In the world of personal finance learning how to make a budget is one of the most important skills to know. If you know how to create a budget and stick to it then you are well on your way to being a good steward with your money.
There are all kinds of ways to approach this topic. No doubt if you’ve done any searching you’ve already found a dozen people each with their own method of making a budget.
In my opinion there are two ways to go about this depending on your situation.
The Back to Front Method
If you have a family or if you’ve been out on your own a while then you’ve already found some way to get by. You may feel like you’re spinning in circles, but you’ve at least found a way to keep the lights on and put food on the table.
By looking back at what income you’ve brought in and where your money has been spent you can at least put together a basic budget based on your historical finances.
Pull out your bank statement, credit card statements and anything else you have that shows your income and expenses for the last 3 months.
Using a notebook or a spreadsheet make a list of your income. If your income isn’t consistent then average out what you have made over the last 3 months. Make sure you don’t include any income that you aren’t expecting to receive in the future. (a one time bonus for example.)
For simplicity, use your net paycheck. Your net paycheck is what you actually get to put in your pocket at the end of each week. That way you don’t have to worry about budgeting for taxes or any other items that are deducted from your check.
Next take a look at all of your expenses. Break down everything you have spent over the last 3 months into the following categories:
- Taxes – (this won’t apply if you used your net paycheck when totaling your income – download tax software if you need some help tracking taxes)
- Savings – (Just an FYI – you should set up a separate high yield savings account for this.)
- Housing – Includes rent/mortgage, renters or home owners insurance, utilities, maintenance and anything else directly related to your home.
- Auto – Includes car payment, insurance, gas and maintenance.
- Food – Includes groceries and eating out.
Do your best to figure how much you spend in each category on average.
Now, subtract your expenses from your income. Are you net positive or are you in the hole each month. If you’re net positive, congratulations! That’s an exciting place to be.
If you spend more than you make each month, don’t fret. You’re right alongside the vast majority of people in America. The good news is though, you’re working on a budget. You are on the road to taking control of your finances.
What To Do If You Spend More Than You Make
Let me give you a straight answer first – you need to start spending less than you make! I’m sure you knew that though. It’s a lot easier to say than it is to do. The reason so many of us are in debt is because we live above our means.
We need to learn to cut expenses and bring our lifestyle in line with our income.
Here are some straightforward tips to cut expenses:
- Downgrade your cable package or cut cable all together
- Limit your dining out to one time per week.
- Try buying off-brand items in the grocery store. You may find that you can’t tell a difference between them and the more expensive name brand items.
- Before you go grocery shopping, make a list. When you get to the store, if it’s not on the list then you don’t buy it.
- Get rid of your data and text message plans on your cell phone.
Another way to get ideas is to see if there is one category in your expenses that is a lot higher than the others. See if there is something in there you can cut out.
Keep trimming expenses until your income exceeds your expenses. You now have a budget that (hopefully) you can stick to.
Check out what I’ve written on how to get out of debt for more ideas on cutting expenses.
The Front To Back Method
The other way to think about doing a budget is to start with a set of ideals then try to work your expenses into those. Between the two methods, I think this is the better way to go. Though it definitely takes more discipline.
A big benefit though is that it has you budget you savings and charity – two things that I think are super important. I also think making a budget this way is easier since you don’t have to pull out all of your financial activity for the last 3 months.
The way that the front to back method works is by assigning a portion of your income to categories using percentages. Think of it like cutting your income-pie into predetermined portions.
Here’s how to make a personal budget with this method – take your gross monthly income and multiply it by the following percentages:
- 12% Taxes
- 10% Savings
- 10% Charity
- 30% Housing
- 11% Auto
- 10% Food
- 9% Healthcare
- 5% Entertainment
- 3% Miscellaneous
You can also look at it on an after tax basis with these percentages:
- 10% Savings
- 10% Charity
- 35% Housing
- 13% Auto
- 12% Food
- 10% Healthcare
- 7% Entertainment
- 3% Miscellaneous
On a $50,000 per year income, here is how your budget would look on a monthly basis:
- Savings – $367
- Charity – $367
- Housing – $1,283
- Auto – $458
- Food – $440
- Healthcare – $375
- Entertainment – $257
- Miscellaneous – $125
I think this is a fairly reasonable budget for a family of 4.
Now these numbers aren’t set in stone. You still need to move things around based on your family and the cost of living in your area. Maybe you don’t have a car payment, then you can shift some of that to housing or entertainment.
I think that’s pretty straight forward. There’s no magic trick to budgeting money. It’s simply a matter of assigning your income to categories and then sticking to it
Budget Tips and Tricks
Here’s a few other things to keep in mind when you’re making a budget:
- Don’t make a budget if you don’t plan on sticking to it. You’re just wasting your time otherwise.
- Be realistic when budgeting your money. If you love to go to the movies then try to find a way to work it into your budget. Otherwise you’re setting yourself up for failure.
- Don’t be afraid to make adjustments 60 days down the road.
- Don’t make adjustments too early though. It’s helpful to have a couple of months of spending history to really judge how well your budget is working.
- Include the whole family in the budget process. When everyone is in on the decision then everyone can be a part of sticking to the budget.
- Don’t let your budget act like a prison. Let it free you. Don’t feel guilty about going out on a date with your spouse. If you have it in your budget then you are free to spend the money.
What about you? What do you think the hardest thing is about making a budget and sticking to it?