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How to Create a Budget Plan

Personal Finance
A couple goes over a step-by-step guide together for how to create a budget plan.

Many financial moves typically require a plan. For example, you likely wouldn't purchase your first home or organize a wedding without a plan.

Budgets are meant to help guide your financial path, enabling you to reach your goals more easily and learn how to manage money more effectively. But, if you've never created one, the process can feel intimidating.

With this in mind, here are seven steps that can help you understand how to create a budget plan and help put yourself on track to achieve your financial goals.

Step 1: Know Your Income

The first step toward helping create an effective budget is knowing what you have coming in. If you work at a traditional 9-to-5 job, you likely earn a salary. However, keep in mind that this amount is very different from your net income. Your net income (or take-home pay) is what you actually bring in after taxes and deductions. For example, you may transfer $100 of your pre-tax income every pay period into your 401(k), or you may contribute to a health savings account or flexible spending account. While these actions can help you save money, they actually reduce the cash you're left with in your paycheck.

Understanding Your Income as a Self-Employed Individual

If you're self-employed, understanding your monthly income may be trickier. To start, consider looking at how much money you've earned to date this year and find the average. For example, you may have some months where you make $4,000 and other months where you may make $6,000, which means your average is likely around $5,000. If you want to take a more conservative approach, you could also look at your lowest-earning month and use that as the baseline for budgeting your income.

Working as a Team to Budget Your Income

If you're a solo earner, it's wise to set aside time when it's most convenient for you to work through these numbers. If you're in a dual-income household, you may want to talk to your partner and find time for the two of you to do this together. Crunching the numbers as a team may make budgeting easier in the long run — and help your family develop better money habits.

Step 2: Understand Your Expenses

Once you understand your income, calculate your expenses. Household spending generally falls into three categories: fixed, variable and discretionary.

Types of Expenses

Fixed expenses may include your mortgage, rent, car or student loan payment. Variable expenses often include groceries and utility bills that can vary in size — such as electric or gas — while discretionary expenses fall into the bucket of wants rather than needs. These expenses can include things like dining out and purchasing clothing as well as costs for your personal care.

Tracking Your Expenses

If you do online banking, it's likely easy to access this information from your computer or your bank's mobile app. Some financial institutions even offer a spending tracker that's divided by categories, so you can easily see where you're spending all your hard-earned money. Otherwise, you can look at your paper bank statements and write down all this information so you can review it later.

Step 3: Set Short-Term Goals

The next step is to set some goals. You can start with short-term or long-term financial goals. If you want to focus on the near term, these goals can include saving for an upcoming vacation, paying off a credit card with a low balance or even building up one month's worth of cash reserves in your emergency fund.

Write down these goals somewhere — on paper or on your computer — so you can continually refer back to them.

Step 4: Set Long-Term Goals

After you set short-term goals, identify your long-term financial goals. Goals that fall into this category can take at least a year to achieve. They can include things like paying off student loan debt, saving for a down payment for a home, paying down a high-interest credit card or having a certain amount saved for retirement by a specific deadline.

The Importance of Setting SMART Goals

The most important part of this exercise, whether you're eyeing a short- or long-term objective, is to set SMART (specific, measurable, attainable, relevant, time-bound) goals. Plans don't have any power if they aren't aligned with a purpose, so creating short-term and long-term financial goals is a key part of developing a budget that you can stick to today and in the future.

Step 5: Decide on Your Budget Approach

When strategizing how to create a budget plan, there are seemingly endless options to choose from. Some common budgeting methods include zero-based budgeting, a rolling budget, a 50/20/30 model and the cash envelope system. There's even the "No-Budget Budget".

  • A zero-based budget forces you to account for where every dollar goes. The premise with this form of budgeting is that every dollar has a job and is assigned a role, whether it's to pay specific bills, save for retirement or build your emergency fund.
  • With a rolling or continuous budget, you have to reevaluate your budget on a monthly or quarterly basis (or whatever time frame you choose). This approach requires more diligence and more effort because you must constantly keep track of your incoming and outgoing income and expenses.
  • In a 50/30/20 model, you allocate 50% of your income for needs, 30% for wants and 20% for savings. There's also the cash envelope system where you put specific amounts of cash in different envelopes for different expenses. For example, you could have a cash envelope for groceries, for dining out and for gas. Once the money in the envelope is gone, it's gone — you can't borrow from other envelopes to cover these expenses. This approach can be really useful to curb spending and help you understand where all your money really goes.
  • The "No-Budget Budget" method involves automating a lot of your budgeting, including savings and bill-paying. You'll know this method has worked when you don't run a negative bank balance every month. This method may not be the best fit for everyone, especially if you have little wiggle room in your budget to cover variable expenses or to set your bills on auto-pay.

There's no one-size-fits-all approach to budgeting, so it's important not to overthink it and just go with the approach that works best with your natural inclinations and the amount of time you can actually devote to budgeting.

Step 6: Create and Track Your Plan

After you decide what budgeting approach works best for you, start mapping out your plan. You can do this in a spreadsheet, on paper or using a budgeting app. The first two options will involve more manual work, but everybody's brains work differently, so seeing this information on paper or a spreadsheet may help you better understand and organize everything.

Benefits of Budgeting Apps

Budgeting apps are great because you have access to your budget anywhere and anytime. You can also link your bank accounts to these apps to see in near real time how much money you're spending, your current savings and your progress toward short-term and long-term goals.

Track Spending Trends

Budgeting apps (or spreadsheets) can also help you keep track of spending trends. For example, you may be able to see during the middle of the month that you're close to spending the total amount you've allocated for clothing. With this information, you could then look for better deals on clothing as you shop online or decide not to spend any more on this line item for the rest of the month.

It's difficult to make positive financial decisions without good information, so it's equally important to track your budget as it is first to then create your plan.

Step 7: Embrace the Journey

Budgeting is an ongoing process. It takes time to understand your money, better manage it and use it as a tool to help achieve your short-term and long-term goals.

Adjusting Your Budget

Even after you create a budget, keep in mind that you'll probably need to make adjustments along the way — either because you were too strict or unrealistic when you originally developed your budget or because your needs have changed. Life happens, so you may need to reimagine your plan as you take steps to learn how to manage money. 

The most important thing is to embrace the journey, be kind to yourself and be proud of yourself for taking control of your financial life, even if there may be inevitable bumps along the way.

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Information provided is general and educational in nature, and all products or services discussed may not be provided by Western & Southern Financial Group or its member companies (“the Company”). The information is not intended to be, and should not be construed as, legal or tax advice. The Company does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. Consult an attorney or tax advisor regarding your specific legal or tax situation.