What Is Budgeting and How Can You Start?

A budget is a plan for every dollar you have. While that may sound restrictive, having a budget may actually lead to more financial freedom and a life with less worry and stress. 

If you’ve always been turned off or intimidated by the idea of budgeting, read on. What follows is a beginner’s guide to budgeting — from how it could help you to how to create one.

What Is a Budget? 

A budget is essentially a spending plan based on your income and expenses. It involves looking at everything that’s currently coming in and going out each month and deciding if you want to make some changes in how you are allocating your funds. 

A budget allows you to set priorities (such as saving for a great vacation or getting out of debt) and eliminates the worry that you won’t have enough money to cover your regular bills. It’s all factored in.

You may write your budget by hand, use a spreadsheet, or get a budgeting app on your phone — there’s no one right way to budget. What works for one person may not work well for another.

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Types of Budgets

The great thing about budgeting is that you don’t have to reinvent the wheel. Personal finance experts have come up with three basic types of budgets:

• Zero-based budget: The point of this budgeting method is to make income equal expenses. You assign every dollar you earn toward expenses and financial goals, such as saving and debt repayment, so that you end up with $0 at the end of the month. 

• Pay-yourself-first budget: With this approach, you set aside a lump sum or percentage of your income for your savings and debt repayment goals before allocating the rest of your money toward living expenses and discretionary spending. Doing this ensures that you’re preparing for the future and building a habit of saving and investing.

• 50/30/20 budget: With this type of budget, you allocate 50% of your income toward essentials, 30% toward discretionary expenses (such as dining out), and 20% toward financial goals (such as paying off debt, saving, and investing). There are more details on this approach below.

Why Is Budgeting Important?

Budgeting allows you to take control of your money, which is helpful for everyone — not just people who are struggling financially. It helps ensure that you always have enough money for the things you need and the things that are important to you. 

While creating a budget, you might discover that part of your income goes toward things that don’t truly matter to you, such as an unused streaming service or daily coffee runs. Meanwhile, important priorities, such as saving for a new car, might be overlooked. A budget helps you adjust your spending to better align with your needs, wants, and goals.

Income vs Expenses

The basis of every budget starts with two categories: 

• Income: This is everything that comes into your bank account each month, including paychecks, bonuses, interest you’re earning on savings, alimony payments, and any money you bring in from freelancing or side gigs. 

• Expenses: This is everything that goes out of your account each month — from the cash you spend on afternoon lattes to essentials, such as rent and utilities, to the money you contribute to your retirement account.

Budgeting vs Forecasting

It’s easy to confuse budgeting with forecasting, but they are actually two different things. 

Budgeting involves making a spending plan based on current sources of income. Forecasting, on the other hand, involves estimating how much revenue and income you’re likely to earn in the future then mapping out a budget or spending plan for six months to a year down the road. 

50/30/20 Rule

The 50/30/20 rule (mentioned above) is a popular budgeting method due to its simplicity. Here’s a closer look at how this approach to spending works.

50% of Your Income on Needs

With this plan, you allocate up to 50% of your take-home income (after-tax income) for needs, which may include:

• Groceries

• Housing

• Basic utilities

• Transportation

• Insurance

• Minimum loan and credit card payments (anything beyond the minimum goes into the savings and debt repayment category)

• Child care or other expenses you need to pay in order to work

If your essentials cost more than 50% of your income, you may have to borrow from other categories and make this category a higher percentage. This is common in cities where the cost of living tends to be high.

30% of Your Income on Wants

Distinguishing your “wants” from your “needs” may be tricky. Generally, needs are essentials for you to live and work, while wants are dinners out, entertainment, gifts, travel, and clothing (beyond what’s essential for work). 

If you’re eager to get out of debt quickly, or if you’re saving for an important upcoming purchase, you may want to downsize the percentage you spend on wants, at least temporarily. However, you won’t want to make your budget so strict that you don't allocate any money for fun.

20% of Your Income on Goals

Finally, you may want to allocate at least 20% of your after-tax income to your financial goals. This includes saving for short-term goals (such as building an emergency fund or saving up for a down payment on a home) and long-term goals (such as retirement or a child’s college education). It also includes paying off debt — any money you pay beyond the minimum monthly payment falls into this category.

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Starting a Budget Plan

While the process of creating a budget may seem intimidating, it may be fairly simple if you break it down into a series of steps.

1. Calculating Your Net Income

If your only income is your paycheck, you may determine your monthly income by looking at your pay stubs. If you have automatic deductions for 401(k) savings and health and life insurance, add those back in to give yourself a true picture of your income.

If you have other sources of income, or you freelance and your income fluctuates, you may look at your checking account statements for the past three to six months and calculate the average. Be sure to subtract anything that reduces this income, such as taxes and business expenses. 

2. Understanding Your Spending Habits

The next step is to track your spending. You may do this by getting out your bank and credit card statements for the past three to six months and listing all of your expenses. You may want to divide them into two categories:

• Fixed expenses: These are regular monthly bills, such as rent or mortgage, utilities, and car payments.

• Variable expenses: These are the ones that may change from month to month, such as groceries, gas, and entertainment. This is an area where you might find opportunities to cut back. 

3. Add a “Pay Yourself” Spending Category

Paying yourself means setting aside money for your financial goals and plans. If you wait to see what’s leftover after you pay for everything else to fund this category, you may end up with nothing — and never make progress toward your goals.

The first step is to list your goals, which might include:

• Building an emergency fund

• Paying off debt

• Maxing out your retirement contributions

• Saving up for a major purchase

Next, you may want to decide how much you want to allocate toward each goal per month. If a goal has a deadline, it can be a good idea to take the number of months you have and then divide the total cost by that number. This may tell you how much you need to set aside each month to meet the goal.

4. Creating a Budget Plan

This is where you look at how much you are currently spending on fixed and variable expenses each month and determine how you may want to change things.

You may immediately see places where you could cut back, such as canceling a membership to a gym you never use or ditching a pricey cable subscription you no longer need. Or you might decide to make your coffee and/or lunch at home rather than getting it out each day. Any money you free up may then be reallocated toward other areas, such as the “pay yourself” category.

If the numbers still aren’t adding up, you may want to look at adjusting some of your fixed expenses. For example, you might be able to save more by shopping around for a better rate on homeowners or auto insurance or by getting a cheaper cell phone plan.

5. Tracking and Modifying Your Budget

It may be a good idea to periodically review your budget and your spending to make sure you are staying on track. The reason is that many of the elements of your budget are subject to change. You might get a raise or a new job, or your expenses may change, or you may reach a goal and want to plan for a new one. As a result, you may want to regularly check in with your budget using the steps outlined above.

Another reason to check your progress is that it may motivate you to keep at it. Seeing the fruits of your labor, whether it’s a rising balance in your savings account or a fully paid off credit card, may give you the motivation to stick to your program.

The Takeaway

While budgeting often gets a bad rap, creating and using a budget is not about punishing yourself for overspending. It’s about doing more with what you have and spending money on the things that matter to you.

By calculating your income and expenses, determining how you may meet your financial goals, and planning for discretionary (or fun) expenditures, you may have the roadmap you need to make your finances fit your life.

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