How to Create a Budget
One of the first steps to building good financial habits is creating and implementing an effective budget. Learning how to create a budget while you are in college can set you up for greater financial success down the road, as your income and expenses inevitably increase after graduation. Follow the steps below to create your first budget.
Step 1: Figure Out Your Financial Goals
Although many people believe that budgets start with number crunching, a better method is to first come up with financial goals. By setting financial goals, you are giving yourself tangible goals to work towards, instead of the nebulous idea of “being better with money.” The more concrete your financial goals are, the easier they are to connect to your budget. The best way to create financial goals is to think about the SMART mnemonic. This means that goals should be:
Specific
Measurable
Achievable
Relevant
Time-Bound
Common examples of SMART goals for college students include:
- I want to save $2,000 for my semester’s tuition by the end of the summer.
- I will save $50 a week for the new car I want to buy in two years.
- I plan to save $100 a month in my emergency fund, until it reaches $1,000.
Your financial goals should always be factored into your budget. Your goals do not have to be lofty and long-term yet. Instead, at first, focus on smaller goals, like saving a small emergency fund, or enough to cover books for the semester. As you get more comfortable with goal setting, you can then move onto bigger projects, like saving for a down payment or setting a retirement goal.
Step 2: Track Your Income and Expenses
The next step to budget creation is tracking your income and expenses. This should be done for the span of 1-3 months, so you get a good idea of what your average spending is. It is recommended to track for a longer period of time, as spending habits change throughout time. A common example of changing spending habits is the usual uptick in gift spending during the holiday season.
Income is money that flows into your bank accounts/wallet. Most people make income through a job they work, but it can also come from investments, rental income, tips, bonuses, or side hustles.
Expenses are all the ways money flows out of your accounts /wallet. Expenses can be further broken down into two subcategories: fixed or variable.
Fixed expenses are those that tend to not change month to month. This includes items such as rent or mortgage payments, debt payments, and subscriptions. Not all fixed expenses are necessary for survival, but they are harder to negotiate.
Variable expenses are those that tend to fluctuate. This can include utility bills, groceries, clothing, and entertainment costs. With variable expenses, you tend to have more pricing freedom, meaning they can more easily be negotiated down, reduced, or otherwise changed to be lower in cost.
Tracking income and expenses can be done a variety of ways. Some people prefer to use a notebook and pen. Others prefer Excel sheets. Still others may prefer to use a variety of free tracking apps, which link to your various financial accounts and summarizes all money flow onto one screen. When using apps, ensure that they come from reputable sites, and do not have major history of consumer data leaks.
Step 3: Categorize Income and Expenses
Once you know your general inflow and outflow, it is now time to categorize how your money moves.
Common categories for income include:
- Paychecks
- Tips or Bonuses
- Side Income
- Gift Money or Cash Back from Credit Cards
Expenses have an even more expansive list of category options. The most basic labels include:
- Housing Expenses
- Utilities
- Groceries
- Entertainment
- Debt Repayment
- Household Goods
- Education Expenses
- Saving
- Investing
- Medical Costs
- Childcare Costs
- Transportation
- Clothing
Some of these categories can be broken down even further, and should be personalized to fit your spending habits. Do you regularly spend $70 a month on a new video game? Or go to the salon every month to get a pedicure? Do you have a specific medication that you need to ensure you budget for? What about tithing to a religious organization, or sending money to family members outside of the US? Whatever you spend your money on, each dollar should be assigned a specific category. Even having a small budget labeled “Other” can help, in case you have money that doesn’t fit into any of your regular categories.
Step 4: Evaluate Your Current Spending Habits
You now have a three-month list of all your income and expenses. The next step is to evaluate your inflow and outflow. While in this evaluation phase, ask yourself important questions like:
- How much do I make per month? Is it more, less, or about the amount I thought I was making before I started tracking?
- How much do I spend per month? Are there any categories of spending that surprise me? For most individuals, they are shocked the first time they see how much they spend on non-essentials, like take out or subscription services.
- Do I make more a month than I spend? This is an extremely important question to ask. If you spend more than you make, this can mean you are regularly over drafting your bank account, not paying off your credit card bills, or taking on debt to supplement your lifestyle. Such deficits need to be immediately addressed. If you have money left at the end of the month, move onto the next question.
- How can I best utilize my financial resources? Are there ways you can immediately see that you can reduce expenses What about increasing income? Has seeing how you spend money changed the way you view your financial health, or even change some of your financial goals?
Step 5: Create a New Budget Aligned with Your Financial Reality
Now is the time to create a new budget, aligned with the reality of how much you actual make in income.
For individuals whose income varies month to month, it will be best to create a budget based on the months you make the least income. For those with salaried jobs, or more regular hours, base your monthly income on the average take-home pay you see.
Once you have a number for your monthly income, first budget categories for your basic living expenses. This will include: housing payment, utilities, internet and phone services, groceries, medical care costs, transportation, insurance, childcare, saving, investing, and household goods. The above categories are called needs, or expenses that help you with basic survival.
For the categories like groceries and transportation, it is important to budget for the basics. For example, you could shop at an expensive boutique grocery store that only sells organic, grass-feed beef and cage free eggs. But, it’s easier on the wallet to shop at your local bargain grocery store with less expensive goods.
Saving and investing should always be considered needs. Everyone should strive to have a funded emergency fund, which can be tapped in the case of unemployment, natural disasters, car break-downs, or other costly emergencies. Investing even $5 a month to retirement is better than not investing at all.
After you budget for your basic needs, you can now move onto wants. Wants include fun categories like gym memberships, movie nights, snacks, and other things that bring joy and fulfillment to your life. Even on a tight budget, you should have at least a modest amount of money per month for wants. This can help you avoid burn out, and motivate you to stick to your financial goals. A small sweet treat can go a long way in motivation!
You should also budget for categories that tend to come at irregular intervals. Such categories include annual membership fees, semi-annual insurance payments, or gift money for the holiday season. To budget for these categories, take the average cost for the entire year’s category, and divide it by 12 months. For example, if you want to save $240 for Christmas gifts, simply divide $240 by 12. You would have to save $20 a month for a year to reach this goal. This can help “smooth” such irregular expense, causing them to be less of a surprise each year.
Step 6: Implement Your Budget
The most important step is to implement your new budget! This may be difficult your first few months, and you may go over some categories at first. However, as the old adage says, “Practice makes perfect.” Implementing a budget can take self-control, and may mean denying some immediate pleasures for long-term gain. Creating a budget should not be about deprivation, however, if you find yourself struggling to meet your budget after a couple of months, considering adjusting some categories. If you are still struggling with spending less than you earn, it may be time to seek professional help from a reputable financial counselor.
Step 7: Adjust Your Budget as Needed
A budget is never a one-and-done document. Instead, your needs and wants fluctuate throughout your life, and even within a year. It is important to adjust your budget as necessary. For example, during the holiday season, you may create a gift buying budget, or increase your grocery budget, to account for holiday cooking and gift giving traditions. During tighter financial months, you may get rid of unneeded subscriptions. During the spring, you may increase your clothing budget as you do a closet refresh. No matter how your budget changes, ensure that your expenses do not exceed your income regularly, and you will be on a good path to financial health.
Creating a budget takes time and willpower. However, making the effort can help you learn more about yourself, your spending habits, and what is truly important to you. Additionally, budgeting to begin a savings or investing habit can set you on the right track to financial longevity and success.