A budget is a way to plan your spending for each month, balancing how much you earn with how much you intend to spend. Budgets can be useful for everyone, but especially for people tackling debt, saving for short- or long-term goals or new to personal finance.
Let’s examine how budgets work and how they might be useful for you.
Budgeting basics to know
Creating a budget is a step-by-step process that involves considering your earnings and assessing your spending needs and habits. Let’s walk through the considerations.
1. Estimate income
Your budget starts with your net income. Your net income is the total amount you take home on a monthly basis. It’s different from your gross income, which is your earnings before deductions like taxes and healthcare benefits. For budgeting purposes, it’s important to consider only the funds that you make after deductions. This is the money you can spend each month.
Your net income may include earnings from your main job and side job, but it might also include money you receive from interest on your accounts, dividends from investments or any other funds you collect regularly.
2. List expenses
After estimating your income, you’ll want to create a projection of your monthly bills and expenses.
Start with your necessities, including your rent or mortgage payment, groceries, commuting costs and any other expenses you can’t live without. Then, project how much you’ll spend on your “wants,” or things that make you happy that you tend to spend your money on. This might include going out to eat, going to the movies or any other expenses that might not be essential, but allow you to enjoy life to a fuller extent.
While you might feel like you can ballpark your regular spending in your head, you might consider estimating your expenses by looking at past bank statements. This may be a more accurate assessment of how much you spend every month. It may also help you see spending you want to cut back on, like unused subscriptions you’ve forgotten about or frequent takeout meals.
3. Create financial goals
The next step to creating a functional budget is identifying your short- and long-term savings goals. Short-term goals might include paying off your credit card in full, saving for a vacation or building up an emergency fund. Long-term goals might include paying off a home, saving for a child’s education or planning for retirement.
You may decide to put aside funds for both types of goals at once. For example, you might put aside a portion of your income in a savings account to use on a future vacation while putting another portion in a 529 account to save for your child’s college tuition.
4. Allocate funds
After you have calculated your earnings and your expenses, compare them against each other. If you make more money than you’re spending, you have surplus funds at your disposal, and if you make less, you have a deficit.
If you have a surplus, consider saving those funds and allocating them to your short and long-term financial goals. If you have a deficit, take a look at your spending and see how you can cut back to avoid accumulating debt. Even if you have a surplus, there may be ways to start saving more by cutting back on non-essentials and putting more funds towards your goals.
5. Review and adjust your budget
Your income, your spending needs and financial goals may change at different times of your life. Whether it’s because your rent increased, you received a raise at work or you paid off a long-term debt, your budget won’t be set in stone forever. Periodically review your budget to make sure it continues to align with your lifestyle and financial objectives.
