Surprised? Many people think that creating a budget means obsessively tracking where you've spent every penny. But all that tells you is where your money has gone. It doesn't tell you where your money should go in the future, and why.
A budget is a spending plan that you design to meet your personal needs. Is getting out of debt your biggest goal? Give it plenty of room in your budget. Do you want to buy a house? Up your monthly savings target. Do you love to travel? You can choose where to cut back to fund a special trip. Your budget can be incredibly powerful, because it serves as a guide for your everyday financial decisions and ensures that you have enough cash for what matters to you.
Our 10-step guide shows you how it's done. All you need is a little time, and a pen and paper, spreadsheet or online tool to do the numbers.
1. Set your priorities.
Your money should go towards what matters. What three goals are most important to you right now? It doesn't matter if it's educating your kids, renovating your house, or losing weight -- it all gets factored into the budget. So write it down.
2. Gather your documents.
3. Calculate your monthly income after taxes.
To spend money, you have to have money. Write down exactly how much you make each month -- after taxes, since that's an ongoing cost you can't control. If you don't know how much you earn, pull out those pay stubs! If you get paid twice a month, calculate your monthly income by doubling the after-tax number. If your income is irregular, look up your last tax return and divide what you reported by 12, or estimate the minimum you will earn over the next year and divide that by 12. Don't forget to include income from rent, dividends, alimony, tips, or other sources. Write down the total.
4. Add back automatic deductions.
Does your employer deduct retirement contributions or health insurance costs from your paycheck? Add those back to your monthly income number -- you'll account for them in your budget.
5. Create the big three buckets.
Decide how much of your income to allocate to each of three big categories: needs, wants and savings. Some guidelines: Financial experts usually recommend saving at least 10 percent of your income. If you don't have an emergency fund or retirement savings, bump that up to at least 20 percent. Allocate 50 to 60 percent of your income to needs like housing, food, education, and transportation. The rest goes towards things that you want, but aren't strictly necessary, like movies and new shoes. Calculate the dollar figure for each spending bucket.
6. Divide it up.
Now comes the heavy lifting: Create your detailed spending list. Keeping your priorities in mind, estimate how much money should be devoted to each thing in your "needs" bucket (rent, health insurance, gas, cellphone...) and your "wants" bucket (clothes, cosmetics, dinners out, magazines). Only one rule applies: You can't plan to spend more than your monthly income.
7. Compare and adjust.
This is your reality check. Take a close look at the spending plan you just made, and compare it to the documents you collected. If you left out a major expense, add it to the budget. If you've allocated $100 to dining out but spent $600 last month, you need to adjust your food budget or stay out of restaurants. Consider where you're wasting money -- every dollar you save on bank fees can go towards that new sofa.
8. Set up your system.
It's one thing to create a budget and another to stick to it. Make it easier by automating as much as possible. Have your bank or employer deduct retirement savings each month. Set up online bill paying so you don't need to balance a checkbook or hunt for stamps. If you're more comfortable with an old-fashioned system like keeping envelopes for different expenses, set it up!
9. Check back in.
Your goal is to have your spending roughly match your spending plan. Once a month, spend 15 minutes reviewing your goals and your outflows. Adjust accordingly.
Once a year, revisit your priorities and your budget, to make sure it still works for where you are in life.