How do I set up a budget? Where do I start?
I am asked this question frequently—especially by recent college graduates. Typically, once you have graduated and you snag your first job, you ever begin to think about all of the money you will have. It will likely be the steadiest income you’ve had in your life. I remember my excitement when I landed my first job out of college. When I received my offer letter, I immediately created a three-year budget to plan my spending and saving.
It is important to set up a spending and saving plan. And that’s where a budget comes in. A budget is a road map for you to determine how you want to spend and what you plan to save. It’s important to remember that a budget is only as flexible as you are.
You create your own budget.
How to Create a Budget
Your budget is dynamic and can and should change as your circumstances change. I started my working career with a three-year budget to work my way through credit card debt repayment to pay off my car loan. That budget changed drastically at the end of the three-year period because now I had a major chunk of funds to either save or spend as I wished.
A budget has three major parts: long-term savings, short-term savings and spending. A simple budget divides income into these three main buckets.
Steps to Creating a Budget
1. Figure out how much you make.
You may think that this would be the easiest step, but many young adults have no idea how much they make. Pulling together all of your income is the first step in creating a budget that you will stick to. When you are pulling together your income, make sure to use your net income. You can then factor in your tax refunds if you expect to receive them.
2. Figure out how much you spend.
If you think this is the hardest step, you would be correct. Tracking expenses is the boring part of budgeting. But the good news is that once you complete this step, you may not have to do it again for a while.
Using a debit card for an entire month is an easy way to track your expenses. At the end of the month, take the time to categorize your expenses and see where you are spending money. This includes necessary expenses like college textbooks and rent, as well as unnecessary expenses like entertainment or shopping.
3. Decide on your short-term and long-term goals.
Now that you have your income and expenses, it’s time to decide how a budget can help you achieve the success you want in your life with long-term and short-term goals. In general, a short-term goal is one that can be accomplished within 3-6 months. A long-term goal is one that can be accomplished within 3, 5 or 10 years.
For example, when I landed my first job out of college, I knew I would want to take a trip each year on my birthday. To meet this short-term goal, I knew that I would need a few months to put together my budget and save accordingly.
Paying off my car loan and credit card debt was one of my long-term goals, which I accomplished in three years.
4. Save to reach those goals.
Each of your goals should be quantifiable. That means you should be able to put a number on each of your goals. I knew that I would want to spend about six hundred dollars each year on a birthday trip. Divided evenly over 12 months, I would need to save 50 dollars each month or 25 dollars from each paycheck. I immediately set up a travel fund with automatic transfers to help fund this goal.
A long-term goal, such as maximizing your savings, should also have a number. How much do you want to have saved? When do you want to reach that number? Quantifying each of your goals will help to prevent procrastination. The author Napoleon Hill once said, “A goal is a dream with a deadline.”
5. Decide how you would like to live and where you're willing to make trade-offs.
Now you should stop and think what is important to you. Remember that budgets are all about trade-offs. Do you want a nice apartment or a nice home? Would you rather live in an inexpensive apartment so you can save for a home, or is a swanky apartment important to you?
Do you want a nicer car with a car payment, or could you survive with an older car that you own free and clear?
It’s all about timing and patience. Be patient and remember that a budget can help you achieve all of your financial goals.
This is the simplest way to set up a budget.
Let's look at a sample budget.
Long-Term Savings and Investing: 10%-50%
Housing: 25% to 35%
Food (groceries and dining): 10% to 15%
Personal Care (including clothing): 5% to 10%
Loan Repayment (excluding car payments): 7% to 15%
Transportation: 5% to 15%
Utilities: 4% to 7%
Entertainment: 1% to 5%
Goal Saving: 1% to 5%
Notice that food, clothing and shelter are at the top. A good rule of thumb is that your monthly rent or mortgage payment should be no more than 30% of your gross monthly income.
Use the percentages to figure out what you should be spending. If you can easily break down your expenses into these categories, then that is a good start.
Take a moment to start planning your first budget. Time spent planning now will allow you to enjoy what you desire later.