How to Create a Budget in 5 Simple Steps

As a general rule of thumb, we’re taught to avoid spending more than we earn. Easier said than done, especially if you don’t have a concrete plan in place.

jar full of cash

That’s where a budget comes in. But creating a budget that you will actually stick to can prove to be challenging. So, here’s what to do to ease the headaches and frustrations.

Before You Begin

To build a budget that works, you’ll need to accept the right mindset so you won’t be defeated before you start. This means creating a realistic plan and being committed to seeing it through, even in those tough weeks and months.

If you have more bills than you have money, it’s totally understandable to struggle with budgeting. In this case, you’ll need to find ways to supplement your monthly income and possibly start searching for more lucrative opportunities.

Also, keep in mind that the whole point is to cut frivolous spending so you can make your money work for you and achieve your financial goals.

What exactly is a budget?

The textbook definition of a budget is “a plan for the coordination of resources and expenditures.” This definition doesn’t do much at all, beyond conveying the need to figure out how to make your income and expenses work for you, hence the word “coordination.”

But what does that really mean? Well, when you budget your money, there’s a desired outcome. For some, it could be basic survival until the next paycheck rolls around while others aim to pay off debt, save for college, or buy a home.

How to Create a Budget

Being able to track your spending should ultimately move you in the right direction towards meeting your financial goals. And this doesn’t mean penny-pinching or deprivation. A personal budget simply helps you get a more accurate idea of where your money is going and where it should be going instead.

But in order for it to work, your budget should be realistic and you must be committed to seeing it through.

Step 1: Gather Some Financial Information

Now that you’ve adopted the correct mindset about budgets, or spending plans, and gained an understanding of their real purpose, it’s time to build your own. But before you download some fancy software program or start filling out a budget worksheet, you’ll want to gather a detailed list of your net income (take-home pay) and fixed expenses.

Step 2: Select a Budgeting Method

In essence, you want to figure out how you’ll budget your money so you can build up your savings for emergencies and the future. (No, it’s not a one-size-fits-all approach, and your needs could change over time).

Many financial experts recommend the 70:20:10 or 50:30:20 method, but it all just depends on what you’re trying to accomplish. The 70:20:10 method suggests that you allocate 70 percent of your income to expenses, 20 percent to savings, and the remaining 10 percent to debt repayment.

Under the 50:30:20 method, 50 percent goes to expenses, 30 percent goes to wants, and 20 percent goes to a combination of debt and savings.

For example, 70:20:10 may work for someone with a healthy emergency fund and minimal debt repayment. By contrast, an individual with a healthy amount of disposable income but loads of debt could probably benefit more from the 50:30:20 method.

Step 3: Create Your Budget

Run the Numbers

Next, tally up all your monthly expenses and income to see where you stand. As mentioned earlier, if your expenses greatly exceed your monthly income, the first step is to get that total down to a manageable amount.

Have a look at your bank statements, receipts, and credit card statements to see where you are spending. Once you’ve resolved the issue, you’re ready to begin creating a budget.

Allocate Expenses

Depending on the budgeting method you selected in step two, you’ll need to allocate outflows or expenses accordingly. In most instances, the buckets are:

  • Fixed expenses, or your needs. These include rent or mortgage, food, car payments, clothing, insurance, childcare, pet care, and other household-related expenses.
  • Debt, or your monthly debt obligations. These include all types of loans and credit card debt. The more you can pay each month, the better. Prioritize the most expensive debt first to save on interest.
  • Savings, including funds for your emergency fund and nest egg. You’ll want three to six months of expenses in your emergency fund to avoid incurring more debt should a financial emergency arise. It’s also important to contribute to retirement accounts to secure your future and to take advantage of your employer match (if applicable).
  • Consider automating your retirement contributions to ensure you stick to the plan and meet your retirement goals on time. You also want to allow enough time to let your money work for you through the power of compounding interest, so it’s better to get disciplined with your retirement contributions sooner than later.
  • Flexible expenses, or wants, as it doesn’t make sense to deprive yourself. It’s your money, and you deserve to enjoy it!

You’ll also need a cushion that acts as a buffer to cover any small overages or unexpected expenses that come up. For example, if your utility bill is $25 more than you projected or your child has a field trip fee of $15 that has to be paid, you won’t have to dip into your savings to cover the expense.

Step 4: Execute Your Plan

If you want to go old school, a notebook, or pen and paper will do. You can also dump your figures into a spreadsheet and work your monthly budget from there.

But if you’re always on the go and would prefer to manage your money at the tap of a fingertip, an online budgeting tool or app may be more ideal. Don’t know where to start? Check out this comprehensive list of budgeting software apps to put your spending plan in motion.

Step 5: Reward Yourself

You’ve worked diligently all month long to follow your budget. So why not reward yourself? This doesn’t mean blowing a wad of cash at the mall or on a mini-shopping spree or anything of the like. But you can work a small percentage into your budget to treat yourself each month.

Additional Tips

Online Scheduling or Online Bill Payment

Scheduling your payments ahead of time using online or through your financial institution’s bill pay feature decreases the likelihood of blowing your budget. Why so? Despite the fact that funds will be sitting into your account until the date they are due to be withdrawn, you’ll know the money is off limits for casual spending.

Automated Savings

Instead of scrambling to save money each month after the well runs dry, make it a priority by automating your savings. By having the funds sent to a separate account the moment your direct deposit is disbursed, you don’t have to go through the hassle of making an additional transfer. Plus, it won’t be as tempting to spend money that’s sitting in a savings account that you don’t make regular transactions out of.

If you’re self-employed, you’ll have to be a bit more disciplined. Assuming you don’t pay yourself a salary, make it a priority to transfer funds into your bank account each time funds hit your account. Doing so will ensure you hit your savings targets each month.

Envelope System

Not a big fan of cards and prefer to use cash for everyday expenses? The envelope system may be the perfect fit for you. In a nutshell, you’d transfer the amount you budget for savings to the appropriate account, pay your bills, and place what’s left in envelopes labeled by their intended use. Funds can be moved between envelopes, but once they’re empty, your spending stops until the next budget cycle.

This system can be highly beneficial if you frequently overdraw your account from making everyday purchases. It also eliminates the need to track every penny of your disposable income spent on “wants” as it’s much easier to see where you stand with cash in hand than to keep track of account balances that may not reflect what you’ve actually spent.

If the idea of having that much cash on hand doesn’t sit well with you, try opening an account solely for your disposable income. Request a debit card and set up account alerts to avoid overspending.

And if you’re really disciplined, you could use a rewards credit cards to earn something in return for your spending, but you must pay it off each month to avoid interest. The easiest way to make this method work for you is by setting spending limits.

Bottom Line

Making a budget doesn’t have to be a grueling exercise. By following these budgeting tips, you’ll be on your way to mastering your money. And don’t forget to tweak your numbers as your goals or needs change.

Allison Martin
Meet the author

Allison Martin is a syndicated financial writer, author, and Certified Financial Education Instructor (CFEI). She has written about personal finance for almost ten years and holds a master's degree in Accounting from the University of South Florida.