So many, like myself, will begin “budgeting” without any clear direction of where they are financially heading. No understanding of how they got here in the first place. To follow a budget sounds like the right thing to do and since everyone is doing it, I should jump on the bandwagon with them.
But diving in headfirst can work against you. It can build guilt from not achieving financial goals because of overspending. Undeniably considered a “budget killer”, this will set you back down the spiral of throwing money away at your financial “needs”. You will avoid this by setting some ground rules that are created from figuring out your true budget.
The best way I’ve found to create a budget is using the good old fashioned pen and paper. Sounds very boring and really it is. It doesn’t get any better than actually sitting down with a notebook, writing down every transaction you make in a clear and organized manner to identify key areas for improvement. If that’s what it takes for you to come out ahead – and prevent future financial headaches – then you should be just as excited.
In this post, it will cover How to Create a Budget in 6 Steps.
Table of Contents
- Why Is It Important?
- Gain Clarity
- Better Management
- More Connected
- Provides Early Warning Signs
- Figure Out Your Savings Rate
- Puts You In Control
- Communicate With Your Significant Other
Before creating a budget, one must understand the importance behind having one. While personal reasons like poor money management are obvious, there are much deeper relevant levels beneath the surface that will be uncovered.
Why Is It Important?
Going back to the start, having a budget just to “have a budget” is an alright idea. In the end, it’s much better than not having anything at all. Just know that this notion won’t emphasize any key areas to improve, it’s more like just “checking the box”. The fact that people have a budget can make them feel a certain sense of accomplishment. This doesn’t translate well when actually trying to fix the underlying behaviors that keep them in debt though.
Gain Clarity
Your financial plan will bring to light exactly where your money flows to. You may think that you’re doing a great job with your grocery budget but then realize you’ve spent double (or triple) what your budget actually called out for. This could be said for any one of the spending categories (food, transportation, home, personal). By the way, many people underestimate how much they spend on food each month.
Laying out every transaction on paper provides the accuracy many people lack. They aren’t able to correctly pinpoint why they don’t have money leftover at the end of the month. Well without an accurate budget, it’s almost impossible to do so.
Better Management
Measure your spending against a detailed budget will translate to your money being managed better. This stems from having a concrete plan that will compare to the reality of everyday spending. Without a budget, you can be misled to think you’re doing great with money when in fact you’re not.
This is common amongst many people because the feeling of normalcy revolved around their lifestyle. If it isn’t broke – or they don’t know it’s been broken – they won’t seek to fix it. The normal feeling of buying the same cost-ineffective products is just what they do. They haven’t taken the hard look at their finances to make a change.
Sync that urge to manage money better with a carefully planned budget to be one step closer toward financial success. Keep a constant measure against your budget to improve how your money is managed.
More Connected
If you ignore the reality of your spending habits long enough, an enormous distance will form between your current state and the end financial goal you have in mind. This distance is a result of disconnection. Disconnected from simple factors like your monthly take-home pay, recurring payments, or savings rate won’t inch you closer to your goals.
Taking the time to recognize your interaction with money is extremely valuable. Once you’ve followed your budget for some time, you’ll feel rooted to your financial values. If an unexpected expense that doesn’t align with those values comes up, it’ll be easier to say no. It all comes back to the connection you have with your plan. With a plan, you are more connected to your personal finances.
Provides Early Warning Signs
Ever been hit with an emergency and not enough money to cover it? How about being surprised by that annual membership because you forgot? These happen way too often but can be easily avoided. Rather than try to remember everything, use your budget to guide you.
A budget can help build an emergency fund. It will inform you of variable expenses that catch you by surprise. The more detailed it is, the better prepared you are for any circumstance, as long as you’ve actually followed it. You can live a happier life knowing that a crisis won’t steer you off your financial path.
Figure Out Your Savings Rate
Saving is an important factor when it comes to financial independence. The more money you save, the closer you are to retiring early or any dream you hope to achieve. You can save to purchase an asset or a down payment on your forever home. If leaving your 9-to-5 is the goal, then knowing your savings rate is critical. It’s really simple to understand.
1 year of expenses = 1 year of financial independence
As you can see, your yearly expenses determine how close you are to retiring early. Those expenses are evident from the budget you set. Without knowing your budget, you have no idea the weight your expenses carry. At least with a budget, you can direct your attention on adjusting expenses or increasing income.
Puts You In Control
No better feeling than being in the driver seat of your personal finances. A reactive approach towards finance will only set off alarms. Every expense that comes up will feel like a shock. Like a fire that needs to be put out. This is not where you want to be.
Instead, seek a proactive method with your money. Be in control of every dollar – or every penny if it suits your personality – and pioneer yourself towards financial success. In the beginning, you may lack the discipline required for it. The good news is budgeting can be done by anyone.
Communicate With Your Significant Other
Arriving at the point where you understand your personal finance situation will be laborious. If your finances involve someone other than yourself, the difficulty level increases more. They will depend on and commit to your financial plan because, well, you are the one who takes it seriously. They trust you and your judgement.
If you’re reading this, then you are exactly the right person for the job. Being able to frame your financial situation to your loved ones will make the journey easier to progress forward.
You being here defines the type of mindset you have. Possessing this mindset will play a vital role in your family’s success. The purpose, you will come to realize, is serving something bigger than just yourself.
As you derive what makes a budget important, it is time to dig into why starting with using a pen and paper first should be the first budget you ever begin with.
The Pen Is Mightier Than The Sword
To fully grasp what a budget is trying to tell you, a deeper level than just money coming and going, that’s where the pen and paper concept presents its strength. Having to write down every single transaction revolved around your finances will do that to you. You’ll begin to question why certain things are the way they are.
There will come a time when you view those “normal” recurring expenses in a different light. They are viewed more as a hindrance to your financial goals. While it never donned on you before mainly, they were never looked at so closely. Expenses like that happen more often than one might think. It just continues to pile on to every other bill until it’s too overwhelming to control.
Adding a family or planning to start one to the picture and you’ll quickly regret not having some financial starting point. Mistake I made was caring about my family’s finances after our oldest child was born. Had I started sooner, we could have been much better off to begin with. This proves that it’s never too late to start. Other families don’t start until their kids are off to college!
A great thing about budgeting is anyone can do it. A budget doesn’t care if you’re male, female, single, married, young, or old. Those factors don’t matter. Every person’s situation is different which means every budget is different. There is no one size fits all budget. As life progresses, so should your budget to meet those changes. I am trying to emphasize that your budget will be personal to you.
A Budget Could Save Your Finances
There are massive money saving benefits to using a budget. Actually just having a budget is better than not having one at all.
Benefits of a budget include:
- Preparation for financial emergencies
- Financially organized
- Identify spending habits
- Eliminate guessing monthly expenses
Emergencies Will Come
It isn’t a matter of if, but when. And when it happens, you want to be prepared financially. A good rule of thumb is to hold at least six months’ worth of expenses in a high-yield savings account. Keep this money as liquid as you can so it can be easily withdrawn when a crisis occurs.
This money, known as an “emergency fund”, can be built into your budget. Tiny allocations will soon build into a substantial amount that can weather any financial storm.
Financially Organized
A big plus to having a budget is knowing what needs to be paid and when. Since all bills are not paid equally, meaning some are paid monthly and others aren’t, staying on top of your game will keep you ahead of the curve. A budget makes you aware which expenses take which chunk of your money.
Also, when you develop a system to store all your data, whether it be a filing cabinet or journal, you’ll have concrete records of your budget. It’ll show you what worked, what it didn’t, and where you need to adjust your spending. This will serve as a great reference for organizing all your transactions, statements, and bills.
Identify Your Spending Behavior
Spending money is unavoidable. Spending money is meant to bring joy. To those that abuse it, oddly enough, will encounter guilt. How you identify with your spending habits are just as important to your financial success as you deciding to become debt free.
Educating yourself on smart spending habits keeps you from emptying your bank account, giving into an impulse purchase, or overspending an area (or all) of your budget. As you learn more about your spending, your money has more opportunity to grow. This is better identified through following a budget.
Eliminate Guessing Monthly Expenses
What keeps so many people in debt is they don’t know enough detail about their bills. A budget provides a spending outline for each category of expenses. Taking the time to look ahead at upcoming bills and save enough funds to cover the bill provides the peace of mind that many yearn for.
This may not seem like a big deal if you don’t have many monthly expenses at the time. But as you age, you will see how essential it really is. Adopting a proactive approach will keep you from getting too deep into debt.
Disadvantages Of A “Pen And Paper” Budget
On the flip side, there are cons to using a pen and paper budget at least when compared to using an electronic template (ie: apps, worksheets, Excel, etc). Having a budget is important no matter which method you choose.
- Easier to lose
- Not recommended for those who don’t like math
- Takes (a lot) more work
- Least favorite option for the tech-savvy budgeter
- Constant manual data inputs
- No creating fancy graphs or charts
In order for the average budgeter to make use of their budget in the future, they need to account for a decent filing system. Something to fall back on and compare their current self to the former self. At least have a way to entertain the idea.
To go through such a high amount of administrative work once only to repeat it over and over again because of disorganization will create massive headaches. You’ll be forced to jog your memory which won’t play to your favor.
I don’t suggest that you write down your budgets forever either, only in the beginning. After you gain the value of writing your budget, you can convert to using an Excel or Google Sheets template (or any other software you prefer).
Obviously, creating pie charts or graphs won’t be an option. This isn’t a huge deal breaker but there are many who prefer a visual depiction of their finances. These can be recreated at a later time after upgrading to electronic templates.
Don’t forget, the pen and paper method isn’t meant for a long-term strategy. Unless you enjoy writing down everything, this is meant to bring more awareness to your personal financial situation. Once that is understood, it is fine to convert to an electronic counterpart. But if you don’t mind writing your budget, you can continue doing so. To this day, I still use a combination of both with my family budget.
How To Create Budget In 6 Steps
Before you commence on creating a budget, you will need to understand the first rule, write everything down, I mean EVERYTHING. This will eat a huge amount of your time but it is the first step to gaining financial clarity. To know exactly where your money is going means you understand where your financial blindspots are.
Grab any journal, a notebook, index card, or sticky notes laying around the house. You don’t need the fancy journals to begin. Keep it cheap and inexpensive.
Step 1: Gather All Your Financial Documents
First, begin with gathering all of your financial paperwork. This includes:
- W-2s and paystubs
- 1099s
- Bank statements
- Investment accounts
- Credit card bills
- Mortgage statements
- Insurance statements
- Loan (personal, auto, student) statements
- Utility bills
- Receipts
Take time to organize all your documents. The more documents you have, the better it’ll be for your budget. You will want to keep these nearby as you figure out your income and expenses.
Step 2: Write Down Your Monthly Take-Home Pay
Take-home pay is the net amount of income paid to you after taxes, benefits, and contributions have been deducted from the paycheck. If you receive a stable paycheck, you can use the net income amount. Next, determine the average amount of income you take home monthly and use that figure.
For those who receive variable income, use an average of the last six to twelve months of recurring income. If you don’t have access to that many paystubs, use an average of what you do have. As stated earlier, the more access to information you have, the better.
Step 3: Create A List Of Every Expense
Compile a list of your recurring debt payments you expect to pay during a month. That includes auto loan payments, mortgages, insurance, credit card debt, student loans, and any other debt that you pay monthly. For a more comprehensive list of expenses, get personal with your monthly expenses. Only you know what you spend your money on. Now you need to sit down and get it on paper.
Add any debt payment you expect to make throughout the year to your list. Since timing can be different from one debt vehicle to the next, take your time to dig through every bank statement, credit card statement, and receipt.
Step 4: Define Fixed And Variable Expense
A fixed expense is defined as “any expense not subject to or able to be changed during a portion of time.” Spotting a fixed expense should be fairly easy. Typically, these amounts shouldn’t change from month to month.
Related : What Is A Fixed Expense? And How It Relates To Your Budget
A variable expense, on the other hand, are expenses that change over time. Dining out with your family each month is a variable expense. Shopping for groceries is also a variable expense. Even utility bills may change from month to month so those could be considered a variable expense.
Another version of variable expenses would be time based. You may come across bills that are paid quarterly, semi-annually, or annually. For these, average your annual total into a monthly amount that way it can fit into your monthly budget easier.
Begin separating each expense into categories. The easiest to start with will be your fixed expenses. Figure out a spending amount you’ll need for each month. Then, work on the variable expenses in the same manner. For these, use an estimated spending you’d need each month to cover all of your annual variable expenses.
Step 5: Check The Bottom Line
Now, total up every source of income as well as each expense from your list. If you have more income, then you’re in a great spot to make extra payments toward debt or add to your emergency fund.
If your expenses are more than your income, then you’re overspending and will need to adjust your expenses. Dialing back on certain expenses won’t be too difficult if this is your first time actually digging it. You’d be surprised on how much you can cut out of your life but still maintain the same level of happiness.
Step 6: Adjust Your Spending If Necessary
One thing to keep in mind is, up to this point, you’ve acquired certain necessities which are now considered a part of your lifestyle. Those are things that you can’t see yourself living without. These usually fall under variable expenses because they aren’t actually required for everyday life, they’re more like things that you want. So cutting back in this area will be tough.
Instead you should look at lowering your fixed expenses. A benefit to this is these are the “gifts that keep on giving”. Once you’ve managed to decrease a fixed expense, it remains at that amount for the duration that you and the supplier agreed upon. Should anything change, then you shop around for another, more affordable option with someone else. This won’t affect much of your lifestyle, if any.
A perfect example to start with is your insurance. You might be aware of shopping around for a cheaper insurance company. This helps in creating a price comparison for you while stirring up competition for your current insurance provider. But let’s say that you value your relationship with them and don’t want to go that route. You could bundle several different policies with them and receive a discount that way. It’s a win-win situation for both of you.
As you exhaust all options for decreasing your fixed expenses, the next area to work on is the variable expenses category. As noted above, these are your costs involved with groceries, dining out, fun, and gas. Maybe eating out less is an option or save those meals for special occasions rather than any random night. Look into walking to work or carpooling with a buddy.
There are many ways to reduce your spending but keep in mind that you don’t want to change your lifestyle too much too soon. Making drastic changes will likely keep you from continuing your budget and you’ll find yourself back at square one. Aim to make small, incremental, 1% changes every month. You’ll be surprised how unaffected those tiny changes will make to your life.
“It’s supposed to be hard. If it were easy, everyone would do it”
– Tom Hanks from “A League Of Their Own”
Find Joy in the Process
This style of creating a budget is painstakingly boring. Unless you enjoy writing for a living, which I don’t, you’ll find yourself at a crossroad whether to continue with the journey or turn back around to something comfortable. It may not be obvious in the moment but getting through this phase is important for your personal finances.
Don’t focus on how difficult it is to write down everything. The process is not permanent. You won’t be writing everything down for the rest of your life. Only in the beginning is this really required. Should you want to continue it, that is all up to you. I suggest you make it a routine so that it will permanently change your finances for the better.
Do it every day, without fail, for every single transaction, payment, bill, and expense. I promise you, you will feel different coming out of this. 3 years from now, you’ll look back at this moment and be extremely grateful to have given it a try.
Related: Are You Making These Common Budget Mistakes?
Don’t Be Hard On Yourself
Any time you invoke change, you will be presented with resistance. You may not experience the same struggles that I did. But there will be moments that can be turned into reasons, or excuses, to stop all progress. Avoid these like the plague, it just isn’t worth it to give any attention to them.
A few things to avoid are being too general with your budget line items, missing excessive days in a row, and feeling guilty for overspending. There are many valid reasons to list but like anything new, they aren’t credible enough to stop you from your goals. The best thing you can do is, build the habit and keep the habit going. Regardless of anything that is happening, aim to be 1% better than yesterday.
Conclusion
Creating a budget for the first time can seem daunting especially when you don’t know where to start. Start the easiest way I know, with a pen and paper. Personally, this has worked for me and is a part of my budget to this day. The pen and paper budget has saved me from financial troubles numerous times and can do the same for others.
If you don’t have a budget, now is the time to start one. With the steps above, you will be one gigantic step closer to your financial dreams.
Are you willing to commit to a budget? Do you have a budget in place right now? What is stopping you from following a budget?