So, we are pumped and ready to roll on our debt-free, wealth building journey. Luckily for you, you’ve already completed Step 1: Getting Started. The next phase of this process is creating a budget, and for that we are here to help.
Let’s begin by saying a budget is not a restriction, but rather giving yourself permission to spend your money the way you want. As a result, budgeting allows you to be in control of your finances.
Making a budget in steps:
- Calculate your after-tax income
- Calculate your monthly expenses
- Choose a budgeting plan
- Write it out and commit to it (your spouse too!, if applicable)
- Reconcile and revise
Calculate your after-tax income
Your income is your most powerful wealth building tool. Therefore, calculating your after-tax income is key to begin the budgeting process.
Your after-tax income is generally the paycheck that you receive however, there may be built-in expenses that reduce that amount.
If you normally contribute to your 401(k), automatic draft savings, health insurance, HSAs etc., you will need to add those sources back in to receive a real view of your wealth building tool.
There may be other sources of income to consider as well. When you think of income consider EVERY dollar that comes in monthly.
This includes side jobs, second jobs, social security checks, disability checks, child-support, and anything that is increasing your income.
If you are married, include your spouse's income as well. A married couple should be on the same page with their finances.
Most importantly, being aware of everything coming in will prepare you to manage how it goes out.
Calculate your monthly expenses
Monthly expenses can vary from month to month, so creating a budget will allow you to keep track of everything.
Before you even start a budget, make sure you are current on all of your bills. After you complete that, here's your order of events.
Take care of your household first by paying the mortgage (or rent) and buying your family food. The next thing to do is pay the light and water bills (utilities).
Then take care of transportation and basic clothing needs. These items should be considered as your regular monthly bills and necessities to live.
Always take care of your necessities first before doing anything else.
Furthermore, factor in your irregular bills such as: debts, cell phone, gas, auto insurance, etc. that are due for the month you are budgeting for. Do not get behind on your mortgage (or rent) and current on your student loan.
We are not suggesting be behind on payments, but sometimes that can happen. You must be clear on what has priority on your budget. Next add in costs that you generally have during the month including entertainment, Netflix, Spotify, etc.
If you are having a little trouble getting started with this step take a look at your debit/credit card statements to give you a good idea of your monthly expenses.
Once you sit down and review your financial statements you may find items that can be canceled/removed.
Often times we have monthly bills charging us that we are not aware of. A budget will make certain this never happens!
Choose a budgeting plan
Your budget must essentially address two basic things: your needs and your wants. Identifying a need versus a want can be as simple or as complicated as you would like to make it.
As a rule of thumb, the stricter you are with your wants the faster you will get to your debt-free and wealth goals.
Your income minus your expenses equals zero. This is by far the simplest and most efficient way to budget.
By using the zero-based budget you have successfully given every dollar in your control an assignment. "So a zero-based budget means that I will have no money at the end of every month?!" NO.
A zero-based budget does not mean that you go down to $0 in your account every month. Some of the money you budget will go towards a savings account. So yeah, you can take a deep breath now.
However, if you cover all of your expenses during the month and have extra money left over, you still have to give that money an assignment.
You will lose the opportunity to allow your money to work for you in the areas of debt, saving for an emergency, investing, paying off your mortgage, or giving generously if you do not give it an assignment.
If you are still in debt throw any extra money at your smallest debt (not including your mortgage) and continue this process until you are completely out of debt. This is called the debt snowball method and gives you the confidence to keep moving right along your debt-free journey.
We recommend reading The Total Money Makeover to help understand the basics of budgeting.
If you are completely out of debt minus your home, your extra money should be used for the following:
- Clutch Fund (used for emergencies)
- Saving for down payment on house purchase (if applicable)
- Investing for retirement
- Saving for kids college (if applicable)
- Paying extra to your mortgage (if applicable)
- Spending and enjoying life
Create envelopes for your monthly expenses and fill them with the amount of money you have allocated for each expense. Keep track of each purchase by writing it on the back of each envelope.
Once the money is all spent you are done with spending in that category for the rest of the month. Some have chosen the food, clothing, bills, and entertainment envelope system.
You can get as sophisticated as you'd like, however it is usually best to keep it simple. The great thing about the envelope system is that it forces you to spend cash.
The emotional connection we have with spending cash usually keeps us from spending frivolously.
There are loads of budgeting apps on the market. Budgeting apps help to take the guess-work out of creating categories for your budget. This is the method we recommend for your monthly budgeting.
You have the ability to sync your budget across many devices, and it is at your fingertips at any moment. For those of you who are not math-nerds budgeting apps handle all the calculations for you.
All you have to do is enter the data and the app will take care of the rest.
The upside of a budgeting app is that it can provide a user-friendly way of comparing your progress from month to month. An added bonus for couples is that it gives you real-time updates from your spouse.
This allows both of you to always be on the same page with your monthly budget.
On the other hand, it requires you to consistently input your transactions when they occur.
You can get behind with tracking your transactions if you do not create a process that works for you.
We make it a habit to input the amount we spent as we are at the register completing the transaction. This holds us accountable for ensuring our budget stays accurate.
Some apps offer a paid version that syncs to your bank account and automatically enter the transactions. But, since we are still on our debt-free journey we are sacrificing by doing it manually.
In addition, Trim is a great option to help automate saving money. It will find and cancel unwanted subscriptions and negotiate bills for you. You can also receive text alerts for your spending habits. Trim has saved its users over $1,000,000 last month alone.
Write out your budget and commit to it
After you have created your budget you will need a way to keep track of your progress. It is often said, "on paper, on purpose." Whether you are an "on paper" person or not, that should not stop you. There are several ways to keep yourself on track with your budget.
Reconcile, revisit, and repeat
In the future, there will be changes in your income and expenses. So, you want to be prepared for the ebbs and flows in your finances. As a result, this may cause you to shop around for other services or insurance providers if their rates increase too much.
For example, your auto insurance may increase without any justification. You must revisit your different accounts at least annually to make certain you are receiving the best deals.
Make adjustments to your budget as needed. It may be daunting at first, but keep going. You'll be a pro in no time!
Final words - how to create a budget
Creating a budget takes time and effort, but having a good one is well worth it. Personal finance is so important and most people do not fully grasp that concept.
A thorough budget will help you manage your money more effectively, so you prepare yourself to build generational wealth.
Do you have a detailed budget? What helps you stick to your budget?
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