The United States continues to hold its position as the world’s largest economy. Although the American people aren’t the highest earners — the U.S. ranks 11th in gross national income per capita — the average American does earn $60,200 per year before taxes.
Despite that amount, a 2017 GOBankingRates survey found that less than half of Americans have $1,000 in savings. And a Debt.com survey found that just 67% of families put themselves on a budget.
So how does someone who lives in one of the wealthiest countries in the world budget in a way that allows them to build wealth? This guide will explain how to create a budget that works with your lifestyle and your financial goals.
- Why Budgeting Matters
- Benefits of Budgeting
- Which Budgeting Method Should I Use?
- How To Create a Budget
- Things To Consider When Budgeting
- Budgeting Apps That Can Help You Stay on Track
- Taking the First Step
Why Budgeting Matters
Learning how to budget your money puts you in control. It helps you make sure you have money to meet expenses. It also can add safeguards that prevent overspending.
Moreover, if you cannot immediately afford a goal, you can set aside money every month for that purpose. This helps keep you in budget while making the limits of living on a budget more tolerable. It also ensures that you — unlike most Americans — hold on to some of your earnings.
Benefits of Budgeting
When you budget, you’re confronting the harsh realities of what you can or can’t afford. That’s the tool that might tell you that that Caribbean cruise or new car is out of reach for now, and it can even mean living in a run-down apartment, driving a clunker and eating rice and beans for dinner every night. But this discipline also offers benefits.
- Budgeting brings control. People often spend and then wonder where their money went. A budget solves this problem because it creates a plan and a purpose for every dollar.
- Budgeting prevents overspending. Overspending can be fun in the short run, but the consequences can come back to haunt you. You’ll probably agree that budgeting is the lesser of the evils in the longer term.
- Budgeting encourages saving. Budgeting helps ensure that you allocate a percentage of your income to savings so that you save before you spend. Saving only what is left over after you spend could lead to less savings or no savings at all.
- Budgeting can give you anything you want — eventually. You can make that want or goal a budget item. After you’ve allotted money for giving, saving, monthly living expenses and miscellaneous spending, whatever’s left can go toward a special purchase.
- Budgeting can bring simplicity and peace. Budgeting simplifies money management and makes it more difficult to engage in the kind of spending that can sabotage your budget and your peace of mind.
Which Budgeting Method Should I Use?
You have more than one option when choosing how to budget; consider your income flow, spending habits and financial goals in order to choose the ones that could work best for you.
Here are some of the most common budgeting approaches and ideas for whom each might work best:
|Budgeting Method||Description||Use This Type If You…|
|50/30/20||Expense types allocated by percentages||Need to save more and pay off debt|
|Activity-Based||Records, analyses all budget items||Need to reduce spending|
|Envelope||Envelopes for each expense type||Need to closely track spending|
|Flexible||Varies according to changing needs||Have frequently changing expenses|
|Incremental||Based on previous budget||Rarely change your budget|
|Rolling||Constantly adds new budget periods||Have consistent expenses|
|Static||Incremental budget using anticipated income||Control expenses well|
|Value Proposition||Budgeting by value derived||Need a more focused budget|
|Zero-Based||Income minus expenses equal zero||Need to limit spending|
Sen. Elizabeth Warren created the 50/30/20 budget. Under this method, you cover essentials with 50% of your after-tax income. This includes groceries, housing, utilities and transportation. Then, 30% of the budget should consist of “wants” such as vacations, eating out or gadgets. The remaining 20% goes to savings, investments and debt reduction. This budget instills discipline but might be too rigid for those whose necessary spending doesn’t fit neatly into the 50% category — or too lenient for someone with a lot of debt.
Activity-based budgeting records and analyzes every budget item to identify inefficiencies. This can give you a deeper understanding of spending and can save you money in many cases. But this method requires a significant time investment and can lead to costs later if the process cuts muscle rather than fat.
Financial personality Dave Ramsey often touts this strategy. Under the envelope method, you place money in an envelope for each budget category. This limits spending for a specific purpose to the amount of money in the envelope. The system is effective and tangible, and it brings discipline to budgeting. But it requires the use of cash in an increasingly cashless society. It can also cause confusion when a trip to Walmart, for example, involves multiple spending categories.
Flexible budgets are the opposite of static budgets. As the name implies, they vary according to a changing set of needs. But predicting expenses can be difficult, and this budget provides no means for setting spending limits.
Also Check Out: Best Budgeting Tools
Incremental budgeting utilizes last year’s budget to build the current one. At the end of each year, you tweak the budget to accommodate changes in income or expenses for the coming year. This approach can simplify the budgeting process. But it’s also inflexible, as it doesn’t allow you to add or eliminate spending categories.
Rolling budgets add a new budget period once the current period reaches completion. Hence, when a yearly budget completes its first month, it adds an extra month, meaning the budget continues in perpetuity. This model has you overseeing and continuously tweaking the budget for needed changes, but it can also treat the newly added period exactly like the period that just ended.
Check Out: Easy-To-Use Free Budget Templates
Static budgeting is similar to incremental budgeting, but it uses anticipated revenue as the baseline. This method focuses on “variances,” where higher revenues and lower expenses are considered favorable variances and lower revenues and higher expenses are labeled unfavorable. Such budgets are easy to follow, but they offer no flexibility.
Value Proposition Budgeting
Value proposition budgeting involves analyzing budget items and determining what “value” they offer. This method can make you really think about how much that expensive home or season tickets are worth to you. But it can waste time when your budget covers necessities whose values need no explanation.
With zero-based budgeting, income minus expenses always equals zero. The process assigns a function to each dollar, so even giving and saving qualify as “expenses” that zero out your budget each month.
Learn More: What Is Zero-Based Budgeting?
How To Create a Budget
Creating a budget isn’t always easy, but knowing the way to start can help. These step-by-step instructions for how to create a budget will get you going:
1. List All Expenses
Include all regular monthly expenses and irregular expenses for the upcoming month. Also consider prioritizing expenses. Groceries, shelter, utilities and transportation should be top priorities. You should also set aside money for debt payments as well as giving, saving and wants.
2. Calculate Total After-Tax Income
Include income from your spouse or domestic partner if applicable. This includes full-time jobs and all secondary sources of income.
3. Set Aside Cash for Savings and Debt Payoff Goals
Setting aside cash brings you closer to meeting your financial goals. How much you devote to this depends on your personal needs and the method you use. If following the 50/30/20 budget, for example, you would set aside 20% for this overall category.
4. Record and Track Spending
Record what you spent on each category and note deviations from the budget. Also track this over time, both to better keep up with expenses in general and to note changes.
5. Tweak As Necessary
Once you have a track record, you can note seasonal, inflationary or other changes and vary monthly budgets accordingly. Account for the fact that prices will rise over time. And some bills, such as utilities, could vary by season.
Find Out: Biggest Budgeting Mistakes You’re Making
Things To Consider When Budgeting
Income and expenses might vary month by month. Preparation is key to riding them out while sticking to your budget. Consider the following factors that could affect your budget:
Budgeting can become an issue for self-employed and commission-based workers. It could also come into play with a side business. Once all monthly budget items are covered, this money can go to faster debt payoff, wants or savings.
These expenses are predictable but infrequent. Property taxes and periodic car maintenance are examples. You can budget the amount in a specific month. Or, if you have less flexibility, a monthly contribution toward that eventual expense might work better.
These are irregular expenses that you can’t predict, such as a hospital visit or storm damage to your home. Create an emergency fund for these items by setting aside a percentage of income or maintaining a fixed amount in your savings account.
Budgeting Apps That Can Help You Stay on Track
Managing money usually involves some type of system for designing a budget and tracking spending. More traditional methods, such as the envelope system, use cash or templates. But budgeting apps make these tasks easy, even while you’re on the go. Base your choice on whether you want a free app with basic features or are willing to pay a fee for more bells and whistles.
Here are some budgeting apps to consider:
- Mint: A free app that allows you to keep all finances in one place. It’s useful for those who regularly go over budget.
- Spendee: Offers the benefit of visual aids and help with finding “financial pain points” where you can improve. The basic version is free.
- Qapital: A free app to help you cut spending expenses in order to save. It also offers a debit card.
- Mvelopes: A digital envelope system that links debit and credit cards and automates tracking, even with non-cash transactions. Cost is $6 per month.
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Taking the First Step
Budgeting practically defines the phrase “simple but not easy.” Although allocating and limiting spending by category is achievable in a mathematical sense, working through the emotions and temptations associated with spending can be daunting.
It took time to get to the financial point you’re at today. Adapting to your budget will also take time. But committing to the plan and taking it in incremental steps can help you reach your goal. In the end, budgeting gives you control of your financial life, and ultimately, an improved and less stressful life overall.
More Budgeting Resources
- Recommended Budget Percentages: How Much Should You Spend?
- Lifestyle Creep: Avoid Becoming a Victim to This Financial Pitfall
- Carving the Cost of Thanksgiving Dinner
- 50 Ways To Live the Big Life on a Small Budget
Will Healy is a freelance business and financial writer based in the Dallas area. He holds degrees in journalism and business and has covered a variety of topics, such as stocks, real estate, insurance, personal finance, politics and macroeconomics.