Budgeting 101-How to create a budget
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The first step in getting control of your finances is making a budget. However, people are constantly asking, how to create a budget and stick to it. If that sounds like you, then welcome to budget 101-how to create a budget. Budgeting does not have to be complicated. Creating a budget allows you to both get a bird’s eye view of your personal finances and take a deep dive into the costlier parts of your life. Budgets are also incredibly eye opening for a lot of people who are either ignorant to their own spending habits or in denial. Below are 5 easy tips to show you how to create a budget and stick to it.
Budget Tip #1: Make a list of all your monthly expenses
In this list you’ll include things like your mortgage/rent, utilities, groceries, car insurance, etc. If you have annual expenses, for now convert it to a monthly expense. When you think you’ve listed everything, do another pass and make sure you include those sneaky expenses like personal care items, grooming (hair/nails), car washes, etc. Do your best to estimate how often you indulge in these things.
Budget Tip #2: Note everything as either a fixed expense or a variable expense
Companies do this with their own budget-they make note of what is a fixed expense and what is a variable expense. The difference is quite simple but can make a big difference in how you budget.
Fixed Expense: When companies allocate fixed expenses, they see it as expenses or costs that do not change with volume. Example of fixed expenses would include office rent, employee salaries, etc. If you translate that into your own life, your fixed expenses would be things that cannot easily be changed like rent/mortgage or car payments. While you could in theory make changes to these payments by refinancing, it would be a rather lengthy experience so we qualify these as fixed.
Variable Expense: Variable expenses are those that change based on volume. For example, for a company, a variable expense could include their marketing budget. In your home, a variable expense is more often than not tied to discretionary expenses such as grooming, eating out, or shopping. You have direct influence over these expenses and therefore can make changes “fairly easily” (I have this in quotes for a reason-we’ll get to that in a minute).
Budget Tip #3: Let’s start budgeting
Now that you’ve noted all your expenses, let’s start totaling. Total up your monthly fixed expenses and variable expenses.
At this point we can go one of two ways. If your expenses are greater than your monthly income, you’ve got a problem but don’t worry we’ll tackle that in step 4. If your expenses are less than your income, let’s start budgeting. While this is just a rule of thumb, your expenses should be guided by the following breakout as a % of your take-home income:
- Housing (rent/mortgage): 25-30%
- Utilities: 5%
- Transportation: 5%
- Food: 10-15%
- Savings: 10-15%
- Insurance: 15%
- Entertainment: 10%
- Other: 10%
These are just guidelines and should be utilized accordingly. Everyone will have different circumstances and will have to adjust accordingly. However, if you’re new to budgeting, this could be a helpful guide to check your spending, particularly when it comes to bigger items like housing.
Budget Tip #4: Time to make changes
First line up your expenses against the recommended percentages above. Make note of where you are straying. Very often, I see people overspending on homes they can’t afford, or leasing expensive cars, or spending too much on entertainment/dining out. Lining up your expenses against these guidelines will give you a base level understanding of where you’re overspending. Also, this is budgeting 101-you can’t spend more than you make.
Now let’s start to make some changes. I talked earlier about variable expenses being a “fairly easy” place to trim but the reality is that while on paper it’s easy, in practice it’s actually quite difficult because it requires a change in lifestyle. Therefore, I recommend tackling your fixed expenses first. Below are some tips/things to consider:
- Housing: If you’re overspending on housing, can you refinance at a lower rate or renegotiate your lease? Can you move to a less expensive area?
- Car payment: If you’re leasing, can you negotiate ending your lease early or trading in for a less expensive car?
- Cell phone/cable: This is one where I’ve found that the threat of walking away always nets out a lower price. Call the company and ask if you can trim down on channels or the bells and whistles.
While trimming down those variable expenses is harder in practice, you still have to do it. My best tip is to pay your variable expenses in cash. Yes-let’s go back to a time before credit card and Apple pay. When people pay in cash they generally spend 12-20% less than when they do with a credit card. Take out a fixed amount every month and use that for dining out, shopping, movies, etc.
If you’re having trouble cutting expenses, get motivated with a money saving challenge.
You can also check out our tips on how to save money now.
Budget Tip #5: How You stick to it: Track your actuals vs. your planned expenses.
This may sound tedious, but at least for a few months track your actual expenses vs. what you planned. This will help you realize where you’re going wrong-similar to why people track calories when trying to lose weight. To create a budget and stick to it, you need to be disciplined. Tracking your spending is a new habit you should exercise everyday to practice this discipline.
Below are some budget tracking apps I recommend:
