Mint, PocketGuard or Goodbudget to help you track the comings and goings of your money.

8. Regularly review your progress

While apps can keep your budget one swipe away, Tara Unverzagt, CFP, founder and chief advisor at California-based South Bay Financial Partners, says that it’s important to carve out time for a thoughtful evaluation of your cash flow.

“Set aside a ‘money time’ each week to review your reports to see how you’re doing,” Unverzagt says. “If you’re a couple, you should have joint money times. Couple money time helps your finances and research shows that couples that regularly discuss their finances have a more intimate relationship in other areas, too.”

What if you fall off track?

Life doesn’t always go as planned, and neither does a budget. If you fall out of your budgeting parameters, it’s time to revisit your budget calculator and rethink your approach to money.

“When your budget doesn’t balance, there are only two things you can possibly do,” Sullivan says. “You can decrease your expenses, or you can increase your income. Which one are you willing to do?”

For those who find themselves facing serious budget shortfalls, there is no shortage of tempting offers to apply for another credit card, a balance transfer or a personal loan. Avoid those.

“You cannot borrow your way out of debt,” Sullivan says. “That’s not a strategy. That’s an immediate tactic to make it to the next month.”

Bottom line

A budget is the cornerstone of your financial well-being. No matter how much you earn, a budget plays a key role in making sure that you can spend more time enjoying your life and less time stressing about how to pay for it.

Learn more: