Want to know how to make a budget for your family? The first step to reaching your financial goals is to take control of your money by creating a budget plan. But figuring out how to start a budget that actually works can be tough. That's why we’ve put together this comprehensive guide that outlines all of the steps in the budgeting process. Whether you are setting up a budget for the first time or you have a personal budget but it isn’t working for you, this step-by step guide has your back.
Over the past eight years, Joseph and I have saved up over $250,000 and are on track to cross $300,000 (fingers crossed) this year. And we’ve done it while weathering major life changes like changing jobs, taking pay cuts, moving cities, and having a baby. Plus we’ve also been able to do things like take our children to Singapore on our first international vacation. There is no way in the world we would have accomplished that if we hadn't created a budget plan.
Budgeting is all about mindset. Before we go through the steps to set up a budget, let’s look at what a budget is, why some people hate them, and why budgeting is the key to reaching your financial and life goals.
- What is a budget and why do you need one?
- The real reason people hate budgets.
- Creating a spending plan for your ideal lifestyle.
What is a budget and why do you need one?
In its simplest terms, a budget is a spending plan for your money. When you create a budget, all you are doing is deciding exactly what you what to do with all of your hard earned dollars. By taking control of your money, you make sure that it is working as hard as possible at helping you reach your financial goals and create your ideal lifestyle both now and in the future.
People who don’t like budgeting usually point to a handful of reasons why. The first, is that they have absolutely no idea where to start. Most of us don’t learn much about personal finance in school. And not everyone is lucky enough to have parents who were able or willing to teach them about money. Luckily, budgeting is pretty easy once you learn how to do it. That’s where this guide comes in.
The second reason people hate budgeting is because they feel like they aren’t numbers of spreadsheet people. The good news is that having a budget that works doesn’t mean tracking your spending down to the last penny. In this article is chock full of information about how to make budgeting as simple and hands off as possible.
The real reason why people hate budgets.
A third reason–and maybe the biggest reason–why people don’t like budgets is because it makes them feel restricted. They hate the idea of not having the freedom to do whatever they want with their money on the fly. This is a bit of mental misdirection. The truth is that you are entirely in control of your budget. That means that you can choose to build as much padding into it as you need to so that you don’t feel restricted.
But here’s where the mental misdirection comes in. When we budget we have to actually look at how much money we have coming in and going out. Then we have to make sure that there is enough left to meet our other financial goals plus do all the fun stuff like travel and home decor.
The true friction with budgeting comes when we don’t quite have enough to fill all of those spending buckets. When that happens, then we have to actually choose between those competing priorities. The choice isn’t often easy or fun. So we blame our budget because it is easier than coming to terms with the fact that we need to say no to some of our wants.
It sucks not having all of the money you need to have all the things right now. Trust us, we know. But avoiding budgeting is a surefire way to not fix the problem. So here is what you can do instead to get over that mental hurdle.
Creating a spending plan for your ideal lifestyle.
When you go through the process of making a budget, what you are actually doing is deciding what you want your life to look like and what you actually value. Having a household budget makes it a lot easier to spend your money in the areas that actually make you happy. For example, you might come to realize that rather than buy a new phone every year, you’d rather put that $800 towards a few modest weekend getaways.
Budgeting also gives you an opportunity to set financial and life goals and provide a meaningful way of measuring progress. Back in 2012, Joseph and I set a goal of one day maxing out our 401k at work. We wanted to be millionaires in our 40s and to retire early to a life of travel and comfort by our mid 50s. Each year we increased our savings with each new pay raise. 2015 was the first year we were able to max out both of our 401ks and we haven’t looked back since.
Your budget can help you recognize that you need to make some changes in your life. This feels scary to admit but one of the keys to living a happy life is to be willing to recognize when things are going off course and to make the necessary changes to get back on track. Your budget might not perfectly reflect your ideal life when you first start, but can in the future when combined with goals and action.
How to Start a Budget Step 1: Gather all of your documents.
In making your budget, the goal is to capture all of your money-related items all in one place. You are going to be looking at your income, your expenses, and your future expenses (aka goals) and coming up with a plan that incorporates all of those things.
To make the process go as smoothly and quickly as possible, you will want to go ahead and gather all of the necessary documents up front. That way you won’t have to stop every two minutes to hunt through your
junk drawer filing cabinet for the additional documents that you need.
Some basic items that you will want to have before you get started:
- Recent pay stubs
- Most recent bills for all expenses (credit cards, utility payments, mortgage, services, etc.)
- Bank statements (including retirement accounts)
Nowadays many people do most of their business online and so you might not necessarily have paper documents for all of your income and expenses. In that case, you will want to gather the username and passwords for all of your accounts. Just make sure that you keep your computer nearby as you go through the next few steps so that you can pull up the information you need quickly.
How to Start a Budget Step 2: Calculate your income.
When you are setting up a budget for the first time, the first number that you are going to want to know is how much money you are bringing in. Your gross income is the money that you make before taxes and employer benefits are deducted. Your net income is what is deposited in your bank account after all of the taxes, insurance, etc. is taken out.
Grab a piece of paper and write down every regular source of income you have. Then to the right of each source of income, write down how much you make.
Ideally, you will want to calculate how much you make on a monthly basis even if you are paid weekly, bi-weekly, or have an irregular income. This keeps things as simple as possible because most of your expenses will be monthly expenses. This also makes it easy to do longer term planning for a year or more in the future once you get to the goals section.
Here is how you translate your income into a monthly number:
- Weekly income – 52 paychecks a year
- Option 1: Multiply your weekly income by 52 (weeks) and divide by 12 (months)
- Option 2: Multiply your weekly income by 4. (The remaining two checks are treated like bonuses in the month they are earned).
- Weekly income – 52 paychecks a year
- Bi-Weekly Income – 26 paychecks a year
- Option 1: Multiply your bi-weekly paycheck by 26 (pay periods per year) and divide by 12 (months)
- Option 2: Multiply your b–weekly paycheck by 2 (The remaining two checks are treated like bonuses in the month they are earned *this is what we do*).
- Bi-Weekly Income – 26 paychecks a year
- Bi-Monthly Income – 24 paychecks per year
- Multiply your paycheck amount by 2 (pay periods per month)
- Irregular income
- Add up your yearly projected income (or use last year’s numbers) and divide by 12 (months)
- Bi-Monthly Income – 24 paychecks per year
Do this for every regular source of income that you have. When you are done, add up all of your sources of income to come up with the total income you will be working with for your budget. Now it’s time to move on to the expenses.
How to Start a Budget Step 3: Total up all of your mandatory monthly expenses.
The goal of this step is to add up all of your required expenses in the same way that you did with your income. On the same piece of paper (or spreadsheet) from the previous step, write down the name and amount of all of your mandatory expenses.
Your mandatory expenses are thing things that you absolutely have to pay every single month. This includes housing-related expenses like rent/mortgage, electricity, and trash. It also includes any debts, like your car payment and credit cards. To keep things organized you will want to break your expenses up into categories that make sense. For example, mortgage, electricity, gas, trash, and the alarm system would all fall under “Household.” You might also have a separate category for expenses related to your car and your children (daycare, braces, etc,).
Use estimates for any item you aren’t sure about, like groceries. You can update that number in the future as you start tracking your budget from month to moth.
It’s possible that you might have mandatory expenses that are already captured elsewhere. For example, your health insurance premium would be a mandatory expense, but you may not end up recording it in your budget if your employer takes the money out of your paycheck before it hits your bank account. That’s completely fine, and is actually a form of automating your finances.
Now, not all of your expenses will be monthly expenses, but you will want to make sure to include them in your budget too. Things like getting your oil changed or your chimney swept only happen a handful of times a year. So what you want to do here is list them out, estimate how much you spend a year on those items, and then divide that number by 12 to get your monthly total for non-monthly expenses.
Add up all of your mandatory expenses and write down the total underneath.
How to Start a Budget Step 4: List out your monthly discretionary spending and costs.
Alright, now we are going to tackle our discretionary expenses. We recommend separating your discretionary expenses from your mandatory ones because these are the easiest to lower or cut out entirely if you need to make tweaks to your budget to accommodate the financial goals we are going to identify in the next step. Plus it can be really eye opening to see just how much money we spend on wants.
To get your discretionary spending number, follow the same process outline above for mandatory expenses. List all of your expenses out along with their monthly payment amounts. Calculate the monthly amount for any irregular expenses by dividing by twelve.
To figure out your discretionary spending numbers, you might have to look at your bank statements or credit card accounts to identify recurring subscription payments and other electronically billed items. Make sure to include things like gifts, trips to visit family, and the random throw pillows you seem to come home with when you go to Target.
Add up all of your discretionary spending and write the total underneath.
How to Start a Budget Step 5: List your financial goals and the monthly costs associated with them.
This step is what dreams are made of. Want to take that family trip to Disney next year? Emergency fund a little skimpy? Looking to purchase a new house or renovate your current one? Now is the time to start saving up for those goals and your budget will make it happen.
Although we’re just getting to this in step five, this is actually the most important part of your budget. It contains items that are critical to your financial health like your retirement savings goals and emergency fund goals. It also has lifestyle items that are important your overall happiness like traveling more or moving to a new city.
Keep in mind that not all of your financial goals have to be captured in your budget. You may choose not to include 401k or HSA savings offered through your employer if you automatically contribute the exact same amounts every month. But if you don’t want to keep it in your budget, just make sure to review your contributions periodically to make sure that you stay on target to meet your goals.
Take some time to think about your financial goals and how much they are going to cost. If you need some inspiration, check out our 2017 financial goals. Again, break down the yearly cost of your financial goals into a monthly amount by dividing by twelve.
Now it’s time to put it all together and see what you are working with.
How to Start a Budget Step 6: Calculate your monthly budget surplus/deficit and make changes if needed.
It’s time to add up all of your month expenses and subtract them from your monthly income. If all goes well, then the resulting number is positive and you get to add some extra padding to one of your budget categories. Once you’ve done that, feel free to move on to Step 7. On the other hand, maybe working through your budget has made you question some of your current expenses and you want to tweak them a bit. If so, stay on this step and keep reading.
It is possible, and perfectly normal, that the number you have come up with is negative. While it is less than ideal, it is certainly fixable.
In the short term, the easiest place to cut expenses is with your discretionary expenses and potentially your financial goals. Go through the items on each of those lists and rank them from most to least important. Next, cut back on or eliminate entirely the lowest ranked discretionary expenses and financial goals until your budget goes positive.
If you have cut out out all of your discretionary expenses and financial goals and are still negative, you will need to revisit your mandatory expenses. Are there places where you can cut costs? Can you downsize or sell a car? Mandatory expenses are often harder to change than discretionary ones, especially in the short term.
Your last option is to address any potential budget shortages by making more money. Even if you don’t have any budget shortages, it pays to review your expense categories periodically so that you can trim the fat and re-purpose the money to other priorities.
How to Start a Budget Step 7: Automate your finances to simplify your budget.
At this point, the hard work is done. You know how much money you having coming in, you’ve reviewed and tweaked your expenses, and you’ve set financial goals that you are now working towards. Now you need to decide on a process for making sure that you stay on track with your spending plan.
It is a good idea to work towards having one month of expenses in the bank. This is known as paying this month’s bills with last month’s income. This is especially true if you have an irregular income. Having a month of expenses in the bank breaks the paycheck to paycheck cycle and makes it so that you don’t have to worry about not having enough money for a regular expense because your paycheck didn’t line up.
You’ll need to decide whether you want to take a super hands on approach to managing your money or if you’d like to automate your finances. Some people like to track their money down to the penny free apps like Mint or paid apps like You Need a Budget. These apps allow you to categorize every expense from all of your accounts so you can see if you are staying on track throughout the month.
We prefer the hands-off approach and use multiple bank accounts to make that happen. Create a savings account for each of your major savings goals and sinking funds. Have one checking account for your monthly expenses and one for your personal/family entertainment budget. Personal Capital helps us organize all of our financial accounts in one place plus it helps us keep track of our net worth.
When you segregate your finances like that it earmarks the cash for that specific purpose and makes it less likely that you will spend it on something else. And if you do choose to move money from one category to another, you’ll know that you took $200 out of your clothing fund and used it to eat out, for example. No more wondering where all of your money went.
How to Start a Budget Step 8: Do a Weekly And/Or Monthly Budget Review
It is important to review your budget periodically. Weekly and monthly check ins make sure that you are actually sticking to your budget. They also allow you to tweak your budget as you get more information on your spending habits. For example, you might discover that you actually spend $200 more a month on groceries than you thought. Or that your $100 fun money allowance is actually not sustainable for you in the long run.
Be sure to review your budget any time a major life event happens, like having a kid or buying a house. In fact, now that you know how to budget you can create what-if budgets to see what your life might look like if you decided to make a big change, like moving to another city.
Once you get the hang of monthly budgeting, we recommend also trying out yearly and multi-year budgeting to help with your financial goals.
Finally, a simple guide to budgeting for beginners! Learning how to make a budget is easy with these budgeting tips and step-by-step guide. Learn how to make a budget and create a family budget in no time with these simple budget techniques. #budget #budgeting #personalfinance