If the word “budget” doesn’t make your heart skip a beat with joy, you’re not alone. Budgets are often overly complex and challenging to keep up with.
But having a good budget is key to controlling your finances, kicking overspending to the curb, and reaching your financial goals.
The trick is setting up a budget you can live with. Thankfully, all you need is six simple steps.
How to create a budget
Creating a monthly budget can be a simple process, as long as you understand what you’ve been doing with your money so far, and what savings goals you’d like to allocate it towards. Here’s the six-step process to creating a budget.
Step 1: Calculate your net income
The first step is calculating your monthly income. Start with your net income (aka your gross income minus taxes). This income will include your take-home pay if you’re employed full-time and any freelance work or online side hustles. Suppose you’re enrolled in a retirement plan such as a 401(k) or health insurance plan. In that case, you’ll want to factor those automatic deductions in, partly so that you don’t treat that money as available cash and partially to add those items to your monthly savings and investments.
As a full-time employee, the paycheck you receive is after-tax income. However, as a freelancer, you’ll want to subtract the self-employment tax from the money received to arrive at your monthly net income number.
While this is an easy step if you have a regular income, it gets complicated if you’re paid irregularly. If that’s the case, unless your income varies wildly from month to month, you can calculate the average for the last three to six months to determine a number for this step. Alternatively, consider the lowest month’s income as your base for further calculations.
Step 2: List your expenses
We’ve listed out the money that’s coming in. Now we list what’s going out to see if you have a positive balance at the end of the month and by how much. If you’re left with a negative balance, that’s good to know, too, so you can take remedial measures to curb any non-essential monthly spending while you get your income up.
The two types of monthly expenses you’ll want to list out:
- Fixed expenses: These are regular monthly bills that are the same or have minimal fluctuation from month to month. They’re also necessities. There are short-term and long-term financial consequences if you don’t make these monthly payments. Fixed expenses include rent or mortgage, utilities, car payments, car insurance, and student loan payments.
- Variable expenses: These are discretionary expenses that can vary from month to month. Examples include groceries, gas, coffee, entertainment, dining out, and subscriptions. You can look through your credit card and bank statements for the last month or two to get a good idea of how — and where — you’re spending your money.
Step 3: Set your financial goals
Now comes the fun part: all this budgeting and number crunching is only worthwhile if we have a purpose. Before we move on to the next step to determine where your money should go, consider where you’d like it to go. Would you like to save money for a holiday? Put it towards retirement? Start investing in real estate?
While your goals are unique, and you should be mindful of what motivates you, experts do advise that you get rid of any bad debt before you put large amounts of money towards savings or investments.
Here are some financial goals to consider:
- Build a starter emergency fund: Most experts recommend stashing six months’ worth of income, but you don’t have to start that big. Even putting $1,000 aside for emergencies is good.
- Banish bad debt: High-interest credit card debt, personal and payday loans, and any unsecured debt that could balloon up quickly should be on your priority list to get rid of.
- Save for a down payment on your home: If you don’t own a home already, this would be the time to start looking at home values and saving for a down payment.
- Start funding your retirement: Your personal finance goals should factor in future you, too. Now is a great time to start if you’re not already stocking away money in a 401(k) or IRA.
- Invest: Most experts recommend investing beyond your 401(k) if you can swing it. With a wealth of options from stocks to fractional real estate, you can build your net worth over time by contributing small amounts each month.
Step 4: Make a plan
Now have your financial goals, know how much is coming in each month, and have an excellent idea of what’s going out. Calculate how much you have left over in your bank account at the end of each month, and start putting that money towards the steps you’ve outlined for yourself above.
As you meet your personal finance goals and move down the steps, money starts getting freed up, for example, from debts you’ve paid off. This speeds up the process even more.
Many popular budgeting apps and plans are available to help you figure out how to distribute your money. One of the most popular budgeting methods is the 50/30/20 rule, which recommends that you spend:
- 50% of your income on needs, such as housing, utilities, and groceries
- 30% on wants, such as entertainment, meals, cell phone data, and shopping
- 20% on the personal finance goals we listed above, including savings accounts, emergency funds, retirement savings, and credit card payments.
Step 5: Make adjustments
Now, you run with the plan. Take your budget for a test drive for a month or two to see how it feels. Do you have less extra money left over each month than you realized? Are you spending more money on discretionary spending than you budgeted for? Could you put additional money into the places you’d planned for it to go?
The first month of working with your budget will also give you insight into your spending habits. A word of caution to be realistic, however. While it may be tempting to remove every item of discretionary spending from your budget in pursuit of your personal finance goals, that daily cup of coffee might be the difference between you loving your life and choosing to take positive financial actions regularly and feeling joyless and wanting to throw in the towel after a few weeks.
Step 6: Review your budget and goals regularly
Your budget is not a static document or plan. It changes regularly with your life and your finances. Set aside time each month to review your budget, update any income, expenses, or debt changes, and continue to add to your personal finance goals as you check off the previous ones. Money management is not a one-and-done event, and how much money you make — and keep — will ultimately come down to how intentional you are about managing it.
The bottom line
Whether your current financial goals include saving that first $1,000 as a starter emergency fund or saving up tens of thousands to invest in your first rental real estate property, a budget will keep you on track and motivated to keep pushing forward with your goals.
At Arrived, we believe that real estate investing should be a possibility for everyone, and we make it easy for anyone to sign up and own shares in rental properties, no matter whether their net worth is $1,000 or $1m. Through our platform, you can purchase shares of rental properties for as little as $100 and start building a portfolio — and earning dividends — today.
The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The views reflected in the commentary are subject to change at any time without notice. View Arrived’s disclaimers.