“A budget simply tells us how much money is coming in, how much is going out, and where it’s going—and this is essential information for everyone,” Jonathan P. Bednar II, CFP at Paradigm Wealth Partners in Knoxville, Tennessee, told The Balance in an email. As many as 80% of Americans say they are following a budget, according to a 2021 budgeting survey conducted by Debt.com. The two most common reasons for budgeting, according to the survey, include wanting to increase wealth or savings, or being prompted by debt, according to the survey. Learn what steps you should take to create an efficient and useful budget, ultimately leading to a financially stable future.
The 50/30/20 Rule
When it comes to budgeting, the simpler the better is usually the motto, as you’re less likely to be consistent with a complex budgeting process. One popular budgeting strategy is the 50/30/20 rule, which separates your spending by category: must-haves, wants, and savings or debt payoff, respectively, using net income. A full 50% of your income should be budgeted for essential expenses, according to the rule. “This includes housing, utilities, auto payments, groceries, gas, minimum monthly debt payments, insurance premiums, etc.,” Bednar said. And ideally, according to Bednar, no more than 30% of this amount should go toward your housing payment. The next portion of your net income, 30%, should be allocated for personal expenses, or things you really want but do not need. “These are items that you could cut if you had to, like dining out, hobbies, entertainment, gym memberships, and fun, monthly subscription boxes,” Bednar said. The final 20% is the most essential part of your budget, according to Bednar, because what you do with it will largely determine whether you’re financially successful or not. “This portion of your budget goes toward your financial goals—things like paying off debt, saving for an emergency fund, saving for a home, and investing.” While it’s tempting to make minimum payments on debt and put whatever’s left at the end of the month in savings, Bednar warns against this approach. “What usually happens is that there is nothing leftover, so if you don’t deliberately budget for those things, they’re unlikely to happen,” Bednar said.
Calculate Your Income
After deciding on a budgeting strategy, the next step is to determine your monthly income. “If you work for an employer as a W-2 employee, they will take care of all of the tax withholding, so you can use your after-tax income amount to create your budget,” Dave Henderson, CFP, ChFC, CLU, a self-employed advisor at Colorado-based Jenkins Wealth, said in an email to The Balance. If you’re self-employed, you’ll need to subtract your self-employment tax before calculating your net monthly income.
List All Your Expenses
After you determine what’s coming into your bank account, determine what’s going out. “You can do this by reviewing your credit card statements, as well as your bank statements for the last two-to-three months to determine where your money has been going,” Henderson said. Some expenses are fixed, staying the same from month to month, and others are variable and change often, such as groceries and entertainment. With variable expenses, it’s helpful to look back at your receipts from the previous few weeks or months and calculate an average.
Create and Track Your Budget
Now that you know the information you need for a budget, it’s time to actually create a budget. While you can easily track your monthly spending habits by hand using pen and paper, there are several budgeting apps and software programs that make this process easier. One popular budgeting app is Mint, which is Bednar’s favorite, because it is accessible and free. With Mint, as well as most others, you will need to gather details on your financial accounts, like credit cards and investments. These will be connected to the app and visible all in one place, ensuring all of the tracked information is accurate and up to date. According to Bednar, Mint recommends a budget based on the information you provide, but you also have the option of customizing it. Here’s a sample of how the 50/30/20 rule might look, based on a net monthly income of $5,000, according to Bednar. By reviewing these gaps in spending, you can make adjustments accordingly. It’s also key to remember that even though you have a budget, it will only be useful if you periodically track and update it to reflect any changes to your income and expenses.
