- A budget is a plan for spending and saving money to meet current and future goals.
- You should adjust your budget over time as your life changes.
- A good budget can help you meet challenges like unexpected costs.
What is budgeting? Budgeting is making a plan for every dollar you earn or spend.
Remember when you were a kid and got an allowance? Back then, you knew how much you could spend by how much money was in your pocket. You had a few choices of how to spend it, and when the money was gone you knew you were done spending till your next allowance.
Now that you’re grown up, there’s more to managing your spending than figuring out how much you have in your pocket. You need a budget: a plan that matches the money you have coming in with all the things you could potentially spend it on.
- Explains what a budget is
- Discuses what to include in a budget
- Lays out a step-by-step plan for creating a budget
- Provides tips on how to make a budget work
Definition: What Is a Budget?
A simple dictionary definition of a budget is that it’s a list of what you need, what it costs, and how you’ll pay for it.
That sounds simple enough on paper, but in practice, it’s a little trickier. Here are some of the real-world challenges you have to plan for when budgeting:
- Timing. Budgeting has to plan not just for how much money you have coming in and going out, but when those things will happen. For example, your wages over the course of a year might be enough to cover all your planned expenses, but if a big expense comes up early in the year you won’t yet have those later paychecks available to pay for it.
- Credit. Borrowing money can help you handle any mismatches in timing between income and expenses. You could charge something to your credit card if you don’t have enough cash in your bank account, or you could take out a loan to handle a bigger expense. The problem is that credit can also blow up a budget by making it all too easy to spend more than you’d planned.
- The unexpected. You can sit down at the start of a month or a year and very carefully plan out what you expect to spend money on. In the real world though, stuff happens. A key to successful budgeting is learning how to adjust to the unexpected.
Budgeting Basics: What to Include in a Budget
Budgeting means planning ahead – what you expect to spend money on over the course of a year, and where that money will come from.
Start with your month-to-month living expenses. The rent or mortgage that puts the roof over your head. Bills for things like power and water that make your home liveable. Your groceries.
So that takes care of food and shelter. Of course, another basic need is clothing. This is a little trickier because clothing needs don’t come up in regular amounts from month to month, but you have to plan on spending something for clothing over the course of the year.
Once you go beyond those most basic needs, there are a variety of other things that have become essential to modern life. Your phone plan, transportation costs, etc.
So that more or less covers your survival. But you want to do more than survive -- you want to enjoy life. So budget a little money for that as well. That could mean anything from a streaming subscription to a holiday trip.
When you start thinking about all the things you’ll need over the course of a year, and then throw in some things you want, there’s a lot to budget for. And this is just the beginning.
Beyond the Basics: Budgeting for Debt and Savings
On a simple level, a budget could be nothing more than a plan for how your wages will cover your month-to-month spending.
That’s fine for people who live entirely on a cash basis. It’s like an expanded version of walking around with your allowance money in your pocket. But the fact is that most people these days don’t live on a cash basis.
Debt and savings give you more flexibility than that:
- Borrowing allows you to cover expenses even when you don’t have the cash on hand.
- Saving allows you to set aside money to make future expenses easier to meet.
Both borrowing and saving need to be part of your budget.
Borrowing and budgeting
Avoid borrowing to meet month-to-month expenses. You’re going to have to meet those same expenses next month, and eventually, you’ll run out of room to borrow.
Borrowing is fine for expenses that only come up occasionally, like buying a car. However, once you borrow, your budget must include loan repayment.
Borrowing should not be used as a way to cheat on your budget plan. It should be part of that plan, but only if that plan also addresses loan repayment.
Saving and budgeting
As for saving, it should be a regular part of your budget. People make the mistake of thinking they’ll save whatever’s left at the end of the month – but somehow they always find ways to spend instead.
Start by budgeting money to build an emergency fund. This will get you in the habit of budgeting part of your income for saving. Also, an emergency fund can rescue a budget at times.
When an unexpected expense comes up, your emergency fund can cover it without blowing your budget. Then you start saving again to build that emergency fund back up.
Once you save enough to cover six months of expenses in an emergency fund, it’s time to start thinking longer term. That means saving for retirement.
Think of retirement savings as a very long-term form of budgeting. It’s not as detailed as figuring out how you’ll spend your money over the next year, but you need to do some retirement planning to figure out how you’ll replace your income after ending your career.
If you don’t include borrowing and saving in your budget, you may live to regret it. After all, borrowing today will make tomorrow’s budget more difficult to meet. And, if you’re only focused on immediate expenses, you’ll neglect to save for the future.
How to Make a Budget
Here’s how to bring this all together -- your needs, your wants, your immediate expenses, and your future ones too.
You can make a budget on paper, on a spreadsheet, or by using a budgeting app. The technology may vary, but the process is much the same.
Step-by-step, here’s how to put together a budget:
Start with after-tax income
Forget your annual salary or your hourly wage. You know you never actually see all of that money.
Assuming that your tax withholdings are correct, take-home pay is the starting point for your budget. Look at what’s left of your paycheck after they take out federal and state taxes, Social Security, and any other deductions. That’s what you have available to spend.
Track your spending
Now look back over your checking account and credit card statements and figure out what you spent money on over the past year.
Make a list of each item and what you spent. Also note whether it’s a regular monthly expense, something that comes up less frequently, or something that’s not likely to be repeated at all. Adjust this list for any new or increased expenses.
These items – especially the ones that occur regularly – are the initial candidates to include in your budget.
Now that you’ve identified what you currently spend money on, it’s time to look ahead.
Plan on setting aside money to build an emergency fund. Once that’s done, plan for retirement savings instead.
Your chances of saving money increase tremendously if you budget for it rather than waiting for extra money to magically become available.
Prioritize your expenses
That exercise of listing everything you spend money on can be a real eye-opener. There will probably be some items that are clearly more important than others.
Start with items that absolutely have to be paid each month, then list all your expenses in priority order. This way, if there isn’t enough money to cover them all, you’ll know where to start cutting.
This doesn’t mean you can’t include some spending on having fun. On the contrary, you should make that part of your plan. Budgeting an allowance for you to spend however you feel like it will make sure you keep that kind of spending to an affordable amount.
Balance your budget
Balancing your budget means making sure planned income and expenses match.
You might think that it would be wise to leave a cushion between income and expenses. However, that just leaves slack in a budget which may not be the wisest use of your money.
Instead, the cushion should come in the form of planned savings, starting with your emergency fund. That way you’ll make sure that cushion is kept available for future needs, rather than just frittering it away.
If you find that you don’t have enough income to cover everything on your wish list, that’s where prioritizing your spending comes in.
Start at the top, and make a running total of every expense on the list. When that total equals the amount of income you expect to have, stop.
At that point, you’ll need to cut out everything left or figure out how to reduce spending on the items higher up the list.
Adjust to changes
The thing about budgeting is you can’t just set it and forget it. Otherwise, real-world changes will quickly throw your budget out of whack.
Your income changes, rent increases, and cars break down. Stuff happens, and you need to adjust your budget for it when it does.
Making the Budget Work
A plan is only as good as its execution, so here are some quick tips for making your budget work once you’ve created it:
- Deposit pay to savings. If your whole paycheck goes into a checking account, it will be too easy to spend. That’s how budgets get bent and broken.
- Pay yourself an allowance. That allowance should be based on how much your budget says you can spend that month. Transfer that amount from savings to checking, so only your allowance is readily available for spending.
- Budget before you borrow. Whether it’s the convenience of a credit card or the ability to spread payments out over time with a loan, borrowing can be a vital part of managing household finances. The key is to budget for repayment before you borrow. That way, you’ll make sure you’re not digging a hole you can’t get out of.
- Bank your raises. If you want to get ahead financially, don’t simply expand your spending to match your income growth. Try to bank at least half of your raises. That way, you’ll still have some extra money to allow you to enjoy your success, but you’ll also be using that success to build long-term wealth.
Get Help If You Can’t Make a Budget Work
Budgeting is easiest if you’re starting with a clean slate. In reality, though, people often don’t even think about budgeting until they have money troubles.
Budgeting can help you solve those problems. It can show you how to plan to pay off your debts and get spending back in line with your income.
If you can’t work out a budget that will do those things, don’t just give up. Get help.
Debt counseling and debt relief services can help you get your finances under control. Getting help may be the first step towards a solution.
How do I budget if I’m a freelancer whose income varies from month to month instead of someone who earns a regular paycheck?
That kind of lumpy income makes budgeting all the more important. Use your earnings history and current gigs to estimate what you’re likely to make during the year. That will tell you what to keep in reserve after a good month, so you don’t run short in a leaner month.
How do I adjust my budget when I pay off a loan?
Figure out the best way to reallocate the money you’d been using to meet those loan payments. If you have other debt, target that money towards paying it off faster. Start with your highest-interest debt. If you don’t have other debt, redirect that money towards saving to build wealth.
How much of a yearly raise should I anticipate in my budget?
It’s best if you don’t factor raises into your budget until they occur. After all, the timing and amounts of raises are uncertain. Relying on them in your budget could get you caught short if things don’t go according to plan.