I was shocked to find $100 spent for coffee at Dunkin on my credit statement five months ago. I could have saved money if I brewed coffee at home.
I started tracking my monthly expenses. I found that on a monthly basis I can easily cut back $80 on movies and $200 on dinner.
I knew I need a budget.
Dave Ramsey, one of my favorite financial gurus said –
“A budget is telling your money where to go instead of wondering where it went.”
After going through the article you will be able to budget like a pro even if you are a beginner.
You will no longer wonder where your money went every month end once you get into the habit.
Budgeting will help you –
- Cut back on unnecessary spending
- Stop wasting your time and money on things you can easily do
- Know exactly how much money you have for spending
- Have more money for the things that you really care about
- Have more control of your finances & life goals
So let’s get started –
How to Budget like a Pro in 5 Simple Steps
#1. Set Your Budgeting Goals
Unless you have set a purpose for savings, budgeting will feel pointless.
The purpose can be –
- FIRE to escape 9-5 grind
- Saving for a car, exotic vacation, or house
- Funding for college
- Paying off existing debt
- Children Education
- Retirement fund
Having a random goal can potentially sidetrack your budgeting exercise.
You will be committed and most likely to budget if the purpose is clear and meaningful to you.
#2. Account for Expenses
Figure out how much money you spend every month.
Make a column on your spreadsheet or use a paper pen to list –
- All of your monthly bills & expenses
- Savings contributions & mortgage payments
- Investments money
You need to include both fixed and variable expenses that you incur every month.
A pre-set amount of money that you need to pay every month is termed fixed expenses.
Fixed expenses include –
- Rent or mortgage payments
- Loan repayments
- Insurance, payments
- Retirement account contributions
- SIP investments, if any
Variable expenses are amounts that keep on fluctuating because they depend on your spending habits and lifestyle.
For example, if you like to cook at home, then your food expenses will be lower as compared to people eating out.
List of variable expenses –
- Utilities – electricity, gas, mobile and internet expenses
- Entertainment activities
- Personal care items
Without making any changes to your normal buying habits track all your spending for a month.
3 Easy ways to check your spending
- Using credit card and bank statements
- Through budgeting apps like YNAB, Personal Capital or Mint
- Spreadsheets (you need to put in the expense amount manually)
The monthly expenses pie chart looks like the one below –
You find there is less flexibility to change the “Needs” and “Savings/Debt” segments.
But the “Wants” segment is where you can cut down your expenses.
#3. Add up all Income Sources
You need to know exactly how much money you make every month and where it is coming from.
Your income can be in the shape of –
- Salary / Wages
- Investments returns / Interest receipts
- IRA / pension receipts
- Freelance or Gig income
- Social Security / SSI / Child support
Add up all of your income and all of your monthly expenses.
#4. Calculate Disposable Income
Once you have both the income and the expenses figure.
You need to subtract all the expenses from your income. The remaining amount is your disposable income.
Positive disposable income means you have surplus money that can be invested or saved for future goals.
You need to cut your spending in case you get a negative disposable income (meaning you don’t have enough income to cover all of your expenses).
Items that can be trimmed –
- Frequent eating out or getting coffee
- Costly Cell phone plan
- Cable or satellite package
- Clubs/memberships that you don’t use
- Hosting parties
- Ordering Alcohol while dining
Instead of eating out 4 times you can cook twice and go out 2 times if you find it hard to stop eating out.
Cancel memberships that are no more in use. Try negotiating for a better cell phone & net plan as per your utilization.
#5. Review Your Budget Periodically
A periodical budget review will help you find areas for improvement in spending habits.
You wouldn’t know if you are doing proper money management or getting off direction if you created a budget and never reviewed it.
Adjust your budget if there is any change in your income levels or when your expenses go up or down accordingly
Reviewing your budget will help you to better manage your spending habits, thereby increasing your savings and ultimately helping you progress on your long-term financial goals.
4 Simple Budgeting Methods to Try in 2022
#1. 50/30/20 Budget
The 50/30/20 budgeting method is pretty straightforward and easy to grasp.
You are required to classify monthly expenses into three categories –
#1. 50% as Needs – includes rent payments, groceries, utility payments & car payments.
#2. 30% as Wants Section – includes shopping, entertainment, vacations
#3. 20% in Savings and Debt Payments – towards a credit card, retirement, emergency fund
If your monthly expenses fall under the above-stated percentage then you are sure of your budgeting is on track.
Note – that the percentage buckets are not hard fast, you can vary by a point or two.
50/30/20 budgeting is a rule of thumb, you can tailor it to fit your needs.
For example, you can increase 5% savings from 20% to 25%. Simultaneously you can also reduce 5% from the needs section.
The main drawback of the 50/30/20 budget is that – the formula is unrealistic for people who have a lot of debt (like fresh graduates) or for someone with big savings goals.
For them, the “Wants” section will be 10-15% and the “Savings & Debt Payment” will have a 40-45% figure.
Best for – Helping newbie budgeters identify needs and wants & prioritizing needs.
#2. Zero Based Budget
Income minus expenses should be equal to zero is the concept behind zero-based budgeting.
Suppose $8,500 per month is your money inflow and there is an outflow for an equal amount. Then you have a net zero surplus amount.
Note – that the outflow total will also include savings, investments and debt repayments too.
You need to be precise in identifying all your expenses and tracking them for the Zero Based budget to work properly.
Misjudgment or excess spending on any particular item (like medical expenses or utilities) may force you to cut on other expenses.
It may take a year or more to get to this level of diligent budgeting.
Best for – Pro Budgeters who track their every penny.
#3. Cash Envelope Budget
Here take a bunch of envelopes and label them with your monthly spending categories.
Now you are supposed to fill physical notes in the designated envelope before you go out for shopping groceries.
The cash Envelope Budget method prevents you from overspending on that particular expense item. You come to know the amount that you can spend for a category.
But the problem occurs when you run out of cash.
Avoid raiding other envelopes or you will run out of cash before the month’s end. Cash budget helps curb overspending habits and mindless shopping.
Youngsters who prefer credit cards may not like the method.
Best for – Habitual overspenders who want to improve their finance.
#4. Pay-Yourself-First Budget
Calculate your monthly debt repayments, target savings and investment amount.
Straight away keep this amount aside from your income. Auto deduct facility on your paycheck facility will help you.
That is paying yourself first means.
Later you are free to spend the rest of the amount on any expenses as you like.
The idea here is to prioritize your debt repayment and savings goals.
Note – You can add utilities and groceries too as a priority.
You will be forced to live within your means once you pay yourself first.
Let your money pay for your top priority first, and then dole the remaining amount for expenses as you wish.
Best Suited to – a person struggling to save or tracing every expense.
People struggle with debt repayments and savings for an emergency.
Debt.com chairman and CPA Howard Dvorkin said – “It’s astonishing that something as simple as picking up a pen and paper and writing down your expenses can get you out of debt,”.
Creating a budget is as simple as that.
Use budgeting apps like – Good Budget, YNAB, or Mint, if you hate the paper-pen method. The process will help improve your financial habits.