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Budgeting 101: Creating a Budget

Last Updated: February 8, 2023
13 min read

Key points about: setting up a budget plan.

  1. Before you create a budget, figure out your monthly income vs. how much you pay in bills each month.

  2. There are different budgeting techniques to help people of all lifestyles pay bills on time and save money.

  3. Monitoring your account, setting automatic payments, and adjusting your budget can all help you meet your financial goals.

Ready to take charge of your finances and work towards a financial future you’re excited about? Great. To get started, you’ll likely want to create a budget. The good news is that you can tailor your budget to what works best for you.

The word “budget” may leave a sour taste in your mouth. Here’s the deal, though — creating a budget doesn’t have to be restrictive, nor does it mean you’re stuck eating rice and beans for dinner every night (unless you want to!). A budget is a simple tool to tell your money where to go so you can create the life you want.

Essentially, a budget is a spending plan that accounts for your income, expenses, and goals. It’s designed to serve as a roadmap to reach your desired destination. If you’re wondering how to set up a budget, you’re not alone. At first, glance, creating a budget can seem complicated and overwhelming. But it doesn’t have to be. Your budget can be as simple or elaborate as you want. You can create a budget using pen and paper, a spreadsheet, or with a budgeting tool like a budget calculator or budgeting app. Remember to account for possible interest charges from your credit cards unless you have a card with 0% APR.

Learning how to create a personal budget or reach your savings goal — even for the first time — only involves a few simple steps, and you’re in charge every step of the way. Here’s how to get started.

Before you create a budget

1. Calculate your monthly income

Before you get fancy with budgeting templates or apps, it’s essential to understand your monthly income. That’s the amount of money you earn each month from a full-time or part-time job, your side hustle, or another income source. If you don’t know how much you make each month offhand, check your paychecks from your employer or any invoices you’ve sent to clients, for example. For budgeting purposes, you’ll likely want to base calculations on your net income because you’ll pay most of your bills after deducting taxes. For most people, monthly income is relatively consistent. However, your monthly income might fluctuate if you own a business or work as a freelancer or gig worker (like driving for a rideshare or delivery service). If that’s the case, calculate your earnings over a few months to get an idea of your average earnings. Once you’ve calculated your monthly income, you’re ready to create a budget.

2. Make a list of your expenses

Now that you know your monthly income, the next step in creating your budget is focusing on your expenses. Start with fixed expenses: housing, utilities, insurance, debt payment or student loans, and any other monthly expenses that are fixed costs, like a car payment. You’ll also want to account for variable expenses like groceries, dining out, and entertainment. Then, consider other flexible expenses you may have, things like monthly subscriptions or getting a haircut.

All you need to do at this phase is make a comprehensive list of your expenses and spending. Think of it as information-gathering. There shouldn’t be any judgment, nor should you feel the need to eliminate or cut out anything right now. After you’ve compiled your expenses, however, you may look more closely at your spending habits and adjust where you feel they’re needed.

For a simple breakdown of your expenses, consider the 50-30-20 rule for how to budget money. The 50-30-20 rule says that 50% of your income should go to necessities like living expenses, groceries, transportation, utilities, and insurance. The following 30% goes toward your “wants” or discretionary spending, like dining out, travel, concerts, and shopping. The final 20% should be allocated to long-term savings like retirement savings, and to pay off debt. When you’re new to creating a budget, the 50-30-20 rule is a simple budget template that can help you stay organized.

Some people manage personal finance on a weekly budget, while others prefer to plan out a budget for the whole month. Remember to account for variable costs for whatever budgeting tool or timeframe you use. It’s good practice to establish an emergency fund or a fund for any other unexpected expense, just in case. This is because variable expenses fluctuate from month to month, and it’s better to have extra money in your bank account, not an overdrawn account since that could negatively impact your credit score. 

3. Plan for your goals and dreams

After you’ve listed your income and expenses, it’s time for the fun part — planning for your goals and dreams. The best part about creating a budget is that it provides a framework for spending that enables you to enjoy your life intentionally. Keeping your goals in mind makes it easier to stick to your budget, particularly if you’re budgeting on a low income.

When budgeting for your goals and dreams, it’s essential to consider what you hope to accomplish in the next one, five, or even ten years. Consider any big-ticket items or experiences you might need to start saving for now. For example, if you want to buy a house in the next five years, you need to figure out how much to save for the down payment each month. Or perhaps you’re interested in redecorating your current home and need a fund for new furniture. You’ll need to create a budget category for that.

Similarly, if you have a tropical vacation in mind for next summer, then now is the time to start saving. Sometimes, these budgeting categories are called “sinking funds.” Essentially, this is a savings account where you set aside money each month for a one-time or irregular expense.

This may also be an excellent time to review your credit card spending. Are you carrying a balance you want to pay off? Or do you need a credit card with rewards that better align with your goals? For example, if you’re trying to save extra money for future travel, you might consider a rewards card, like the Discover it® Cash Back Credit Card. This allows you to earn rewards while spending on everyday items like groceries or gas. You can use these rewards towards your savings goal.

From zero-based budgeting to the anti-budget: Choose your budgeting strategy

Now that you’ve got a solid understanding of your financial picture, you get to choose a budgeting system that works for you. Keep in mind that there’s no right or wrong here. It’s all about what works best for you and which system aligns with your personality. Four of the most common budgeting strategies are zero-based budgeting, the 50-30-20 rule, the envelope method, and line-item budgets:

Zero-based budgeting: The premise of this budget strategy is simple — each dollar in your budget is given a specific “job”. You assign every dollar you earn to your expenses, savings, or debt payments and leave nothing. The calculation is income minus expenses equals zero by the end of the month. If you earn $2,000 per month, for example, you will budget exactly $2,000 to spend, save or pay off debt. Zero-based budgeting tends to work well for people who like being hands-on and involved with their money since regular check-ins may be required throughout the month to keep this strategy on track and aligned with your cash flow. This method can be challenging if your monthly expenses or variable expenses fluctuate significantly, though. Remember that the idea isn’t to allocate your personal capital entirely to discretionary expenses to get to zero, though.

50 30 20 rule: If you’d prefer a “set it and forget it” approach to budgeting, this strategy could be a great fit. After allocating your income according to the 50-30-20 rule (as mentioned above) — 50% for necessities, 30% for things you want, and 20% for saving or debt repayment — you’re good to go. Since you need to understand your general spending categories and monthly expenses first, this budgeting strategy can take some time to set up. Once you have the basics down, though, the 50-30-20 rule is a low-maintenance way to manage your money. Plus, you can rest easy knowing that you’ve set yourself up for financial success.

Envelope method: This budget strategy may work for you if you need to control your spending or stick to a strict budget. Some people turn to the envelope method to keep their spending in check when paying off debt, for instance. With the envelope method, you assign each category in your monthly budget (groceries, transportation, utilities, etc.) a specific amount of money. Then, you set aside that amount in a physical or digital envelope. Once each envelope is empty, you can’t spend any more money in that category until you replenish the envelope the following month. That’s why the envelope method works so well to help reduce overspending and stay on budget.

Anti-budget: Not into tracking your spending or creating a budget with specific categories? This budget strategy may be a good choice for you. Instead of tracking your budget in categories, the anti-budget plan allows you to set aside a specific percentage of your income towards savings or debt repayment at the beginning of each month. Then, you get to spend whatever is left over. The trick to making this budget strategy work is ensuring you always have enough money to pay for recurring bills and other non-negotiable expenses like housing.

Monitor your budget

Here’s the thing about budgeting — it’s a work in progress. Instead of waiting for the perfect budget strategy, you can pick one and see if it’s a good fit. You’re already off to a great start if you have a basic plan in place and a clear understanding of your income vs. your expenses.

Set your money to save automatically

Once you’ve decided how much money to allocate to savings, automating the savings part of your budget means you’re less likely to spend the money elsewhere. If your employer offers an automatic deduction into a 401K plan, that’s an excellent place to start. You can also set up a direct deposit of a portion of your paycheck into a savings account.

Adjust your budgeting plan

Creating a budget is deeply personal, and your spending plan will evolve depending on your needs and stage of life. The best way to make and stick to a budget for the long haul is to keep an eye on your strategy and adjust as your needs change.

Save money and stay on budget

What’s the most important thing you can do today to learn how to budget? Start now! Then you can enjoy the money you save and the knowledge that you’re taking care of your financial future.

Learning how to create a personal budget or reach your savings goal — even for the first time — only involves a few simple steps, and you’re in charge every step of the way. Here’s how to get started.

  1. Calculate your monthly income

    Before you get fancy with budgeting templates or apps, it’s essential to understand your monthly income. That’s the amount of money you earn each month from a full-time or part-time job, your side hustle, or another income source. If you don’t know how much you make each month offhand, check your paychecks from your employer or any invoices you’ve sent to clients, for example. For budgeting purposes, you’ll likely want to base calculations on your net income because you’ll pay most of your bills after deducting taxes. For most people, monthly income is relatively consistent. However, your monthly income might fluctuate if you own a business or work as a freelancer or gig worker (like driving for a rideshare or delivery service). If that’s the case, calculate your earnings over a few months to get an idea of your average earnings. Once you’ve calculated your monthly income, you’re ready to create a budget.

  2. Make a list of your expenses

    Now that you know your monthly income, the next step in creating your budget is focusing on your expenses. Start with fixed expenses: housing, utilities, insurance, debt payment or student loans, and any other monthly expenses that are fixed costs, like a car payment. You’ll also want to account for variable expenses like groceries, dining out, and entertainment. Then, consider other flexible expenses you may have, things like monthly subscriptions or getting a haircut.
    All you need to do at this phase is make a comprehensive list of your expenses and spending. Think of it as information-gathering. There shouldn’t be any judgment, nor should you feel the need to eliminate or cut out anything right now. After you’ve compiled your expenses, however, you may look more closely at your spending habits and adjust where you feel they’re needed.
    For a simple breakdown of your expenses, consider the 50-30-20 rule for how to budget money. The 50-30-20 rule says that 50% of your income should go to necessities like living expenses, groceries, transportation, utilities, and insurance. The following 30% goes toward your “wants” or discretionary spending, like dining out, travel, concerts, and shopping. The final 20% should be allocated to long-term savings like retirement savings, and to pay off debt. When you’re new to creating a budget, the 50-30-20 rule is a simple budget template that can help you stay organized.
    Some people manage personal finance on a weekly budget, while others prefer to plan out a budget for the whole month. Remember to account for variable costs for whatever budgeting tool or timeframe you use. It’s good practice to establish an emergency fund or a fund for any other unexpected expense, just in case. This is because variable expenses fluctuate from month to month, and it’s better to have extra money in your bank account, not an overdrawn account since that could negatively impact your credit score. 

  3. Plan for your goals and dreams

    After you’ve listed your income and expenses, it’s time for the fun part — planning for your goals and dreams. The best part about creating a budget is that it provides a framework for spending that enables you to enjoy your life intentionally. Keeping your goals in mind makes it easier to stick to your budget, particularly if you’re budgeting on a low income.
    When budgeting for your goals and dreams, it’s essential to consider what you hope to accomplish in the next one, five, or even ten years. Consider any big-ticket items or experiences you might need to start saving for now. For example, if you want to buy a house in the next five years, you need to figure out how much to save for the down payment each month. Or perhaps you’re interested in redecorating your current home and need a fund for new furniture. You’ll need to create a budget category for that.
    Similarly, if you have a tropical vacation in mind for next summer, then now is the time to start saving. Sometimes, these budgeting categories are called “sinking funds.” Essentially, this is a savings account where you set aside money each month for a one-time or irregular expense.
    This may also be an excellent time to review your credit card spending. Are you carrying a balance you want to pay off? Or do you need a credit card with rewards that better align with your goals? For example, if you’re trying to save extra money for future travel, you might consider a rewards card, like the Discover it® Cash Back Credit Card. This allows you to earn rewards while spending on everyday items like groceries or gas. You can use these rewards towards your savings goal.

  4. Monitor your budget

    Here’s the thing about budgeting — it’s a work in progress. Instead of waiting for the perfect budget strategy, you can pick one and see if it’s a good fit. You’re already off to a great start if you have a basic plan in place and a clear understanding of your income vs. your expenses.

  5. Set your money to save automatically

    Once you’ve decided how much money to allocate to savings, automating the savings part of your budget means you’re less likely to spend the money elsewhere. If your employer offers an automatic deduction into a 401K plan, that’s an excellent place to start. You can also set up a direct deposit of a portion of your paycheck into a savings account.

  6. Adjust your budgeting plan

    Creating a budget is deeply personal, and your spending plan will evolve depending on your needs and stage of life. The best way to make and stick to a budget for the long haul is to keep an eye on your strategy and adjust as your needs change.

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