I get asked about how to set up a budget quite a bit, so I thought I'd take the time to break down the steps on how to set up a budget that works. You know, a real budget that works for your life – one that is flexible and that can work for different situations.
Whether this may be your second or third, budget, if you use these steps, you'll end up with something that is both fabulous and that works for you.
What is a budget?
A budget goes by many names: a spending plan, an estimate of your income and expenses, a financial tool, etc. etc. In short, a budget is a map for how you spend and save the money you earn during a given timeframe. You can build a yearly budget, or do a weekly or monthly budget if you prefer to keep a closer watch on where your money goes.
You know how you can literally put a # sign in front of a cluster of words and create a hashtag? Anything can be a hashtag! A budget works in the same way. Literally, anyone can have a budget, and a budget can be many different things to different people. A budget doesn't have to live in a fancy app or an extensive spreadsheet. It can be as simple as some calculations on a piece of paper or the back of an envelope or napkin.
Really, a budget is not defined by what it actually is, but instead by the answers having a budget provides. A budget lays it out in plain black and white how much you have to live, to spend, and to put toward your financial goals.
How to Set Up a Budget in 6 Steps
Step #1 – Track Your Spending
Start with signing up for online budgeting software. Here are just a handful you can use:
- You Need a Budget
- Mint (what I use now that Learnvest is no longer in service – wah wah)
- The Balance's 10 Best Budgeting Apps of 2019
Sync your checking accounts and categorize your transactions so you can see exactly where your money goes each month, these apps do it for you automatically. You can also build your own using an Excel spreadsheet.
Personally, I use a healthy mix of the two for greater control.
If you’re not an Excel sheet pro, and you don’t want to make something from scratch, you can use the done-for-you template that I created here.
It doesn't matter what you do, just make sure your budget “lives” somewhere other than just in your mind.
You absolutely CANNOT build a budget without knowing what you're spending on first.
Step #2 – Find the Budget Strategy You Like Best
Here are four budgeting strategies to try. Each of these strategies requires a different approach to building a budget, which is why it is important to first decide how you'd like your budget to work before you set pen to paper.
The 50-30-20 Budget
When I first started budgeting, I was a BIG fan of the 50-30-20 method, I even was quoted in this article for GoBankingRates about my love for this technique.
I thought it was awesome because for a financial newbie like me who had never talked to anyone about what is/isn't an appropriate amount of spending in any category, it gave me a rough idea of how much of each paycheck I should be spending.
I think for those starting out, 50-30-20 is a fantastic approach to divvying up the budget. It works by taking your paycheck and putting aside 50% for fixed expenses, 20% to debt and/or savings, and 30% to discretionary expenses.
The One-Number Budget
The gist of this method is that you pay yourself first, subtract what you want to save at the beginning, then subtract your bills, and the amount left over is what you have left to spend. No more dividing money between categories, and it is a lot more flexible than worrying over every penny.
The one-number strategy especially works well if you want to aggressively save.
The Zero-Based Budget
For those of you who are a little more hardcore, a zero-based budget might work. Within the zero-based budget framework, every dollar gets assigned, even if it is to a particular saving or debt-pay-down goal.
At the end of each month, your budget should be at $0.
Having tried to make this work several times myself, I can ardently say I am not a zero-based budget person, but many other bloggers like it.
Cash Only Budget
If you have a hard time staying within budget, a “cash only” diet or no spend challenge, might break you of that habit. We've written about the envelope budgeting method before, but this theory banks on the psychological reaction we all have to spend cash. Unless you are me, and cash seems to float out of your pocket faster than you can say, “boo!”
Step #3 – Build Out Your Budget
Once you start tracking your spending and decide on a budget strategy, it’s time to actually build your budget. Below are some of the most important things to remember when figuring out how to step up a budget and putting it on to paper.
Figure Out Your Amounts
As I stated before, many budgeting newbies (including myself when I was first getting started) find it helpful to use the 50-30-20 rule to start.
This is why: The 50-30-20 provides a nice baseline for how much you should be spending each month on fixed expenses, financial goals/debt repayment, and personal spending money, based upon how much you take home in your paycheck.
It goes a little something like this: 50% for fixed expenses (rent, utilities, groceries, insurance, cell phone) 20% for debt repayment and savings (student loans, credit cards, and savings) and 30% for discretionary spending. So for example, if someone takes home $3000 per month after taxes their budget should break down a little bit like this:
- 3000 x .50= $1500 for fixed expenses
- Then, 3000 x .20= $600 for debt/savings
- And finally, 3000 x .30= $900 for spending or “fun” money
You can also use the method of backward planning to get an amount that works for you.
Income – Fixed Expenses – Debt Repayment/Savings – Variable Expenses = Personal Spending Money
Start with what you absolutely have to pay in fixed expenses like rent, utilities, car payment, etc. then factor in your debt repayment and savings goals FIRST. Then break out the personal spending money based on what your needs are each month.
If you want a done-for-you printable and excel sheet programmed with a 50-30-20 calculator, then click here.
Budget for Expenses and Goals
If you spend first and then assume you'll make savings/debt payments at the end of the month with what is left over, you'll be disappointed every time.
It's the golden rule of personal finance – PAY YOURSELF FIRST, HOMIES! (See my 82 best tips for saving success here.)
If you want to get really aggressive with your goals you can cut your personal spending money to try and funnel more cash toward your progress.
In NYC I paid off my college credit card debt by only allowing myself 15% spending money out of my paychecks each month. It was tough, but in the end, it was for the greater good. In 2015, I was able to pay off over 50% of credit card debt by going on a “debt diet.”
How to Budget Money for Spending
Budgeting is like dieting – it only works in the long term if you allow yourself indulgences. So while you can definitely get aggressive with your goals by cutting personal spending money, you should still allow some money just for fun. Otherwise, why work so hard? You'll get burned out, or suffer from debt fatigue.
Budget for whatever you want: A weekend getaway, travel, a Sephora run, a new car…it is all possible if you allow yourself to budget for indulgences both big and small.
Step #4 – Review Your Spending
Once you've built your budget and used it for a month or so, review the results.
Reviewing spending over time is the most important component in building a successful budget.
Reviewing your spending allows you to adjust if you go over budget. You can course correct and see your spending patterns over time. Budgeting isn't a “set it and forget it” thing – especially not at first. This is why it's important to review your spending after the first month.
This is how you begin to get a budget that's really tailored to your spending and your lifestyle.
Step #5 – Keep Tweaking the Budget
After a month or two, come back to your budget and see what is working and what isn't.
- Perhaps you spend more in one category, perhaps you spend a lot less. Adjust as needed.
- Certain times of the year you may spend more, especially around holidays, birthdays, or when it’s time to pay for insurance fees.
- You can update your budget as much or as little as you want.
It's very freeing in a way, really.
Step #6 – Familiarize yourself with these common “How to set up a budget” FAQs
What are the most important things to remember when setting up my budget?
The most important things to remember when setting up your budget is:
- Figure out your amounts – Track your money and allow it to your different expenses properly by using the 50-20-30 rule or another budgeting strategy that works for you.
- Budget for your goals – Pay yourself first! Put money aside for goals like paying off debt (the best goal ever), or saving for a car or your first home.
- Budget for spending – Working hard at setting up your budget is cause for celebration, but it doesn’t mean you need to go into debt for it. Set money aside for spending on something fun in the future.
How do I budget when I have an irregular income?
So, you’re budgeting on an irregular income. Perhaps you may have decided to make the transition from being a salaried employee to a freelancer and are now facing a budget with irregular income levels. Kudos to you!
Relax. Making the leap to running your own business is the hardest part of the whole process. Budgeting with an irregular income doesn’t have to be painful, here’s what you can do to make things easier.
Have an emergency fund.
An emergency fund, or “rainy day fund,” is important no matter what type of work you do, but it is critical for the freelancer with an irregular income.
The reason it is called an emergency fund is that the money it contains should be used for emergencies only. That is the key.
How much is enough, you ask? It depends on your spending habits and comfort level.
- Some freelancers can live fairly modestly, especially if they are single and rent an apartment, for example.
- When you bring a family or owning a home into the mix, however, it’s a whole different ball game.
- For a single freelancer, a 3-month cushion can be enough (3 months of living expenses).
- For the freelancer who is also supporting a family, a heftier cushion of 6-9 months of living expenses may be necessary.
Though it may be tempting to dip into the emergency fund to smooth out your irregular income, don’t do it! It's also important to know the difference between a legit emergency fund and a simpler, more flexible “money cushion.”
2. Know your baseline expenses when budgeting irregular income.
Having a handle on your monthly expenses will empower you to know how much you need to make per month in order to get by.
Separate your expenses into two categories:
- Baseline/fixed expenses like rent or a mortgage, car payment, insurance, etc.
- Variable expenses like food, entertainment, health/wellness, etc.
Differentiating the two will help during the leaner months when you need to trim back a little fat. For example, trimming back on the variable expenses that will have less of an impact on your standard of living.
It’s also helpful for a freelancer to know their bottom line — i.e., how much do you have to make per month in order to live and achieve your savings targets?
Then I would suggest building in a 15% contingency into that for unexpected or lumpy expenses.
3. Cultivate other streams of income.
Many businesses are cyclical. Usually, there will be a natural ebb and flow to any sort of freelance income. This is why it’s important to have multiple streams of income, to reduce the risk of relying on one single source.
Turning a hobby into a business is actually a great way to capitalize on what you already enjoy doing. Why not do what you love, and make extra money at the same time!?
4. Forecast as much as possible.
For most freelance or self-employed workers, you only know what your income is going to be a month or two in advance.
It depends on the type of freelance business you’re running, but for some, you may be able to map out your potential income a few months in advance. Keeping track of this in an Excel spreadsheet or even just an itemized list will help you know when you can pull back a little and focus on the client at hand, and when you need to do some more lead generation to bring in a few more projects.
Pro tip: It also helps to budget based on your lowest (projected) income month. You never want this income to be less than your baseline expenses, or else you could end up in credit card debt!
5. Add additional streams of income
Today with the sharing economy, it is so much easier to come up with creative ways to make extra money, if needed. Being a freelancer is hard enough!
- Do you have an extra bedroom that you’re just using to store boxes? Clear it out and list it on Airbnb!
- Have a car that you’re not using? List it on Turo!
- Love dogs and have a fenced in yard? Apply to be a dog sitter on Rover.com!
What do I do if I go over budget?
So you went over budget. First, relax. It happens to all of us more than we probably like to admit.
Below is your three-step game plan for when you blow the budget.
First, review & adjust categories.
Take a look at your budget to see where you went over.
Most of the time an over-budget happens because money wasn’t being tracked properly. Review your categories and see where the overage occurred. Did you go over in the groceries or going out category? Did you underspend in another category?
Second, stop spending.
When you have to rob one category to pay another category, it’s time to put the brakes on all spending and take a closer look at the budget for the rest of the month.
Maybe instead of going out to eat, see what you can make at home from whatever you have in the kitchen pantry.
Or have a staying-in night with friends just to save money on entertainment for the rest of the month. Here are 61 of my favorite ways to save.
Third, stay away from using credit.
Whatever you do, don’t be tempted to use credit. If you’re on a good budgeting system, bills should be paid before spending categories are used up.
Using a credit card to finance your budget overages pretty much guarantees that you won’t have a way to pay off that balance. And it’s the fastest way to put yourself into more debt.
Where Can I Find a Simple Budget Worksheet?
- Anyone can create a budget worksheet with just a pen and a piece of paper.
- I've also got a tutorial on using a budget worksheet here.
- If you want the prompts and done-for-you Excel files, click here.
When you know how much money you have and where it goes every week, you'll be better equipped to save money and use it for things you want to do. And sticking to your budget will also help you meet those important savings goals so you can actually increase your wealth and net worth.
One of the best things you can do when you decide to implement a budget is figuring out why you are doing so. When you know why you want to get control of your finances, you can use that reason to motivate yourself to stick to it when it gets hard.
Even if you have the best intentions, and have been good about sticking to rules, keeping a budget all of the time is hard, it’s supposed to be.
Just remember, life happens, and unexpected expenses will come up. Don’t forget the reasons for controlling your finances, and these situations will be easier to deal with.
Having a budget – and sticking to it – is a great way to help you achieve your financial goals. Budgeting frees up extra cash for debt repayment, savings, or whatever else you want to spend it on.