One of the foundational steps to becoming financially fit is to build a budget, but it can seem daunting at first. A detailed budget will help you track your money so you can take charge of your financial future. I have created 4 simple and easy steps you can follow to help you build a budget.
Step 1. Track Your Income and Expenses
In order to build a successful budget, you must know where your money is coming in and where it’s going. This process starts with taking a detailed account of your income and expenses.
If you and have a stable job, your income stream should be easy to track. In most cases, if you’re on salary your income comes in every two weeks or bi-monthly. Add up all take-home pay (after-tax income) you receive from your primary occupation and that will be your starting point. If your income is commission based or hourly then take your average monthly take-home pay from the past 2-3 months and that will be your monthly income starting point.
Expenses are a little more tricky to track, but a good starting point would be your monthly bank or credit card statement. Typical monthly expenses should be captured in the following buckets:
- Housing – Rent, Mortgage, Property Taxes, and Insurance
- Auto & Transportation – Loans, Maintenance, Gas, Public Transportation and Insurance
- Food – Personally Prepared Breakfast, Lunch, Dinner, and Snacks
- Utilities – Gas, Electricity, Water
- Savings – Emergency Fund, CDs, Money Market Accounts
- Investing – Retirement Accounts, Mututal & Index Funds, and ETFs
- Debt Repayment – Credit Cards, Student Loans, Personal Loans
- Health & Wellness – Gym Memberships or Fitness Classes
- Cell Phone & Internet
- Personal Expenses – Travel, Dining Out, Netflix, New iPhone, Starbucks, etc.
- Child Care
These categories are just general guidelines and as a result may vary depending on your location.
Step 2. Prepare a Budget
Pay Yourself First
In order to build wealth and become financially fit you will need to build a nest egg, and the best way to do this is by automating your savings and investing.
Depending on your age, I recommend budgeting at least 15% of your monthly gross income for savings and investment purposes. This number should increase as you get older, progress through your career and obtain salary increases, for instance. This money should first be used to fund your emergency fund and then other long term investing goals such as retirement and alternative investments.
Monthly Gross Income * 15% = Monthly Savings and Investing Goal $5,000.00 * 15% = $750.00
As a rule of thumb, your monthly housing expense budget should not exceed 30% of your gross monthly income (pre-tax income). For example, if your monthly gross income is $5000, then your maximum housing monthly expenses should be $1,500 and below. It is highly recommended to stay well below this threshold in order to allocate funds to different categories, but this can vary depending on location.
Monthly Gross Income * 30% = Maximum Housing Expense $5,000.00 * 30% = $1,500.00
This piece of your budget will vary, but when calculating your monthly debt expense it is also important to calculate your debt-to-income ratio. According to lenders, this ratio should never exceed 30% and ideally should be as low as possible.
[Monthly Debt Expense + Monthly Mortgage Payment + Monthly Auto Loan Payment] / Monthly Gross Income = Debt-to-Income Ratio [$400.00 + $950.00 + $150.00] / $5,000.00 = 20%
Your other expense categories will vary, but add all of them up and place them into their respective buckets.
Step 3. Balance Your Budget
Your monthly income and expenses have been accounted for and now it is time to build a budget. Simply stated, your monthly income less monthly expenses is your budget surplus or deficit. A budget surplus means that you are on the right track! Earmark the surplus funds for extra savings & investing or increase payments associated with debt.
If your income is less then your monthly expenses then we have some work to do. Some monthly expense categories may be non-negotiable like housing, but now that you have a holistic view of your money you can pinpoint the areas that you need to work on. Identifying areas where you are over-spending can only be captured through steps 1 and 2.
Some small but effective things that may help you balance your budget include preparing your meals at home and eating in instead of dining out. Also, personal expenses, transportation, and utilities might also be a good place to start the cost-cutting.
Step 4. Can you Stick to the Budget?
Now that you have given each one of your dollars a job you are now in charge of your finances. Throughout the month track your progress and make sure you are sticking to your original plan. If unexpected expenses arise, be sure to track them! Some expenses may be covered by your emergency fund, but others will need to come out of your budget surplus.
At the end of each month take an analysis of your budget, and see if you were able to stay on track. To engrain the habit of building and following a budget I
If you can consistently budget a monthly surplus then you will be well on your way to becoming financially fit. To supercharge your journey I recommend Dave Ramsey’s The Total Money Makeover: A Proven Plan for Financial Fitness. Dave teaches about time tested savings and investing principles that you can follow to turn your bank account into a bulked-up cash machine. Sign up for Audible right now to download your free copy of The Total Money Makeover.