Accounting for how you spend your money has never been as crucial as it is right now. If there's anything that the pandemic has shown all of us, it is that we cannot afford the luxury of blowing with the wind anymore.
Being intentional with money is now an essential life hack. How you control your spending boils down to having — and sticking to — a personal budget.
So, the big question is: what is a personal budget, and how do you make one?
A budget compares, tracks, and summarizes the amount of money you make versus your expenses for a specific period, typically one month. The word budget often invokes images of painful restricted spending. Still, a budget does not have to be restrictive to be effective.
So how do you make one?
The first step to creating a budget that works for your lifestyle is to get a firm handle on what you're currently spending, what you can afford to spend, and your priorities.
Below I’ve compiled a list of steps that can help you create a workable personal budget.
1. Get All Your Financial Paperwork Together
Before you begin creating a budget, you'll need to know where you stand financially. Gather all your financial statements, including:
- Bank statements
- Recent utility bills
- Credit card bills
- Receipts from the last three months
- Mortgage or auto loan statements
All these statements will give you an idea about the state of your income versus your expenses. The more information you have, the better.
2. Calculate Your Income
Once you have all the information you need, you'll need to calculate your income. Suppose you're employed and receive a regular paycheck. In that case, this step is more straightforward because your taxes, 401(k), Social Security, and any court-ordered deductions are already automatically deducted.
If you work for yourself or you have an outside source of income — such as Social Security or child support — you'll need to add this income as well.
3. Have a List of All Your Monthly Expenses
The next step is to write down a list of all the expenses you expect to have during any given month. This is where your bank statements, credit card statements, and receipts from the last three months come in handy. They will help you identify your spending habits.
Some key things you shouldn’t leave out include:
- Groceries
- Utilities and bills
- Mortgage payments or rent
- Student loans
- Childcare
- Insurance
- Car payments
- Personal care
- Transportation
- Travel
- Entertainment (including eating out)
- Savings
4. Figure out Your Fixed and Variable Expenses
This step involves categorizing your expenses and setting spending limits for each. If you aren't sure how much you're spending in each category, review your statements from the last three months to get a clearer idea.
Fixed expenses are those things you have to spend money on. They are mandatory, and usually, you pay the same amount every month. Examples include:
- Rent or mortgage payments
- Regular childcare
- Car payments
- Internet services
- Standard credit payment
[!TIP] If you are planning to save a fixed amount or you have a certain amount of debt that you're paying off each month, you'll need to include savings and debt repayment as fixed expenses as well.
Variable expenses, on the other hand, change every month. For example:
- Groceries
- Gasoline
- Personal care (gym membership, salon visits, etc.)
- Entertainment
While these expenses are variable, you'll need to create an average spending limit based on what your statements reveal.
5. Compare Your Monthly Income versus Expenses
Once you have an idea of what's coming in and what's going out, you can now compare the totals of the two.
If what you bring in is higher than your expenses, you're in the green. Extra money means there's a little more to spare, and you can funnel funds towards other areas — such as savings or paying off debt.
If your expenses are more than your income, you're probably overspending. But this is not a cause for alarm. With a few tweaks and changes here and there, you will find yourself in the green again.
6. Make Adjustments to Your Expenses
Suppose your expenses are higher than your income. In that case, the first step is to cut back on certain things within your variable expenses category. Find areas where you can reduce your spending; for example, you can eat out less or cancel your gym membership, maybe consider cutting back your salon visits.
The aim is to balance your income and expenses totals at the end of every month. If you manage to achieve this, it means all of your income is accounted for, and you can budget toward a specific saving or expense goal.
Additional Budgeting Tips
I get asked often: how to stick to your personal budget after creating it?
After going through all the above 6 points, a crucial step is to monitor and continue to track your expenses in each category.
Ideally, this process should be done as often as possible. Experts advise daily tracking, but this might not be possible for you, so you can try weekly monitoring instead. Having your eye on what you're making and spending throughout the month will help you identify unnecessary expenses and problematic spending patterns quickly.
Here comes the tricky part: what do you do when you've reached your spending limit in a specific category?
You have two options; either you can stop pouring money into that specific thing or move money from another category to cater to the gap. Remember that your personal budget is not set in stone.
You are allowed to review and tweak it as circumstances change — for example, when you change jobs, you move, have children, or even when your priorities shift.
The ultimate goal is to keep your expenses equal to or lower than your income for the month. You have the freedom to customize them according to your financial objectives and situation.