Learning how to build a budget is a key step to becoming financially successful. A budget can relieve the everyday stress of paying bills and help you take control of your finances.
Why Budgets Can Be Helpful
A budget is helpful for a few reasons, but in general it’s most useful for bringing clarity to your finances. Note the specific wording in the title above, a budget can be useful. Having a detailed budget is not for everyone, but below are some of the top reasons to consider having one:
- Provides financial clarity: At a minimum, building and tracking a budget gives you a clear picture of your finances. You can see exactly where your hard earned money is going.
- Gives your money a purpose: Having a budget puts you in direct control of your money. You know exactly what each earned dollar should be used for, and no money “slips through the cracks”.
- Stops frivolous spending: It’s a lot harder to make that unnecessary online purchase when you know it’s not in your budget. A budget helps ensure you’ll comfortably pay your credit card bill on time and in full every month.
- Helps to prioritize saving: A budget helps ensure you prioritize saving and investing. Both are necessary to building financial stability in your future.
How to Build a Budget from Scratch
Below are the five necessary steps to build a budget from scratch. This is a form of zero based budgeting – a budget strategy that is detailed in the next section.
1. Determine your after tax income
Look at your paycheck (whether you receive it bi-weekly, monthly, etc.) and determine how much you make in a month. Then, add back any deductions like healthcare and 401k contributions.
2. Calculate your total monthly expenses
This is your monthly “needs”. These are unavoidable and (mostly) necessary expenses. Things such as rent/mortgage payments, healthcare, utilities (gas, electric, water, internet, etc.), groceries, cell phone bill, etc.
3. Set your savings goal*
With your leftover money after steps 1 and 2, you need to decide how much of that to save. Some recommend saving 10-20% of your after tax income, while others strive for 50% or more. It all depends on the funds remaining after steps 1 and 2, what lifestyle you want now (step 4), and when you want to retire.
4. Have fun with the rest
Your leftover money is what you can use for discretionary spending, or “wants”. You can use this bucket of money to dine out, shop, travel or consider raising your savings goal.
5. Track your progress and adjust as you go along
A budget should be a living document. Life can change quickly and your budget should be able to adapt.
*If you don’t have money leftover after steps 1 and 2 (your expenses are greater than your income) then you need to find a way to raise income and/or lower expenses in order to avoid going into debt. Much easier said than done.
Let’s run through a quick budget example to help bring this to life.
Example of How to Build a Budget from Scratch
1. Determine your after tax income
You make $800 a month, but contribute $100 to your 401k and pay $100 for health insurance.
After tax income = $1,000 / month.
2. Calculate your total monthly expenses
You pay $300 for rent, $100 on groceries, $100 on utilities, $100 on healthcare, $50 on your phone and $50 for miscellaneous needs.
Total monthly expenses = $700.
3. Set your savings goal
You have $300, or 30% leftover after steps 1 and 2. You decide 20% is a good savings goal to start out and contribute $100 to your 401k and $100 to a separate investment account or savings account.
Savings goal = 20% or $200 / month.
4. Have fun with the rest
You have $100 leftover to spend on monthly “wants”.
Spending on wants = $100 / month.
5. Track your progress and adjust as you go along
After a few months, you decide you can get by with $50 a month for dining out, going to the movies, etc. and up your savings rate to 25%.
Or you decide you need more fun in your life now, and drop your savings rate to 15% in order to have $150 a month for discretionary spending.
Or you get a raise at work! Your income is now $1,100 a month and you raise your savings rate to 27% as you save the full additional $100.
Etc.
Popular Budget Strategies
While a custom budget that works for you is often the best strategy, below are some popular budgeting guidelines. Feel free to use them to help inform how you build a budget.
80/20 Budget
The 80/20 Budget is one of the simplest budgets out there. It consists of spending 80% of your after tax income and saving 20%.
50/30/20 Budget
Elizabeth Warren and Amelia Warren Tyagi first recommended the 50/30/20 budget. This budget consists of using 50% of your after tax income for needs, 30% for wants and 20% for saving.
The Five Category Budget
The Five Category Budget gets slightly more specific than the 50/30/20 budget. It breaks down spending into five buckets:
- 35% housing.
- 15% transportation.
- 25% other living expenses.
- 10% savings.
- 15% debt payment (like student loans). Turns into savings if 0 debt.
The FIRE Budget (Financially Independent, Retire Early)
The FIRE budget reverses the recommended ratio of spending vs saving seen in the other budget strategies above. Instead of mapping your expenses and saving what is leftover, the FIRE budget involves saving as much as possible (often 50%+) in order to get to financial independence as quickly as possible. Usually this involves lowering your expenses as much as possible along the way.
This budget relies on the 4% Rule. The 4% rule suggests that you need 25 times your annual cost of living to retire. The FIRE budget involve getting to this number as quickly as possible. So, if you need $40,000 a year to live comfortably, multiple that by 25 and you see that you need $1,000,000 to retire.
Want to dive further into the math behind this rule? Read more about The 4% Rule from Mr. Money Mustache.
Zero Based Budgeting
Zero Based Budgeting is essentially building a custom budget (see the section above: Five Steps to Build a Budget from Scratch). It involves assigning all of your available dollars to a task (needs, wants, savings, etc.), rather than bucketing things into percentages.
How to Build a General vs Detailed Budget
As alluded to previously, there are arguments to be made for and against having a detailed budget. For some, they need the rigidity of a detailed budget to stay on track. For others, a rigid budget causes frustration and a loose budget or savings goal is all they need to be financially successful. Finding the right, balanced budget is key to maximizing your savings and also your happiness.
How to Build a Budget Resources
Other Good Budgeting References:
Want to keep learning about budgets? Check out some great strategies and opinions from around the web to learn more about how to build a budget.
- 11 Tips on How to Budget Better from Just Start Investing
- Best Budgeting Books to Read Now from Just Start Investing
- The Reverse Budget: Why Normal Budgeting Sucks And What To Do Instead from The Money Habit.
- How to Budget: The Simple Money Guide Anyone Can Follow from The Savvy Couple.
- How to Create a Monthly Budget That Works from Penny Pinchin Mom.
Budgeting Tools:
See below for some great tools that can help you build a budget that works for you.
- PocketSmith: A premium budget tracking tool. Cost = Varies.
- Personal Capital: An all in one personal finance tool, Personal Capital allows you to monitor your net worth as well as manage a budget. Cost = Free.
- Intuit Mint: Mint is primarily a budget app with other features built in (such as bill paying and credit monitoring). Cost = Free.
- YNAB (You Need a Budget): A premium budgeting tool that provides strategies to help you save money (and hopefully recoup the monthly fee). Cost = $6.99 / month.
- Microsoft Excel: For those who like to tackle things themselves, nothing beats a custom excel spreadsheet that you can create and modify to fit your exact needs. Cost = $69.99 / year.
- Acorns: Acorns helps you save more money by rounding up credit and debit card purchases to the nearest dollar and investing the difference. Cost = $1, $2 or $3 / month (free for students).
- Paribus: Paribus is an awesome tool from Capital One that monitors purchases and if something goes on sale or drops in price after you purchase it, they fight to get you that lower price and some money back (even though you’ve already made your purchase). Cost = Free.
Want to keep optimizing your budget now that you know how to build a budget? Check out some tips to help you save more money.
