Build your first budget in 5 easy steps
In the end, nearly everyone has to operate within some sort of financial guideline.
This post comes from Kentin Waits at partner blog Wise Bread.
"Budget" is about as popular a term as "diet." Most people know they need to watch both, but they hate the thought of each. Budgets call to mind miserly penny-pinching, coupon-clipping and meals made up of instant ramen and cold leftovers.
But creating and sticking to a budget can be one of the most empowering things you do.
Budgeting focuses our fiscal attention like a laser beam -- helping us to pay off debt, protect our credit, fund retirement plans, and save for cars and homes. A budget is a friendly constraint that helps us live fuller lives by knowing how much money we're really making, where it's going, where it needs to go and when we have those oh-so-welcome surpluses.
For recent grads and newly minted professionals, budgeting can seem like an intimidating idea. But shelve those thoughts of complicated spreadsheets and long nights hunched over an adding machine. Creating a budget that's easy to understand and (relatively) simple to stick to isn't as hard as you might think.
Here are five quick steps to get you started on building your first budget:
1. Know how much is coming in.
Sounds obvious, right? But you'd be surprised how many people have only the vaguest idea of the most essential budgeting figure: take-home pay. The first step to building a budget that works is to understand exactly how much money is coming in each month. Combining all sources of after-tax income will show how much cash you're working with and provide a framework for adjusting expenses, determining realistic savings rates and preventing shortfalls.
2. Know how much is going out.
Next, it's time to get a handle on monthly expenses. Typically, expenses fall into two categories -- fixed and variable. Understanding the distinction between them is important.
Fixed expenses: These are usually the same or vary only slightly from month to month (think overhead costs like rent or car payments). Though fixed expenses can be lowered by longer-term strategic choices, for the purposes of budgeting, they represent a constant, predictable outflow.
If you're a recent graduate making a first post-college budget, it's important to remember that you might be facing several new fixed expenses you didn't have to worry about while you were in school. Make sure you take these into consideration when making your budget. New expenses might include:
- Student loan payments
- Health insurance
- Car insurance
An essential part of your fixed-expense category should be personal savings. Remember, paying yourself first (regularly depositing some of your paycheck directly into savings before it reaches your checking account) is one of the most important components to growing wealth long term.
Many new budgeters make the mistake of only saving what's left over -- if there's anything left over -- after expenses are deducted from income. But this strategy is really a non-strategy, and it puts your future at the mercy of everything else that's competing for those dollars. Even if you can manage to sock away only $15 or $20 a month, make a constant savings amount or percentage part of your budget. It'll add up faster than you think, motivate future savings and provide a hedge against life's unpleasant financial surprises.
After you've saved enough for an emergency fund, you should keep saving -- but consider splitting the money, continuing to save with a portion of it, while using the remainder to pay down debt. Take a look at your credit cards, student loans and any other debt you're carrying, and begin paying extra to knock down the debt with the highest interest rate. Paying more now can save you thousands of dollars in the long run.
Variable expenses: As the name implies, these aren't constant and represent costs that are well within your control, like entertainment, clothing and travel. Variable expenses are typically the first targets of cost-cutting measures if your monthly expenses exceed your monthly income.
3. Resolve your numbers.
This is where the proverbial rubber hits the road. Once you know how much money is coming in and can see how much is going out through the fixed and variable expenses, it's easy to see the territory ahead. If the numbers don't add up and you have an income shortfall, it's time to make some strategic adjustments.
Ask yourself, "What expenses can I reduce?" or "How can I boost my income so the numbers add up to balanced budget?" If tinkering with the variable side of things doesn't resolve your budget shortfall, it might be time to take a critical look at how fixed expenses can be reduced. Maybe it's time to get a roommate to share rent and utilities. Maybe cable TV can go or cellphone plans and Internet options can be scaled back.
Making income and expenses balance out is the hard work of budgeting, but it's where the real value lies. Once you can make the numbers work, you'll have a plan for living within your means and gradually achieving your larger financial goals.
4. Choose your method.
Once you have the numbers figured out, it's time to choose the best money-management method to make your budget work. There are as a many budgeting tools out there as budgeters, but I've found that the simplest methods work best.
Many new budgeters go low-tech and choose a variation of the envelope method. With the envelope method, budgeters pay their fixed expenses by check or via online payment services and then they withdraw the rest in cash. The cash is used to fund the variable expenses and is divided per the budget numbers into separate envelopes.
Each envelope lists the category name (i.e., groceries, gas, entertainment, gifts) and corresponding budgeted amount. The cash for each expense must come only from its envelope (unless another envelope category can take a hit) and once it's gone, it's gone. Though the envelope method might sound old-fashioned, it's popular because it's simple and it works.
For new budgeters, there's some real value in having your cash in hand and experiencing financial limits and surpluses in a tactile way. There's no delay in waiting for checks to clear or payments to process; the cash is either there or it's not.
If you're more technology-minded, you can try a site like Mint or software like You Need a Budget. These tools make it easy to import your financial information directly from your bank and other accounts, so you can see in real time how your spending and income are balancing out.
5. Adjust as needed, but stick with it.
"Budget" isn't just a noun, it's also a verb. Sticking with your plan and your method is just as important as creating it in the first place. Remember, there's no secret tip or special trick to successful budgeting. It just takes time, practice and a big dose of discipline. If you trip up in the beginning and overspend in one category or another,resolve to do better next month.
Living within a finite financial limit does three important things. First, it keeps you financially solvent, protecting your credit and reducing your stress. Second, it builds financial know-how that can be leveraged both personally and professionally. Finally, it can help motivate income growth by drawing a direct and experiential line between income and lifestyle.
In the end, nearly everyone has to operate within some sort of financial guidelines. Budgets are the voluntary way of acknowledging limits and deciding where our money should go and where our financial priorities lie. Over time, you'll check the numbers less and less, rarely struggle to make ends meet and seldom run out of money before the end of the month.
This is the goal and the marker of success -- a slow behavioral shift that's born from understanding what it takes to live and thrive in your own personal economy. Happy budgeting!
More from Wise Bread and MSN Money:
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