Many an essay has been written about budgeting, articles published, spreadsheets primed and filled. A Google image search reveals complicated pictures of income and debt, with convoluted arrows pointing every which way, and color-coded lines that look like they could have been painted by Kandinsky. By the look of it, budgeting could be the most complicated financial tool a person could master.
But budgeting is really not all that scary. In this article, I’ll show you how to make a simple, clean budget – one that you’ll realistically be able to stick to without spending too much of your day keeping track of it.
How to budget
There are four simple steps to budgeting, and I present them to you in order of importance.
- Calculate your income
- Determine your essential expenses
- Set out how much you’d like to save each month
- Spend the rest on whatever you want
I’ll delve into each of these categories.
Step 1: Calculate your income – How much do you have coming in each month?
This is the simplest, most important step in the budget. If budgeting is a pie, and we’re figuring out how large each slice should be, then this step is determining how big the pie is.
What we’re looking for is your after-tax monthly income. So if you get paid weekly, subtract your taxes and then multiply that number by four. If you get paid monthly, just subtract taxes and you’re set to move onto step 2.
Step 2: Determine your essential expenses – How much do you need to spend?
To figure out which of your expenses are essential, ask yourself this question: Can I live reasonably well without it? Housing, for instance, is an essential expense. You don’t want to make yourself homeless in your zeal for budgeting. Your annual subscription to Croquet Quarterly Magazine, though, might not make the cut.
Here are some other examples of essential expenses:
Step 3: Set a savings goal – How much would you like to set aside?
There is no right answer for how much you should be saving. Of course, there is a wrong answer: 0. But other than that, each person will want to be saving a different percentage of their income.
Many factors will come into play here, including your individual results to Step 1 (people with a large incomes might be more willing/able to save a lot) and Step 2 (people who have low expenses might be able to save more). You’ll also want to consider other needs – Are you the kind of person who places a premium long term financial security? Or maybe you’d rather live in the moment, spending most of what you make and only saving the scraps?
The point is, though, that this is the section where you invest in your future.
Step 4: Spend at your discretion – Splurge on whatever you like!
By now you should have three numbers:
- Your total income
- Your essential expenses (this should be smaller than your total income)
- Your savings rate (this should also be smaller than your total income)
The rest is just math. Take your income and subtract the other two. Whatever is left is the amount of money you can spend on yourself. Treat yourself to a fancy restaurant, go see a show, maybe even re-subscribe to the Croquet Quarterly Magazine if that’s your thing.
Budgeting methodologies: How much should you spend on each category?
There’s no right answer for how much you should be spending on essentials, or saving, or splurging. There is a general rule of thumb I’m going to teach you, and that’s the 50/20/30 method. It goes like this:
|50/20/30 Budgeting Methodology|
|Essential expenses||50% of your income|
|Savings||20% of your income|
|Discretionary spending||30% of your income|
You can use this to guide you in your decision making, but I urge you not to treat it as law. As I said earlier in the article, some people will spend more on essentials because they really value a nice living space – and that’s perfectly fine! Others might hate cooking at home and will spend most of their meals eating out. And you know what, that’s fine too, if you can cut down on other expenses.
The goal is, though, to maximize the Savings category. But don’t be too hard on yourself. If you sell your car to cut down on essential expenses and drop your friends because you don’t want to waste your money on Friday night beers, you’re budgeting wrong.
There are a lot of budgeting apps out there, but most of them are filled with all sorts of add-on capabilities that make the bulky, bloated, and hard to use. Some are so complicated, and demand so much of your time, that I think they’re actually counterproductive – they’re more likely to make you stop budgeting than start.
I’m going to recommend Personal Capital as the budgeting tool people should be using. Not because it’s the simplest, or even the best for budgeting, but because of its investing platform.
Many of you reading this article are just starting to get into the world of personal finance. And that means that you probably don’t have too much money. But once you master budgeting, I believe you’ll quickly start to see savings pile up. And the next question will become: What should you do with the money you’ve saved.
The answer is investing. If you’re there already, read this article on how to invest. But that brings be back to Personal Capital – their app isn’t really a budgeting app – it’s an investing platform with budgeting capabilities. You’ll get all the budgeting capabilities you need with their free version.
The idea is to get you used to the Personal Capital platform so that once you have money saved up, you’ll be able to transition very easily into investing. Personal Capital offers free, automated analysis of your investments, making it a great all around personal finance choice.
The world of personal finance isn’t as scary as people make it out to be. I’m sure you see that budgeting, at least, is easy as pie. Believe me, so is the rest.