How to Create a Budget That Actually Works (Step-by-Step Guide)
Many people struggle with sticking to a budget, but having a functional budget is key to achieving financial goals. The main reason budgets fail is because they don’t reflect real life, or they’re too rigid. Personally, I struggle to account for unexpected expenses or magically expect for us to not splurge on anything ever. That’s not going to last for the long-term. This guide will help readers create a budget that is practical, adaptable, and effective for long-term use.
Understand Why You Need a Budget
Clarity on Income and Expenses
Your budget will tell you exactly how much you are making and where all of your money is going. Do you know how much you make after taxes? What percentage of your income is going towards housing, groceries, eating out, etc?
Achieve Financial Goals
When you have better clarity on your finances you can save for your priorities better. Maybe you want to save up to buy your spouse a nice grill for Christmas (my personal goal right now), pay off debt or build an emergency fund. Your budget tells your money where to go.
Avoid Overspending
Having a budget prevents living paycheck to paycheck. When you finally document how much you spent on Amazon last month, you may be shocked. That has happened to me in the past. Whenever I was a brand new mother I purchased way too much junk because I believed every mommy influencer out there. Hopefully, like me, this will shock you into creating a better plan.
Peace of Mind
Having savings reduces financial stress because you know there is a plan. You have a cushion for emergencies. You know how much you will have at the end of every month, which helps you know if you need to adjust your current spending rate.
Step 1 – Calculate Your Monthly Income
List All Sources of Income
Include your salary, any side hustles or freelance work in this area.
Use Net Income
List that income amount after you account for taxes, retirement savings, any any other expenses deducted from your paycheck.
Irregular Income?
If your income varies, average your last 3–6 months’ income to get a reliable number.
Step 2 – Track Your Expenses
Start with Fixed Expenses
Pull out your bank statement and if you use them, your credit card bill. Go through the entire last month’s statement and write down each expense. Go ahead and put a star by some of the expenses you may be able to reduce like your cellphone bill and insurance. If you don’t have enough at the end of this exercise, you can start switching providers.
Account for Variable Expenses
Include your groceries, transportation (i.e. fuel and vehicle costs), entertainment and gift giving. September is a big birthday month for our family so I typically start shopping early so September isn’t a big month for us. Track these expenses for a few months to get an idea of what you regularly spend.
Don’t Forget Irregular Expenses
Plan ahead for things like Christmas, oil changes and tire rotations, doctor’s visits, the vet, and regular subscriptions. Add the cost into your regular budget by dividing the annual cost by 12.
Use Apps or a Spreadsheet
I loved Mint and now that it is gone, I haven’t found a free alternative that I love. Honestly, I want a budgeting app that is next to zero work on my part. Rocket Money may be a good alternative. Right now, I’m just tracking everything via a spreadsheet which is a lot of work.
Step 3 – Categorize and Prioritize Your Expenses
Essential vs. Non-Essential Expenses
Identify all expenses as essentials (rent or mortgage, utilities, food, etc.) or non-essential (eating out, impulse purchases, etc.). If after all of this you realize you spend too much consider reading my article on the Psychology of Impulse Buying.
Identify Areas to Cut Back
Identify some ways to reduce expenses without feeling completely deprived. This is where it’s important to consider what is most important to you. Our family values traveling, camping, and experiences. If you look at our budget, then you should notice we don’t spend much on clothing or eating out. You might be the opposite and love eating out but don’t value traveling as much. Cut back on the areas that don’t matter to you. Find systems that help prevent you from spending too much in areas you don’t value (i.e. keeping easy meals on hand to prevent eating out).
Allocate Savings and Emergency Funds
Take that budget and figure out what you should have leftover. Pay yourself before paying anyone else. If you don’t have any emergency savings, try aiming for 20% of your budget. If that sounds too high, remember every dollar counts. Saving 5% or 10% is better than saving nothing. If you do have an emergency fund of 3-6 months, save 15% for your retirement.
Step 4 – Set Realistic Financial Goals
Short-Term vs. Long-Term Goals
Short-Term goals are things like paying off a credit card, saving for vacation or funding your emergency fund. Long-term goals are things like saving for a down payment on a house and retirement.
SMART Goals
Set goals that are specific, measurable, achievable, relevant and time-bound. One of my goals is to save $1,000 for our emergency fund before January. I plan on doing that by participating in a no-spend month (no unnecessary expenses) every other month and eating through some of my freezer meals.
Align Goals with Your Budget
Your budget shouldn’t look like my budget. Chances are we don’t live in the same area, have the same goals, and you don’t have the same goals as me. My husband and I are serious retirement savers, but need to boost our immediate savings. Using my goal in the paragraph above, I have found some ways to reduce our expenses.
Section 6: Step 5 – Choose a Budgeting Method
50/30/20 Rule
50% on needs, 30% on wants, and 20% on savings/debt repayment. Dave Ramsey would say that 30% needs to disappear while you’re repaying debts. I think that it’s ok to occasionally splurge but to make sure it’s in areas that count.
Zero-Based Budget
Every dollar has a job. At the end of the month, income minus expenses should equal zero. You allocate every dollar toward a specific purpose. This and saving (for emergencies) before spending are two areas that I personally am targeting to rebuild our emergency fund.
Envelope System
I like the envelope system for giving yourself a spending allowance. I do not like it for everything. With my luck the dog will eat the money. Also, I find it easier to have scheduled payments for many things so that we don’t forget to pay a bill on time.
Pay Yourself First
Prioritize savings and debt repayment first, then allocate the rest for expenses. This will leave you with less money to impulsively spend on things like Amazon. You are the boss, you tell the money where to go.
Step 6 – Adjust and Adapt Your Budget
Review Your Budget Monthly
Did you feel really deprived? Is there an area you underspent in and didn’t notice? Or maybe you forgot to budget for someone’s birthday- oops! Don’t worry, adjust the document for the following month as needed.
Allow Flexibility
Especially when you are starting, allow some breathing room in your budget. Sometimes even when you are meticulous the budgeted amount may be too little. An example of that is groceries. If you find a deal to stock up on something you will actually use, then now is the time to buy.
Track Progress Toward Goals
Consider making a budget tracker. Put it on the fridge and get everyone involved. Color in a square of something every time you stay on track. Or it could be a savings tracker.
Stay Consistent and Motivated
Celebrate Small Wins
When you reach a goal, celebrate it! Make a cake or a nice dinner at home. If it’s a big one, consider actually going out to eat or on a planned trip.
Accountability
Share your goals with someone who is financially responsible. My husband and I have always been the most financially responsible among our friends and coworkers. I was born frugal and he has been dreaming of retirement since he knew what it was. I still share goals with my family. I just don’t go into the details because I don’t like sharing actual numbers with people. Maybe you do and that’s ok!
Avoid Budget Burnout
Just like when you’re dieting, many people can’t deprive themself perfectly forever. Plan for some fun or a small buy that will make you happy. Don’t do it randomly, plan ahead and make a big deal of it. I’m trying to strengthen my body and have a healthier BMI. Every Saturday is my cheat day. You better believe all week when I see something I want to eat I think to myself “Oh I want that on Saturday.” Find a way to do that with your budget without driving yourself to financial ruin. I find adding things to my Amazon cart throughout the week and then reviewing it once a week to see what is actually in the budget is helpful. Most of the time I don’t even want the stuff that was in there before.
Conclusion
Creating a budget that actually works for you takes calculating your income, tracking expenses, setting goals and picking a method to stick with that fits your lifestyle. Consider what your priorities and values are. Find a way to make those work within your budget.
Take a moment today to calculate your income and review your expenses. Sign up for my newsletter to receive weekly tips on frugal living. Don’t forget to share in the comments what works for you and your family!
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