How to budget: 5 tips to get started

1
Jose Luis Pelaez Inc/Getty Images

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

The coronavirus pandemic has created serious challenges for many households, but the financial uncertainties from the past year did manage to create one silver lining: More Americans focused on how to budget. According to a Debt.com survey, 80 percent of Americans have a budget — the highest number ever in the four years of the survey.

If you fall into the 20 percent of people who do not keep a close record of their personal finances, it’s easy to understand the aversion. Thinking about how to budget might seem as fun as listening to fingernails scrape along a chalkboard. It’s not an activity that everyone necessarily looks forward to doing; however, it’s important.

The benefits of creating a budget

If you’re struggling to put budgeting at the top of your to-do list, it’s important to recognize the key benefits.

With a proper budget in place, you’ll be able to rest easy knowing you’re well-prepared for short-term unexpected expenses and that you are setting yourself up for long-term financial success. Instead of thinking about it as budgeting, reframe it to think of it as knowing where your money is going and maximizing your pathway to savings so that it can help you enjoy your life more. That pathway looks a bit different for everyone, but there are some guiding principles that can help on the journey.

5 steps to creating a budget

Here are five key steps to follow to create a budget.

1. Pay yourself first

If you try to save what’s left over at the end of the month, you’ll likely run into a major roadblock: There is rarely any money remaining. Instead, make saving your No. 1 priority.

It’s wise to stash away between 10 and 15 percent of your income between your employer-sponsored retirement plan and building (and regularly replenishing) your emergency fund. By contributing to that retirement plan and setting up a direct deposit from your paycheck into a dedicated savings account, your funds are automatically ushered away from the temptation of spending.

2. Map out your spending

After you put aside the money you want to keep, it’s time to analyze how to live on the money you have left. Unfortunately, there is not a lot of wiggle room on some of your major costs such as your mortgage or rent payment. Spending 30 percent of your monthly income on housing (including property taxes) is a good rule of thumb, but the reality is that affordability continues to be squeezed in a hot housing market.

With that in mind, it’s important to focus on more flexible costs. Compare auto insurance policies and phone coverage options to determine if more competitive offers can lower your bills. And be sure to focus on the smaller expenses that are in your control such as entertainment, dining out and subscription services.

Revisit the map at the end of the month, too. Count every dollar you’ve spent, and calibrate that with the net pay you brought in the door. If there is a surplus, you get a second bite at the savings apple.

3. Always be prepared to adjust

Once you have an outline of your regular expenses, keep in mind that your costs will evolve. Products and services will get more expensive more frequently than you will receive a pay increase, so you have to continually find a way to live within the confines of that net pay.

For example, if your car insurance gets more expensive, where will that money come from? You will need to cut back or reallocate funds from one spending category to another. Write your budget in pencil — and be ready to put the eraser to work.

If you do receive a raise, don’t simply adjust your spending up to consume the additional income. If you can, maintain the same spending levels and your savings will multiply.

4. Calculate the true cost of your debts

When you’re thinking about how to budget, you will need to manage the tug of war between repaying your existing debts and saving for the future. However, all debts are not created equal, and the winner of that tug of war hinges on the cost of the money you borrowed.

  • When it’s smart to pay down debt and save for the future: For low-rate federal student loans with favorable provisions such as deferment and debt forgiveness, there is no huge rush to get that balance to zero. While paying down student loan debt is laudable, ironically, one of the biggest mistakes young people make is paying down student loans too quickly at the expense of other goals. You need to make the minimum payments on time to continue building your credit, but you may be better off contributing remaining money to your 401(k), particularly if your employer provides a matching contribution. The same rule applies to a mortgage with an interest rate under 3 percent: Any money past the regular monthly payment might be better used with tax-advantaged retirement savings options or putting that money in a 529 plan for your kids’ future education expenses.
  • When it’s smart to focus on paying down debt only: For credit cards or personal loans with double-digit interest rates, it’s a different story: There is an urgency to paying this kind of debt off as quickly as possible. Your car loan is worth a close look, too. It might have a low interest rate attached to it, but it’s not a debt worth dragging out. The combination of a depreciating asset with sizable monthly payments can act as a barrier to achieving financial flexibility. Bankrate’s Auto Loan Early Payoff Calculator can give you a good idea of the difference you can make by accelerating your monthly payments.

5. Make budgeting a regular routine

Tracking your spending is not a one-time exercise. Just like any other part of your life where you want to excel, it needs to become a habit.

From entering your expenses in an old-school spreadsheet to downloading a budgeting app that can help you visualize your spending categories, there are plenty of ways to establish the routine. You can start with your bank; quite a few financial institutions have upgraded their mobile apps with tools that offer daily snapshots of spending and suggestions for your cash flow. You can also sign up for Bankrate’s myMoney to categorize your spending transactions, identify ways to cut back and improve your financial health.

No matter how you revisit your budget, the thinking is simple: By keeping an eye on your spending and saving to hold yourself accountable, you can identify more opportunities to enhance your ability to save, repay debt and earn financial freedom.

Learn more:

Written by
Greg McBride, CFA
Chief financial analyst
Greg McBride, CFA, is Senior Vice President, Chief Financial Analyst, for Bankrate.com. He leads a team responsible for researching financial products, providing analysis, and advice on personal finance to a vast consumer audience.
Edited by
Senior editorial director
Reviewed by
Professor of finance, Creighton University