Simple Steps to Create a Personal Budget
What is a Budget?
The definition of a budget is an itemized estimate of expected income and expenses for a certain period of time. Each penny is accounted for and has a purpose. But how much money is allocated to each line of expenses? What if you are self-employed, or have income that fluctuates?
There are many forms and types of budgets available (like a 80/10/10 budget) or any other customized budget you find works for you. So how do you know which one is right for you?
One of the simplest budgets is called the 50/30/20 budget, meaning that 50% of your budget is for needs, 30% is for wants, and 20% is for savings/debt repayment. Obviously if you have a smaller budget for wants, you can save more or pay off debt faster. This is just an easy guideline to get you started.
The main reason I choose to use a 50/30/20 budget versus any other budget is that, in the event of a major emergency like a job loss, or medical problem, I only need to worry about recovering 50% of my income, or the NEEDS. Any wants and savings or debt repayment gets put on the back burner. I can kick into survival mode till the crisis is over.
Step by Step
- Start with your after-tax income
This is your total gross income minus any federal income tax withheld, social security and medicare taxes. If your employer takes money out for a 401(k), health insurance or any union dues, add these back to your total net income. We will subtract them later within the budget.
- List your needs.
The most important categories are; food, shelter, clothing, utilities and transportation. Try to keep them within that priority list, since there's no reason to pay for utilities if you can't afford the house payment.
The rule of thumb for what is classified as a "need" - if you can delay the purchase for a few months (like eating out) then it's not a must have expense. If it's anything you are contractually obligated to pay (like a cell phone bill), then it's a need, at least for now. Some "needs" will have to be cut in the event of a job loss, or other emergencies.
Your housing expense (rent or mortgage) should never exceed 25-30% of your take home pay. This keeps you from being "house-poor". Housing expense is defined as your monthly house payment/rent, insurance, maintenance and HOA fees and property taxes. You can choose to put utilities into this equation or calculate them separately.
- List your wants
This category includes vacations, gifts, entertainment, and eating out. Anything that is not a basic service is classified as a want. This can include premium cable channels, and even internet access.
Can you live without these? Yes, you may not WANT TO, but if life throws you a curve ball and you can't afford it, these categories will have to be cut first.
- List your debts, savings and retirement
You should always have a small "emergency fund" for unexpected events. About $500 - $1,000 in a money market or savings account that you have immediate access to.
Once you have established this cushion, start with focusing on your debt repayment. Consumer debt has way too many interest charges and late fees associated with it, and it can put a great about of stress in your life.
If you don't have any debt, a basic savings rule is to stash away about 10% of your income on a monthly basis.
This leaves another 10% for maxing out your retirement, or opening up a Education Savings Account (ESA) for your children's college fund. If you find you don't have that many wants, you can adjust your savings budget up.
Let's say you have $5,000 take home pay.
This means your "needs" budget will be $2,500. You can spend about $1,250 - $1,500 for your housing expense, and mortgage or rent payments. Leaving another $1,250 - $1,500 for the rest of your personal household needs.
Your "wants" budget will be $1,500.
Your "savings" budget will be the remaining $1,000.
This is just a basic layout of what your budget can look like. You can just customize it to fit your lifestyle. It can be surprising how much you spend or don't spend within certain categories, but just be patient and work on making the budget balance.
Every penny needs to spent on paper, before being spent in real time.
Always make sure your budget balances, otherwise you might end up overdrawing at the end of the month, or have too much surplus.
It may take a few months of working and trying to stick to your budget, or if you find you have way too many needs, it may take longer. Keep working on it, and it will pay off!