Now that you know WHY you should budget, let’s talk about HOW to start your budget. This part can feel a little daunting at first; gathering materials, organizing your information, and creating a schedule to consistently review your spending so you can stick to the plan. But while it seems like a lot, once you get started, it may surprise you how straightforward and doable the process can be. So, what’s first?
Grab a good old-fashioned pen, paper, and calculator. Or open a new spreadsheet if digital is your thing.
STEP ONE: FIGURE OUT YOUR INCOMING FUNDS
There are a few pieces of information you will need to put in your budget. First you will need to know your income. That can mean your most recent pay stubs, social security statements, or monthly investment withdrawals. You’ll want to account for all income coming into your household – spouse’s income, freelance or side gigs, garage sales, birthday money, tax refunds. ALL of it. With these incoming funds you will need to figure out what your net income is. This is your total take home pay after taxes, which is usually conveniently stated on your paystubs.
However, if you are self-employed, you may have to calculate that amount yourself. To do this, you need to subtract taxes from your income amount. The tax rate for self-employed individuals is 15.3%.[1] You can use a free TaxAct Calculator to estimate how much you’re required to pay in a year.[2]
If you don’t get paid the same amount week to week or month to month (such as freelance, hourly/overtime, tips, side gigs), then it will be most helpful to calculate your average monthly income. To do this, it is recommended to gather info from your last 3-6 months of employment and calculate the average.[3] The more pay stubs you have, the more accurate the total average will be. And how do you calculate that average? (Sixth grade was a while ago for most of us and we’ve replaced much of that knowledge with other things.) Simply add all the total pay amounts together then divide by however many months of pay stubs you have. For example, if Ryan has 3 months of pay stubs where, after taxes, he made $2,600, $2,572, and $2,610, the equation will look like this:
2,600 + 2,572 + 2,610 = 7,782
7,782 / 3 = 2,594
So, Ryan’s average monthly net income would be $2,594. While knowing your average monthly net income is an extremely important step in putting together your budget, remember that this number does fluctuate.
If you are a freelancer or have an income that varies, your budget will need to include a larger savings buffer for the occasional months when your income is lower than expected, as well as a plan for optimizing those months when your income is higher.[4]
STEP TWO: FIGURE OUT YOUR MONTHLY EXPENSES
This is the part that may cause anxiety or even dread, but you’re on a roll now, and nothing is going to stop your momentum from propelling you forward to success.
Once you have all your incoming money figured out, you will need to gather your most recent bank statements, credit card statements, or any other monthly bills that show what you owe or have paid – such as car payments, mortgage / rent, utility bills, and insurance premiums.
Does it seem like a lot? It can be hard to take an honest look at your finances, but that’s okay. Like so many things in life, the anticipation is often worse than the actual experience.
First things first when looking at your monthly bills – figure out what is a “fixed expense” and what is a “variable expense.” [1] A fixed expense is one that recurs monthly and has very little variation to what is owed each pay period. For example, your rent or mortgage, insurance premiums, car loans, day care, etc. Variable expenses can fluctuate from month to month depending on their usage or price. These include utilities, groceries, or filling up your gas tank. For variable expenses, you will want to find an average monthly expense for them like we did with calculating average monthly net income and use that figure as your starting point.
Once you have your list of expenses, it helps to break them down even further from “fixed and variable” to “wants and needs.” Wants would be things like going out for dinner, streaming services, buying new clothes, whereas Needs are what you need to survive; the roof over your head (rent/mortgage, utilities) and the food you eat (groceries). Needs should take priority over Wants but Wants are still an important part of any budget.
STEP THREE: WHAT’S YOUR BUDGET?
Ready to do the math? To figure out your budget, you will now have to subtract your expenses from your income.
If you’re breaking even, take time to determine if you’re happy with your current spending habits or if you want to cut back to increase savings. If you earn more than you spend, congrats! Now make that money work for you! You can divvy those savings up however you like, but experts recommend putting any extra money away into emergency funds, retirement savings, or a general high yield savings account for any big plans you have coming up like vacations or a wedding. If you spend more than you earn, you’re in a deficit and will need to find places to cut back so you can work your way out of it.
But what do you do when you’re broke and in a spending deficit?
Start by making a prioritized list of your bills. What do you need to pay first to stay safe, healthy, and housed? Those need to take priority, so create a payment schedule around your pay days.
Next, let the piggybank go hungry for a little while until you get back on track. A balanced budget that gets you out of debt needs to be your first priority. So, while it may feel counterintuitive not to save what you can, it’s better to rebuild from zero than from a negative balance. Once you’re back on track and out of a deficit, then you can resume incremental savings.
One of the best things you can do for yourself is to become your own advocate and avoid disaster. It’s okay to ask for bill extensions. Many vendors will try to help you during a rough patch by working with you on a repayment plan. One of the biggest cycles of continuing debt is credit card use. It’s convenient and easy to just swipe your card and worry about the bill later, but that is an easy way for debt to pile up. Especially if you’re only able to make your minimum payments each month, which means you’re susceptible to high interest charges and can quickly lead to debt. Debt also impacts your credit scores. One option to consider is to call your credit companies and negotiate interest rates. If you have good credit and a positive payment history, credit companies may be willing to lower your interest rates and help ease that burden.
STEP FOUR: REVIEW. REVIEW. REVIEW.
Lastly, keep your eyes on your budget. Setting it and forgetting it doesn’t work in this case. You’ve done such great work creating your comprehensive list. But it only helps if you keep going. Add a reminder to your calendar and give yourself half an hour each month to focus on your financial health. Keep tracking your incoming and outgoing funds and watch for any unnecessary spending before it gets out of hand.
We get the challenge. It may feel overwhelming to start, but once you establish the habit of looking at your expenses and adjusting where you spend your money, budgeting can really become one of your best tools to keep your bank account and YOU happy.
[1] IRS. “Self-Employment Tax (Social Security and Medicare Taxes).”
[2] TaxAct. “Self-Employment Tax Calculator.”
[3] Forbes, “How To Budget in 7 Simple Steps.”
[4] Forbes, “How To Budget in 7 Simple Steps.”
[5] Huntington Bank, “Create a Personal Budget: How to Make a Budget.”