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How to Budget
By Jessica Dosseh
"I have a hard time wrapping my brain around how to set a budget and then not actually spending more than the budget allows. I feel guilty that I'm a nerd in most other respects, but I just can't sit down and do the math about my spending." – Sarah Robeson, 28 ~ I will teach you to be rich.
If you've ever felt this way, just know you are not alone. This is a sentiment many people feel, and it might be because people view budgeting as a way to restrict their spending instead of viewing it as a way to improve their spending habits.
The best budgets help you improve your financial circumstances. The worst budgets keep you where you started, or worse— slowly make you lose money.
This article walks through the four stages of budgeting.
(Observation) — Understand where you are.
(Optimization) — Make a plan, then execute it.
(Sustainability) — Maintain your plan.
(Growth) — It's time to grow.
If you take anything away from this article, it's this: The goal of budgeting is to create your own collage of strategies that work for you, and that takes time, so be patient with yourself.
Observation: Understand where you are.
It's time to stop wondering where all your money goes each month.
Sitting down to budget can seem overwhelming, but it doesn't have to be. Most traditional budgets only focus on the first part of the process, which is identifying where you are spending money and understanding why.
This way of budgeting isn't for everyone because it can quickly become restrictive and make you feel like a failure if you can't keep up with it.
Even though we are not focusing on traditional budgeting in this article, it's important to at least understand how you are currently using and spending your money.
Here are three tools we recommend using to get an overview of your habits. The tool you choose to use really just comes down to preference.
Don't overthink it. Choose one that makes you feel comfortable. If it doesn't work, then choose another one.
Google Spreadsheet / Excel
Free or purchase a template here
Free, supported by ads and offers
Automatically syncs with your credit card and banks to categorize your spending and show you trends. It helps you get a feel for your habits without much work.
Free trial period, then $14.99/month or $99/year with money back guarantee
Sometimes it's worth paying for convenience.Lets you assign every dollar a job.
You'll get incredible insights into your spending.
Perfect if you want manual control. It can be personalized to fit your specific financial needs.
For more information, read YNAB vs. Mint.
Now that you picked out a tool to use, you have two options. Either start fresh by keeping track of your expenses, or pull data from your past.
What can you do Part 1 – Starting fresh
If you've never made a budget before or if you've really struggled with budgeting in the past, then I recommend starting fresh and doing it manually for at least three months. I know this seems like a real hassle. However, it's extremely important for you to recognize how you feel about certain expenses. The end goal of this exercise is to get you to a point where you are consciously spending on what you love and saying no to spending on the things that don't make you happy. Otherwise, move on to Part 2.
If this is your starting point, then here is the to do:
First, start by jotting down how you think you spend your money, then tuck that note somewhere safe, and we'll return to it in the future.
For the next two to three months, all I want you to do is either write down your expenses in a Google Sheet/Excel, or use an app to track your expenses. That's it. You don't need to make any major life changes. Just spend how you usually spend and document it; take note of how you felt when you made a purchase. Just observe.
If you feel like going a bit more in-depth, I would suggest writing down how much money you have in your bank account at the beginning, middle, and end of the month (the 1st, 15th, and 30th). This will help you understand whether you are losing or retaining money over time.
[Tutorial on how to document your income and expenses.]
Once you've done that, come back to this article and move on to the second part.
What can you do Part 2 – Categorize what you know
If you already have a general idea of how you use and spend your money, then take a couple of minutes and divide your income into a simple pie chart. Think about the major categories (i.e. Fixed costs, rent, debt, shopping, eating out, savings, investing, etc.) and don't worry too much about the exact percentages.
Now ask yourself: What would it look like if I could divide the pie chart however I wanted? Take the next couple of minutes and draw out the second pie chart into the things you want and need. Make sure not to hold back. The idea here is to consciously choose what you want to spend your money on guilt-free. How different does it look from your initial pie chart?
That's it. You've completed the first part.
This section isn't about creating a complicated budgeting system. We just want to see how we act and then make a plan to improve our financial behavior over time. Improving by 1% is better than doing nothing.
Optimization: Make a plan, then execute it.
“Create your own collage of strategies that work for you” — The Financial Diet.
Setting up a workable plan may seem out of reach, depending on your financial situation. If you've already cut your spending down to the bone and still don't have extra money, it may seem insulting or unrealistic to suggest that you use any of these budgeting methods when you are already doing your very best. If you simply can't cut more out of your budget, these spending plans may be useful theoretically, but you have more important concerns like making more money.
Skip down to the "It's time to grow" sections for some helpful links.
Many people assume a budget is a cut-and-dry, one-size-fits-all process, but it's not. There are several different budgeting techniques that can suit your specific needs.
If you've completed the first part of this article, "Understanding where you are." You should have a relatively good understanding of how you naturally use your money, so choose a budgeting method that compliments your habits. If you don't know which one to pick, choose one that sounds somewhat sustainable and try it out for a while. Remember that this is an iterative process, so if one method doesn't work for you, try another.
What can you do Part 1 – Choose a Budgeting method to use.
Here is a quick overview of some of the most popular options:
The Pay-yourself-first Method
The pay-yourself-first budgeting method focuses primarily on savings and debt repayment.
Set aside a specific amount every time you get paid for savings and debt payments, then spend the rest of your money on your needs and wants.
The amount you set aside will depend on how rigorous your savings and debt payment plans are. For example, if you're just starting out, you may want to start by saving $1 a day to build your foundational habits, then increase the amount gradually. On the other hand, you may want to save or use $1,000 a month towards debt repayment. Everyone's goals are different so ask yourself, "what are you really trying to do?"
Note that this plan does not mean neglecting your bills or necessary expenses.
This plan is best suited for people with a relatively consistent fixed cost who want to improve their saving habits, double down on cutting debt, or don't want to spend too much time budgeting each expense.
Consider incorporating an automated process to make this budgeting system work better for you.
The Envelope Method
(Cash Only Budgeting)
This method is about budgeting all in cash or creating multiple savings and checking accounts to manage your money.
Plan out how you are going to spend your money each month and use an envelope for each spending category like rent, groceries, eating out, and so on. Once you have spent the money for that category, then that's it. If it's a real emergency, you can dip into other envelopes, but you will have to cut back until that envelope is refilled because it can quickly become a slippery slope. You don't want to accidentally run out of cash before the end of the month.
This process can be automated with debit cards. Before you go this route, choose the right bank and ask them not to allow you to spend more than the amount you have in each bank account. Once you have that setup, at the beginning of each month, transfer the appropriate amount into each category account and spend as needed.
This method is good for people who prefer to use cash and who are relatively good at organizing themselves.
The 20/50/30 Method
(Bucket Budgeting)
It is straightforward and requires less work.
This method of budgeting divides your money into three buckets:
20% for saving, debt, and investing (emergency fund, gifts, 401k, Roth IRA, etc.)
50% for fixed costs (Rent, utilities, debt, etc.)
30% for guilt-free spending. (Eating out, shopping, entertainment, etc.)
With this method, it's important to put aside savings first because it can be easy to forget.
This budgeting style is best suited for someone who wants to lead a more balanced life and needs some guidance on how much they should be spending on specific things. This budgeting method is a great option for beginner budgeters because it doesn't require meticulous tracking of all your expenses.
This budgeting style can also be automated fairly quickly.
Fractional Method
80/20 budget,
70/30 budget,
60/40 budget,
or even the 50/50 budget
This way of budgeting is a hybrid of the 20/50/30 and the pay-yourself-first method. Determine how much you want to spend and how much you want to save. For example, save 20% and spend 80% or vice-versa.
This method may be good for people who don't have fixed incomes or fixed expenses. This method allows you to be as flexible as you need to be and budget on your own timeline.
The ‘NO’ Budget Method
Don't spend money that you don't have.
This budgeting method is best if you have a strong spending discipline and are confident you can continue maintaining that discipline.
Like all the other methods, start by setting aside enough for savings, debt, and investing. Know when recurring bills hit your account and have enough to cover those bills. Keep an eye on your checking account balance and note whether your overall net worth is growing. Spend what's left over guilt-free and without overdrawing your account.
If I had to give this style of budgeting a different name, I would call it the Minimalist Method.
Consciously decide what you value so you can say YES to the things you want and NO to the things you don't.
"There is power in saying no to the things you don't care about. But there is even more power in saying YES to the things we love. Conscious spending means you decide exactly where you're going to spend your money – and you free yourself from feeling guilty about your spending." – I will teach you to be rich.
Now that you have chosen a budgeting method, it's time to optimize your spending.
What can you do Part 2 – Optimize your spending.
When you first analyzed your spending habits, what did you notice? What is the one big spending problem area?
This section may require more analysis than we can cover in this article. At this point, if you need help, you may want to consider contacting a professional financial advisor or using trial and error to solve your specific financial need.
Sustainability: Maintain your plan.
This is a pulse check.
Creating and maintaining a sustainable plan is one of the most important parts of personal finance. If it's not working for you, then find a different solution. Don't sit around waiting for it to magically get better— because it most likely won't.
What should you do
Once you've created your budgeting plan, it's important to give yourself some time to settle into the flow. It gets easier with time. Be patient with it; give it at least 3 months before changing your plan if necessary.
At this point, you should check on your budgeting plan for at least an hour each week. Tweak things and shift things around to make it suit your needs.
Habits don’t change overnight, so you want to make sure you're building a system you can work with for a long period of time.
Congratulations, you’ve now successfully created a budgeting system that is tailored to you and your personal finance goals. Take a deep breath and pat yourself on the back.
Growth: It's time to grow.
You need to make money to manage money.
There is a limit to how much you can cut or distribute when it comes to budgeting, but there is no limit to how much you can make.
Increasing how much you earn will not be easy, and for most of us, there are no handouts, but we can do our best and find ways to turn some of our skills into profitable sources of income.
If you need to make more money, here are some strategies that may help you.
Negotiate a raise.
Get a higher-paying job.
Start freelancing.
Build passive income.
Start a small business.
Join the creator economy.
The Summary
In this article we covered the four stages of budgeting.
(Observation) — Understand where you are. Document your expenses, categories then and think about how you really want to spend your money.
(Optimization) — Make a plan, then execute it. Choose a budgeting method, then tweak it to fit your habits and goals.
(Sustainability) — Maintain your plan. Check on your budgeting plan at least once a week, ask yourself if the budgeting plan you are using is helping you grow your overall net worth.
(Growth) — It's time to grow. Find a way to increase your income actively or passively.
Good Luck.