How to Create a Budget That Actually Works

Do you live in fear of overdrawing your checking account when several bills come due? Do you carry a credit card balance because you’re living beyond your means? Do you have no idea where your money is going each month?

If you answered yes to any of these questions, you need to learn to budget.

Don’t panic. Budgeting doesn’t have to take a lot of time, effort or number-crunching. A budget simply puts you in control of your cash flow, instead of the other way around. Yes, setting up and tweaking your budget may take a bit of time. But once you get it down, you’ll be good to go and you’ll feel much more in control of your finances. If you need help managing your current budget or if you’ve never used a budget in your life this guide will help you create a budget that works for you.

Why You Need a Budget

The purpose of a budget is to put you in control of your personal finances. Without some sort of spending plan, most of us will overspend and under-save. With the U.S. personal savings rate hovering at a rock-bottom 2.4 percent in January, it’s clear that many Americans aren’t budgeting, so they not saving. A basic budget, however, can help you achieve other goals. The Consumer Credit Counseling Service of Orange County notes that with a budget you can:

• Know when your bills are due so that you can pay them on time.
• Know where your money is going, which helps you cut back on spending when you need to save more.
• Plan for periodic expenses like insurance, or save for major purchases like new appliances or a new car.
• Have money set aside for regular maintenance and unexpected repairs on your home, appliances or car.
• Save money for retirement, college, a home or other major priorities.

To do these things, you need some sort of budget. But how do you create a budget that works?

Figure Out What Works for You

Here’s the secret that most people don’t understand. There’s no one, right way to create and use a budget. Budgeting is intensely personal. If you don’t understand that, you’re probably going to fail at budgeting.

Case in point: Rob Berger and I budget differently. In this article, Rob lays out how he finally arrived at a budget that works for him.

Essentially, Rob operates his personal finances on a super-streamlined budget. He saves a certain percentage of his income first and then spends out of what’s leftover. Rob keeps a closer eye on spending areas that can be problematic for his family to ensure they aren’t spending more than they should.

I, on the other hand, use a detailed budget, and I love Mint.com. My family operates on a pretty tight income, so I like to know exactly where our money is going. We even use a cash budgeting system for certain expenses.

Also, I’m not great at remembering to write down transactions, so I use a budgeting tool that automatically imports our transactions. These are just a couple of ways to budget.

Another option is to create a cash flow plan, instead of a traditional budget. A cash flow plan will track when you’ll have money available so you know when you should pay certain expenses. The key is that you need to learn what works for you. If you get distracted and bogged down by details, simplify it. If you want to know exactly what’s happening with your spending, create a more detailed plan.

Know Where You Are Financially

Whichever budgeting option you decide to try, you need to understand where you are financially to get started. The biggest mistake new budgeters make is under-estimating expenses.

Maybe you’ve read some great blogs about families who live on a very tiny budget, and you think you should be able to do that, too. So you decide you’re only going to spend $200 on groceries this month. Sure, some families of five can do that (with lots of practice). But your family regularly spends more like $600 a month on food.

Shooting for such a drastic change in your spending is unrealistic. At other times, new budgeters don’t have a clear idea of what they have been spending. If you assign spending categories a random value, you’ll feel like you’re failing when you spend more than you budgeted – even if your actual spending is reasonable.

So now’s the time to look over your spending for the past two or three months. If you don’t save receipts, then look at your credit card and checking account statements. Account for fixed expenses first, since those are easiest to deal with. If you don’t have a record of due dates, write down the due dates for these bills. Then, figure out what you spent on variable categories.

If you’re like Rob, you may look at your variable spending as one lump sum, or you may decide to separate out one or two problem areas. If you’re more like me, you might divide your variable spending into several categories: Groceries, gas, childcare, clothing and personal allowances are some of my categories, for example.

Next, try to factor in one-off expenses like insurance, vehicle maintenance, and birthday and holiday gifts. These expenses can be frustrating if they pop up unexpectedly, so try to work them into your budget from the start. If you can save for them a little at a time each month, they won’t be a problem. Finally, set a savings goal.

The recommended savings rate is between 5 percent and 50 percent, depending on your age and income level. But that’s just retirement savings. Don’t forget to save for emergencies, for major purchases or vacations, and for your kid’s college. When you know about what you normally spend on things, make a budget that prioritizes savings and lets you spend within your means for the next month.

Put it All Together

Now that you know what you’ve been spending, you can set reasonable spending goals. Again, customize your categories, which you can do using most online budgeting tools or with your own spreadsheet. Remember, how you set up your budget is entirely up to you. But it’s best to keep it simple. That way, you won’t become frustrated with the details and give up. The goal is to create a habit of being aware of your personal finances so that you can save and live within your means.

Give it Time, and Make Adjustments

Many people give up budgeting after one or two months. Why? Because their budget doesn’t seem to work.

If you’re always overspending in one category or if you’re still using credit cards too much, you may think budgeting isn’t doing you any good. It will — if you just give it time. The key to a good budget is flexibility and learning. Any time you’re coming in overbudget or underbudget in one category, adjust that category or adjust your spending.

If you’re consistently overspending on dining out, you need to do one of two things: cut back on dining out expenses by eating out less or choosing cheaper restaurants, or put more room in your budget for dining out. It’s that simple. It takes most people about three months to create a workable, realistic budget. If you’re mainly tracking your problem spending areas, it will probably take less time than that. Just roll with the punches and make adjustments as you need to.

If you’re tempted to give up because budgeting is too time-consuming, you’re working with too many details. It shouldn’t take more than a few minutes a week to track your expenses and stay on top of your budget. If you’re spending much more time than that, you’re putting way too much thought into the process.

If you’re new to budgeting, these tips will help you get started on a spending plan that will help you live on less than what you earn so you can save money. Just remember: budgeting is personal, so don’t be afraid to customize it. This one tip will serve you better than all the “expert budgeting methods” out there.

How to Create a Budget That Works for You

Now let’s turn to creating an actual budget. Start with these six steps:

1. Figure out what you’re already spending

One of the main reasons many budgets fail is that they don’t line up with reality. Let’s say you’re spending about $600 a month on groceries for your family. You read a blog post from some supermom who clips coupons and feeds her family for $200 a month. So you decide that you’re going to allot $200 for next month’s groceries.

Know what will happen? You’ll fail miserably.

Yes, you can use a budget to cut back on expenses, and yes, you can probably cut your grocery budget by more than half. But it takes time, and your first step is to see where you’re at now.

So go through your bank account and credit card statements for the last month, preferably more like three months, which will give you a more averaged-out view of your spending. Write down how much you spend on things like groceries, gas, housing, clothing, etc.

2. Define your spending priorities

This step will determine whether your spending is in line with your priorities.

It’s helpful, when creating a budget, to look at average spending by percentage from a report like the annual BLS Consumer Expenditure Report. A report like this will tell you, for instance, that if you’re spending 25 percent of your income on food, you’re likely spending much more than you should.

But a generalized report, or some financial guru’s budget category breakdown, can’t tell you whether your spending is in line with your priorities.

So spend some time thinking about your savings goals and your personal or family priorities. Is it important to live in a certain area so your kids can go to a good school? Maybe you’ll allot more to housing than you would otherwise. Do you have to drive often to visit with family? You’ll need more in your transportation budget.

While you’re doing this, look over your recent spending. You’ll likely find areas where your spending doesn’t line up with your priorities. ($100 for a pair of jeans when you don’t care about clothes that much? Seriously?) This will give you an idea of where you might rein in your spending, or shift money from one category to another.

3. Create spending categories

Now it’s time to create a budget. But here’s where it can get a little tricky: how detailed should your budget be? It’s completely up to you.

Rob prefers very broad budget categories — two categories, to be exact. I, on the other hand, budget down to the dollar and down to quite minor categories. It’s a matter of personal preference, and it may take some time for you to figure out what works best for you.

If you’re having difficulty overspending in certain areas — on clothing, Starbucks, groceries, or whatever — set a budget for those areas. This will help you track spending so you aren’t overspending on the same things. That’s just a minimum, though, and you can get much more detailed if you want.

4. Add up all the categories

Now it’s time for the numbers part of the budget. You’ve got your spending categories, and you may have an idea that you want to spend less on groceries so you can spend more on clothing (or whatever). But now you’ve got to assign numbers to various categories.

Start with your average income for the month. (If your income is completely unpredictable, switch to this article on budgeting for a variable income.) Then, begin by writing down your must-be-paid expenses: mortgage/rent, utilities, car payment, other debt payments, insurance payments, etc. Subtract those from your expected income, and you’ll know what you have to work on within the rest of your budget.

At this point, your goal is to work those numbers until you fit everything realistically into your budget. So if you have $3,000 to spend, you might allot $700 for food, $300 for savings, $300 for extra debt payments, $100 for your cable bill, $200 for your cell phone bill, $200 for charity, $200 for gift giving (plan for holidays and birthdays early), and $1,000 for whatever.

(Note: These are made-up numbers and have no bearing on reality or on my budget!)

Your goal will be to have nothing left after you subtract all your budget categories from your income. This is what’s called a zero-based budget, and it’s the best place to begin budgeting. After you get the hang of living within your means, you may not have to be quite as detailed as this, but a zero-based budget will help you get on track financially.

5. Spend within your budget for a month

Now you have to live it. To make a budget work, you have to work it out in your life. Otherwise, it’s just a piece of paper (or a computer program) you spend a bunch of time putting numbers onto.

How you track and spend is another matter of personal style. I don’t like to use plastic of any sort because I find it easier to overspend. But I know Rob uses plenty of credit cards (and racks up some killer rewards) while sticking to a budget.

If you’re not disciplined with spending, consider taking out cash for your variable expenses, such as shopping or dining out. That way, you can’t overspend.

Either way, you do need to keep track of your actual spending. For this month, don’t worry too much if you blow it. It’s bound to happen because you’re just getting the hang of this budgeting thing. (Just don’t go charging $300 on your credit card for that purse you have to have.)

At the end of the month, look at your spending compared with your spending goals (i,e., your budget) and see how they stack up.

6. Tweak as needed

Now it’s time to tweak your budget. Unless you’re a good guesser, you were probably off on some of your spending goals. Maybe you’ll find areas where you need to scale back your budget, or areas where you need a little more cash. Or maybe you’ve come across some spending areas where you need to scale back on your spending so that you can fit into your reasonable budget.

Whatever the case, now is the time to tweak your budget. Luckily, you’ve done most of the work, so this doesn’t take as much time. (Unless you happen to get a huge raise or take a pay cut, then your budget will need an overhaul.)

You’ll probably have to repeat this step most months. Extra expenses will come up, and others will fall away. There’s no overarching perfect monthly budget, so be prepared to tweak liberally at the beginning of every month.

Now you know how to create a budget that will help you meet your financial goals. If you’re unsure how to easily track your budget and spending, check out these online budgeting tools, which can be useful for sticking to your budget. Or, if you prefer a more old-fashioned method, use a spreadsheet. That works, too.