Budgeting 101: The Ultimate Guide to Making a Budget

Melinda Pettijohn

JANUARY 10, 2020

When we hear the term “budget,” we often associate it with a complicated and stressful process. However, budgeting can be quite simple – and is incredibly important for your financial health. 

Think of budgeting as a roadmap for your money. It helps you understand how much money you have coming in, how much you have to spend on basic living expenses, and how much money you have to spend on other more flexible things. 

This article will walk you through what a budget is, how it works, different methods for budgeting, and what steps you can take to get started budgeting your money.

Key Takeaways

  • A budget is guide for your savings, bill payments, and debt payoff goals
  • There are several different budgeting methods for individuals to follow
  • You should aim to save at least 20% of your income regardless of which budget you use
  • Making a budget is worthless unless you actually track your spending and stick to your budget

What is a Budget?

A budget is an estimate of income and expenditures for a set period of time. For personal finance purposes, this is the amount of money you bring in - income from your job, side hustle, child support, etc. - and how much money you spend on items like housing, transportation, and entertainment. 

Most people budget on a monthly basis, which makes sense considering most bills follow a monthly billing cycle. However, you may choose a different time frame depending on your pay frequency, bill frequency, or other factors.

A budget will layout how much you should be spending on set expenses like housing, transportation, and utilities and how much you have left over for variable expenses like groceries and entertainment.

What is The Purpose of Budgeting?

The purpose of budgeting is to keep you on track financially. It balances your income against your expenses and gives you a roadmap to reach your financial goals. 

Contrary to popular belief, budgeting isn’t about cutting costs or depriving yourself of your daily latte (though you might choose to cut back on those once you realize that you are actually spending hundreds of dollars on them per month). 

It is more about taking control of your finances and making your money work better for you.

As you create your budget, make sure that your budget is personalized to your lifestyle. If it doesn’t work for you, eventually you will end up giving up on it.

Why Does Budgeting Matter?

Budgeting is important for a lot of reasons. How many times have you went to pay for something, and your card was declined? Or perhaps you open your banking app, only to find that you have significantly less than what you thought was in there?

Budgeting helps keep you from over drafting from your bank, from paying late fees on missed bills because you didn’t have the funds available, and ultimately can help you get ahead so that you can use your money for more than just paying your bills.

1

It Helps You Understand Where and How You Spend Money

If you’ve ever been in a situation where you can’t quite remember what you spent money on... you might need a budget. It can also help you direct your money to the areas where you want it to go instead. 

For example, with a solid budgeting plan in place, you can figure out how much extra income you have each month, and then funnel that money to the areas of your life that matter most to you.

This could include things like:

  • Paying down student loan debt
  • Paying down your mortgage
  • Investing in your retirement
  • Saving for your kids education
  • Investing in your retirement

Or, if you really want to spend it on a nice dinner, you can do that too

2

It Guides Your Savings for Future Goals

Budgets are also great because they allow you to see your overall financial picture at a point in time. After determining your income and expenses, you can start putting some of your extra money toward larger goals such as a down payment on a home, a vacation, new furniture, a new car, or anything else you might need time to save up for.

 

Think about where you are financially, and where you might like to be a year from now, five years from now, and 10 years from now. What are some of the things you might like to own or do by then? Setting aside a little bit of money each month to save for those goals is the easiest way to get there.

 

As you budget, you should also think about your long-term goals like retirement. Even if  your company already provides you with some sort of retirement benefit, it is important for you to set aside additional savings on top of that. Retirement will be your biggest expense in life, make sure you are saving enough money to retire comfortably.

3

It Helps You Pay Off Debt

According to Debt.org, American household debt is well over $13.21 trillion spread out over 300 million different households meaning you likely fall into this group. Whether you have a credit card, mortgage payment, car payment, student loans, or personal loans - paying it off early can only help your financial standing.

 

By creating a budget, you can again see how much money you have after the necessary bills are paid. This will allow you to regularly set aside a certain amount of your income in order to pay off your debts. 

Think about how much you pay in credit card bills each month. What if, instead of scrambling to get the money together at the end of the month, or worse - not paying your credit card bill at all -  you had the funds set aside to pay it off? It would be great, right?

 

Now that you understand what a budget is, why it is important, and how it can help you achieve your financial goals, the next step is to create your budget.

How to Create a Budget That Works for You

Believe it or not, there are many different ways to budget. Some methods work better for some people than others.

The right method for you will depend on a lot of factors, such as why you want to budget, what your goals are, how you think about money, and what tools you want to use.

The next section of this article will walk you through the basics of setting up any budget, some different budgeting types, and even some budgeting apps you can use, should you choose.

1.

Determine Why You Want to Start Budgeting

You’re reading this article for a reason – hopefully not just because someone told you that you should have a budget.

Maybe you’re tired of paying late fees on bills? Maybe you want to save up for a down payment on a house, but you aren’t sure where to start? Perhaps you’re considering a career move and want to know exactly how much money you need in your salary to keep the wheels turning?

 

Having a sound budget can help you solve all of these issues. The budgeting process is not easy, and it can be stressful. Just remember, when you feel like giving up, there’s a greater reason why you wanted to create a budget in the first place.

2.

Calculate Your Income

The income you are going to use for your budget isn’t your just your salary. The income you should use is your after tax income.

You should include your income, and if you’re married, your spouse’s income. You should also include any money you receive that you could use to pay bills with. This includes  your full-time job, any second job, freelance pay, Social Security checks, child support, or any other ongoing source of income.

3.

Calculate Your Expenses

Begin by listing out all of your regular monthly bills. This includes your mortgage payment or rent, utilities, car payment, car insurance, etc. Then, you should total your other costs such as groceries, gas, and entertainment. 

Every single dollar you spend should be categorized. To get a rough estimate of what you currently spend in each category, look at your expenses in these categories over the last three months and take the average.

 

If you are spending more than you make, this will also help you see which categories you can cut back on in order to prevent overspending.

4.

Set Your Savings Goals and Debt Payoff Goals

Now that you have a good idea of how much money you make, how much you are spending, and what you have left over, you can start making positive financial changes. Usually change starts with saving more or paying off your debt faster.

 

Most financial experts recommend saving about 20 percent of your income. If you have more than 20 percent of your income left over after all of your expenses, put it in an investment account or a high-yield savings account. If you aren’t saving 20 percent of your income, you may want to make some adjustments to your spending habits to help get you closer to that goal.

 

As far as your debts go, there are many methods to paying those off as well. Some people prefer to start with those that are their smallest debts, then move on to their larger debts. This is called the debt snowball method that was made popular by Dave Ramsey.

Others prefer to start with the largest debt or the one with the biggest payment. We recommend that you start with the debt that has the highest interest rate so that they can get rid of that one first.

Regardless of which method you choose, the most important thing is to just start. Start paying down your debts as quickly as you can. Your future self will thank you.

5.

Track Your Spending and Record Your Progress

It isn’t enough to simply have a budget - you have to continue monitoring your spending and adjusting it based on your income, expenses, and goals. 


Your budget is the guide for your money, but that doesn’t necessarily mean you followed it perfectly. Unexpected expenses pop up all the time. 


You need to continue to monitor your spending habits, to be sure your money is headed to the right place, and to help you get back on track if its not.

4 Best Budgeting Methods

There isn’t one budgeting method that works for everyone, and luckily, there are plenty of different options. Even after you find one that works for you, you will probably make adjustments to it over time so that it fits your lifestyle and values.

To help get you started, we’ve highlighted four of the most commonly recommended budgeting methods to give you a head start.

1

The 50/30/20 Budget

The 50/30/20 budget is probably the most popular budgeting methods. This is likely because it is one of the simplest budgeting methods. 


It works particularly well for those who like to have “guidelines” to adhere to. It doesn’t assign specific amounts to individual items such as groceries or clothing. Instead, it assigns specific amounts to broad categories. 


If you’re one of those people who is regularly Googling phrases like “what percent is most ideal to save?” or “how much rent can I afford?” this might be the budget for you.

 

The 50/30/20 rule is straightforward:

  • 50 percent of your budget should be for essentials or “needs”, such as your rent, car payment, and food
  • 30 percent of your income should be for discretionary spending or “wants”
  • 20 percent of your income should go toward savings

Others suggest that that 20 percent can be for savings or put toward another financial goal like paying off debt.

 

Many people like this method because it provides guidelines for what you should be spending. It also provides a pretty large chunk of money for discretionary spending or wants. 


However, it does mean reducing your needs to only 50 percent of your budget. Depending on your current income level and the cost of living in your area, you may find that your current needs are much higher than 50 percent and cutting back on can be complicated.

 

It isn’t a foolproof method either. It can be difficult to determine which expenses are wants and which ones are truly needs. 


Ideally, you would define wants as any payment you can forgo with only minor inconveniences, such as your Netflix or Hulu subscription. 


Any payment that would severely impact your quality of life, such as electricity, housing, or medications, are considered needs.

  

Unfortunately, the rules aren’t always straightforward and will require you to use your discretion from time-to-time. 


In the modern world, a cell phone might be considered a need. However, unlimited data may be a want. If paying extra every month for that luxury puts your over your budget, you may need to consider slumming it with the rest of us on WiFi. 

 

The 20 percent that gets allocated to savings and debt repayment is the most straight forward rule. 

If it goes in a savings account, investment account, retirement account, or pays down your debts, it will fall under this 20 percent umbrella.

 

When most people begin a 50/30/20 budget, they are actually not even close to these amounts. They are likely overspending on needs and wants and leaving very little or nothing left for their savings. 


This budget is meant to give you larger, less detailed goals to strive towards. If your home expense seems to be really throwing off your budget amounts, then perhaps you should consider relocating when your lease expires to a more manageable house or apartment.

 

If you have more debt payments totalling more than 20 percent of your income, then you should probably closely monitor your spending and cut back on everything you can so that you can pay down your debts as fast as possible. 


Again, think of this method as a suggestion for how to spend your money. It is fine if you aren’t there right away – then you just have something to strive towards.

2

The Zero-Based Budget

Zero-based budgeting is a method that involves taking your income and subtracting your expenses to equal zero. With a zero-based budget, every dollar that you make has a distinct purpose.

 

However, it is important to note that a zero-based budget doesn’t mean that your bank account is at zero. It just means that every dollar you make has a plan so that you have zero dollars “left over” – whether that means you spend it on a bill or an expense, pay off a debt, or put it into an investment or a savings.

 

The good thing about a zero-based budget is that it lets you know exactly where all of your income is going. If you struggle to understand where your money goes each month, this could be a great method for you to try. Having a detailed plan for each dollar is one of the quickest ways to make your money goals a reality – no matter where you are in your financial journey.

 

There are some negatives for the zero-based budgeting system. As you may have already guessed, it isn’t necessarily the most flexible option. 


It also requires a lot of planning and a lot of tracking to make sure your impulse purchases aren’t ruining your budget. 


Both of those are great qualities to have when it comes to budgeting and taking control of your finances but may be unrealistic depending on your spending style and lifestyle.

3

The Pay Yourself First (Reverse) Budget

The Pay Yourself First (Reverse) Budget is a little bit different than the previous budgets. It is great budgeting method for helping you reach your big financial goals.

 

The Pay-Yourself-First budget prioritizes saving money above all else. It requires you to put your income towards your big financial goals, such as saving for retirement, before you start allocating your income to other expenses. 


Most budgeting methods are built based on your expenses. But this works in reverse. Instead, you build your budget around your savings goals, and use the left over to pay for your fixed and variable expenses.


Instead of saving whatever money is left over after you pay all of your monthly bills, you determine how much you are going to save before expenses. Then  you need to figure out how to fit your monthly expenses to how much money is left after savings.

 

For example, you may choose to save 25 percent each month. This leaves 75 percent of your income for all other expenses - needs and wants. 


Remember, you can always increase or decrease your savings contribution once you get rolling and see how everything works out for you. Just don’t reduce your savings amount to make it easier. You should always challenge yourself.

 

Once you know how much you’re going to set aside for savings, you can start identifying your short and long-term savings goals. 


Your first priority should be emergency funds. Once you have a comfortable amount of money in your emergency fund, you can start to focus on other longer-term priorities like a down payment for a house or saving for retirement.

 

Some people choose to contribute to two or three financial goals at one time, while others stick to one and wait until that “bucket” is full before contributing to other buckets. This is completely up to you and your personal preferences.

4

The Envelope Budgeting System

The envelope budgeting system is an old school method for budgeting, but it is still very effective. This method is especially good for those who are just starting out with budgeting or those who struggle with impulse purchasing on credit cards.

 

The envelope budgeting method started back when bills couldn’t be paid electronically and were paid with cash. People would separate cash into different envelopes, each with a different purpose (i.e. cash for groceries in one envelope, cash rent or mortgage in another, and cash for a car payment in a third). 


Once an envelope was empty, the person couldn’t spend any more in that category until the next paycheck replenished the envelope. 


Obviously, sometimes unexpected expenses come up and you might need to move money from one envelope to another, but it was a conscious decision and kept people in touch with their spending habits rather than impulsively spending on a credit card.

 

In today’s world, this may seem crazy. However, it is still a very effective way to manage your spending if this is something you struggle with. It also works best if you use the envelope method for your variable expenses such as clothing or groceries rather than your fixed expenses like rent or a mortgage payment. Note: We don’t recommend walking around with hundreds or thousands of dollars of cash in your purse or wallet.

 

The first step for making an envelope budget is developing the categories of your budget. Then you need to set limits on each category. Obviously, the total limit of each category added together cannot exceed your monthly income. 


If you’re having trouble setting a limit on each variable expense, take the average of what you spent the last three months in each category. If you have a bad habit of overspending, this exercise can also help you find places to cut spending in order to save money.

 

Once you set the limit for each variable expense, you need to divide the amount for that category by the number of pay periods you have in the month. This is how much you’ll need to contribute to that “bucket” each pay period. 


Then, you can simply spend however much money is in the envelope, but never more than what is in there until it is replenished.

Adjust as Needed

 

Once you’ve set up your budget, remember that you can always adjust later on. In a perfect scenario, you would have enough money to cover all of your needs, wants, and savings goals. But if you are constantly running short, you might need to find ways to scale back your spending.

 

You can always switch methods, too. If one budget method isn’t working for you, try another one. As your life changes and your finances change over time, you may find different budget methods to work better for you.

 

If you find that you can’t seem to stick to any budgeting method on your own, or you just want to simplify the budgeting process, consider a budgeting app. There are several great budgeting apps to choose from.

Best Budgeting Apps

In today’s tech-world, you can make the budgeting process significantly easier. There are many apps to choose from, and several of them are free. These are some of the most popular apps to consider.

Personal Capital

Personal Capital is an app designed to be a financial dashboard that helps track every aspect of your finances. It is designed for individuals who are looking for an app to track and monitor all of their finances. Personal Capital also offers investment services, and helps provide big picture investment advice. 

Personal Capital comes with two versions:

The free version is primarily used for budgeting, but it does also provide a lot of tools for investing. Personal Capital allows you to connect all of your bank accounts, investment accounts, and credit cards. It then tracks every cent that goes in, and out of your account and provides you a real time snapshot of your net worth.

The paid version, also known as the wealth management version, is an investment management service. Like many investment apps, it does act more like a robo advisor, but there is a lot of live support available from financial advisors as well.

If you are looking to track your spending. However, if you are interested in getting started with more advanced financial techniques, such as investing, it could be a good choice.


Mint

Mint is one of the most popular and well-known budgeting apps. It truly uses technology to streamline the process of budgeting, and customizes your budget based on your spending habits. It is a very secure app, using bank-level security and encryption to pull your transaction data directly from your financial institutions while also keeping your information safe. 

Mint connects to all of your accounts (bank accounts, investment accounts, credit cards, utilities, etc). Once it is all set up, Mint will analyze how and where you spend your money. Mint automatically categorizes what you spend and tracks it for you.

 

Goodbudget 

Goodbudget is an electronic way to use the envelope budgeting method. Goodbudget is a budgeting service that helps you allocate your finances. Goodbudget starts with pre-labeled envelopes, but you can create your own if you need to. 

You can also connect a specific bank account to each envelope. Every time you spend or receive money, you will need to assign it to a specific category.

Each envelope’s balance is represented on the home screen. It gives you a real time view of if you are over or under budget for each envelope category.

Goodbudget does have a free version and a paid version: 

The free version allows you to use up to 10 envelopes and 2 connected devices. 

The paid version, which is $5 per month, allows you to have unlimited envelopes and up to 5 connected devices. 

Goodbudget also allows you to import banking transactions via CSV file to help make tracking less tedious.

 

Clarity Money

Clarity Money is designed to be a technological guide to help streamline your finances and find savings opportunities. Clarity Money is an expense tracking and bill negotiating app. The app asks that you link your checking and credit card accounts so that you can categorize all of your transactions in one place.

You can actually manage all of your accounts through this one app. If you need to transfer money from one account to another, for example, you can do so in the app.

Clarity Money also organizes any transactions you make into visual graphs. This can help you easily gain visual insights into your spending habits. 

Clarity Money also attempts to negotiate some of your bills on your behalf. They claim to have the most success with Telecomm bills. If they can save you money, they take 1/3 of it as a commission, and then you get to keep the rest.

You can also cancel bills through the Clarity Money app. For example, if you want to cancel Netflix, you can do so through the app. They do not charge for this service.


YNAB

YNAB, or You Need a Budget, is an app with a unique budgeting style. The goal for YNAB is to budget so that you are actually living on the previous month’s money. The point of living off of last month’s income is to help you smooth out any financial hiccups early and is also a great method for anyone who has a variable income.

It takes some time to get to a point where you can live off of last month’s income, though. Once you hit that point, you almost have a built-in emergency fund that lives in your bank account. 

YNAB functions a lot like the other budgeting tools we’ve mentioned already. You enter your own categories, track your spending, and adjust if you go over or under certain categories. You can choose to enter expenses manually or connect your accounts. If you go over in a category, you can also shift money around to cover it. 

YNAB does however cost $5 per month to use, but it is well worth it if it can help you get ahead in your savings..

 

EveryDollar

EveryDollar is Dave Ramsey’s budgeting app, so if you are a follower of some of Dave Ramsey’s advice, and also wish to focus on getting out of debt, EveryDollar could be the perfect app for you.

EveryDollar is based on the zero-based budgeting method. In zero-based based budgeting, you assign every dollar you make to a category. Then, you track your spending daily.

If you use the free version of EveryDollar, then you will need to track your spending manually. If you have the paid version, you can link your accounts and it will automatically pull your transaction data.

When you set up EveryDollar, you choose your own money goals, such as saving for retirement, paying for kid’s college, traveling, or even to stop living from paycheck-to-paycheck. The app then helps you organize your money towards the financial goal you selected.

The app also includes Dave Ramsey’s “baby steps” which are 7 steps he recommends for financial health. For example, the first step is saving a $1,000 emergency fund. The app will also track your progress towards these steps.


Final Word

A budget is a great way to get on track with your expenses and take control of your money. Budgeting sounds scary but can actually be quite streamlined and simple when utilizing technology. Regardless of which budgeting method or app you utilize, simply taking some time to dig into your finances is a big step in making progress towards your financial goals.

The hardest part of making a budget is simply getting started. Remember that regardless of which budgeting method you choose, you will need to sit down and determine your income and your expenses. You’ll want to have financial goals for yourself as well, such as saving or paying off debt. Then, try out some different budgeting methods and apps until you find what works best for you.


About the Author


Melinda Pettijohn

Melinda Pettijohn is an expert personal financial writer with more than 10 years of experience in the industry. She covers topics ranging from budgeting, additional ways to make money, credit cards, managing debt, paying for college, and more. As a mom of three kids, she especially loves sharing insights on how to make the most of your money while raising a family. 


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