7 Simple Steps for Setting Up a Budget

Most people have only a vague idea of where their money goes, but they generally find that it doesn't go as far as they think it should. The solution is creating and maintaining a budget, an itemized description of income and expenses. This will enable you to determine how you spend your money, get more out of the money you have, and make it easier to meet the financial goals you've set for yourself. As with just about anything, the more closely you examine your situation, the easier it will be to identify ways to improve it. While you might not consider it the most enjoyable activity, it's a necessary evil in your pursuit of financial success.

There are 7 reasonably simple steps involved in putting together a budget:
  1. Choose a system.
  2. Determine your income.
  3. Determine your expenses.
  4. Compare income and expenses.
  5. Determine your goals.
  6. Improve your situation.
  7. Monitor your progress.

Let's look at each of these steps in turn.

1. Choose a System

Determine how you will track the budgetary information.
If paper and pencil works for you, that's great. We recommend using a personal finance software package. These tools guide you through the process, crunch the numbers for you, and suggest areas of improvement. To further simplify the budgeting process, you might also want to consider banking online.

The next three steps involve looking at your income and expenses.

2. Determine Your Income

For most people, this will be an easy step. Simply calculate and record the income you receive from various sources. For example:It is generally wise to be conservative with the calculations, and not to include income that you aren't fairly sure you'll be receiving. For a more accurate estimate, you might want to total your income over a longer period (for example, six months rather than one), to flatten out any jumps or dips that may have happened in a single month.

3. Determine Your Expenses

This step is more time-consuming than the previous one, but also more important because it's the side of the equation that you probably have more control over. We have listed the most common types of expenses below, grouping them into three basic categories. Begin by estimating how much you spend monthly on each type of expense. Of course, you should feel free to modify this list to suit your specific circumstances.Next, track your spending for a month (or two, if you prefer). Try not to change your spending practices during this time. Track all expenses, no matter how small. To save time, you might want to use your monthly checking and credit card statements, but be sure to itemize cash purchases (rather than just listing a single 'ATM withdrawal'). This is especially important if cash purchases comprise more than 5% of your overall expenses.

4. Compare Income and Expenses

Having completed the above steps, you should now be able to answer these questions:As a guideline, most Americans spend about 70% of their income on fixed expenses.

More importantly, if your total spending exceeds your income, then your first priority should be to change this. It's not an unusual situation, but it is a dangerous one. Borrowing money to meet monthly expenses is like quicksand: it gets harder and harder to escape from. If you're in this situation it's important to get your spending under control before matters get any worse. Sometimes borrowing makes perfect sense, such as to finance part of a college education, but if you have a substantial credit card balance that you're paying a high interest rate on, there is almost certainly room for improvement . As soon as you get that paid off, you'll find that your income goes a lot farther.

The final three steps are to look at your goals and your progress.

5. Determine Your Goals

Now that you have a clear snapshot of your financial health, establish a target budget and work towards achieving it. Keep in mind all the big-ticket expenses that you want to start saving for, such as retirement or a child's education, and begin saving for them. Many people set a goal of reducing their expenses to about 90% of their income, so this is a good starting point if you aren't sure exactly how much you'll need down the road. Once you know how much you need to cut your expenses, you can compare the expenses with each other to determine which are worth keeping: for example, would you rather make your upcoming vacation one day shorter or dine out one fewer time per month?

6. Improve the Situation

The whole purpose of detailing your budget was to find ways to improve it, and that's where this step comes in. The income side of the equation is the hardest to alter, unless you have a job that gives you the flexibility to work more or less as you desire. So let's focus on the expenses side, where you probably have more control.

In step 3 we broke down the expenses into three categories: fixed committed, variable committed, and discretionary. You may be able to reduce a few of the fixed and variable committed expenses somewhat, but most people find that focusing on the discretionary expenses yields better money-saving ideas. Were there some items on the discretionary expenses list for which you found you were spending significantly more than you predicted? If so, those items would be the logical starting point. But even if you accurately predicted where your money is going, you should still ask yourself whether those expenditures are worthwhile.

Here are some money-saving ideas you might want to consider. (Obviously, not every idea works for every individual, but there may be a few on the list that can help you.)

7. Monitor Your Progress

Once you have a budget that allows you to accomplish your goals while living comfortably, you're still not quite finished. The final step is to monitor your budget on an ongoing basis to confirm that you're still on target. It's not as difficult to stay on track as it is to get on track in the first place, so an hour a month should suffice, especially if you're using personal finance software. You don't need to go overboard... your time is valuable, so make sure the time you spend is justified by the benefits you receive from the activity.

If you find that you repeatedly have difficulty sticking with the plan you've set, you might want to check your progress around the 10th of every month and trim any expenses that are getting ahead of your projected numbers. On the other hand, you may find that some of your goals were unrealistic, in which case you should adjust them and find a new budget that works for you. As you begin to accumulate savings, you can start to invest.
By InvestorGuide Staff

Copyrighted 2020. Content published with author's permission.

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