How to Budget: A Step-by-Step Guide to Creating and Managing a Budget
Today I’m going to show you exactly how to create and manage a budget.
In fact, this is the exact process that I use to achieve my financial goals.
So, if you want to live a debt-free life and take control of your finances, then you’ll love this budgeting tutorial.
Let’s dive right in…
Step #1: Set A Goal
Goals provide a sense of direction, a source of motivation, clear focus and they clarify importance.
Your goals should be SMART.
SMART stands for Specific, Measurable, Achievable, Realistic Timely.
SMART goals will help to guide your goal setting, by incorporating all of the above criteria.
These criteria are to help focus your efforts and increase the chances of achieving your goal.
Specific – Goals that are specific have a significantly greater chance of being accomplished.
Measurable – If there are no criteria, you will not be able to determine your progress and if you are on track to reach your goal.
Achievable – This will help you figure out ways you can realize that goal and work towards it. The achievability of the goal should be stretched to make you feel challenged, but defined well enough that you can actually achieve it. Ask yourself.
Realistic – Must be realistic in that the goal can be realistically achieved given the available resources and time. A SMART goal is likely realistic if you believe that it can be accomplished.
Timely – If the goal is not time-constrained, there will be no sense of urgency and motivation to achieve the goal.
Don’t set yourself up for failure by setting general and unrealistic goals like “I want to save more” or “I want to budget better”. These are too vague and lack a sense of direction.
Step #2: Calculate Your Income
List all of your income in an excel, Google docs spreadsheet, or even just with a pen and paper.
Besides your regular salary, add in any extra funds that come your way throughout the year. This may be cash gifts, child benefit, interest, dividends or rental income.
For a lot of people, this is the money they take home from their salary. But if you are a business owner or if you have additional income, you will want to include all of your income on your budget. If your income is inconsistent, take the average of the last three months income and use that as your income.
Step #3: Calculate Your Expenses
You need to know exactly how much you’re spending each month. Calculate this by reviewing your bank statements and credit card statements.
Some expenses aren’t monthly. To get the most accurate picture of your finances, take an average for the last six months.
You need to be thorough or you won’t get an accurate estimate. And you can’t create a realistic budget without an accurate estimate of your monthly expenses.
Little things add up, so try not to do back of the envelope calculations for this.
It’s good practice to add in a contingency for unexpected bills, like unplanned car repairs. I like to add an extra 10 percent to 15 percent. So if your expenses are £1,500 per month, add £150 to £225.
Step #4: Subtract Your Income From Expenses
This should be a positive number. If it’s not, you need to look at where you can cut back your spending. Adjust your budget by decreasing some of your discretionary expenses or find a way to increase your income.
Some ways to decrease your discretionary expenses are to spend less on entertainment, dining out, or other non-essential things.
If you have a surplus, think about putting more into your savings. Or if you have outstanding debts, allocate more to pay these off.
If you break even, this means you have exactly enough money, but no margin. You may want to adjust your budget to give yourself some margin in the form of a “discretionary” category in the event that things come up that you didn’t plan for.
Step #5: Implement Your Budget
Now that you know what you’ve got coming and going each month, it’s time to implement your budget.
One of my favourite budgeting plans comes from the Barefoot Investor.
The Barefoot Investor Budget Model
With the Barefoot Investor you split your monthly income into different pots.
Blow: 50%
This is the 50% of your income which should be allocated to daily expenses.
It stays in your main current account where all of your direct debits and day to day spending come out of.
Grow: 10%
Allocate 10% of your monthly take home pay for growth. This can be your pension pot or other investment accounts.
Splurge: 10%
Splurge is your short-term spending such as entertainment, clothes and hobbies.
Smile: 10%
Smile is your medium-term spending such as next year’s holiday, funds to decorate your home, a wedding, or special event.
Fire Extinguisher: 20%
Short to medium-term savings. Depending on your circumstances these should put out any financial fires. And otherwise pay off any debts.
If there are no financial fires and you’re debt-free then it goes into savings.
Mojo: £2,000
Mojo is your emergency fund. Savings of £2,000 in an instant access savings account with another bank. It’s rainy day money.
Step #6 Manage your Budget
Building a budget isn’t enough, if you don’t stay on top of it. Here are a few tips on how to manage your budget.
Tip #1: Cutback on Spending
Your mortgage.
If your fixed period has expired on your mortgage and you haven’t remortgaged, you could be wasting hundreds of pounds per month.
Utilities
Using a service like USwitch could save you hundreds of pounds per year.
Insurance
Like utilities, you can Uswitch to switch your car or home insurance.
But for more substantial insurance, such as life insurance or income protection, you’ll want to contact a broker.
Tip #2: Put Savings on Autopilot
It can be tempting to keep your savings in a cash account. But if it’s readily available you may be tempted to spend it.
Opening an ISA and setting up a direct debit will help you to save money each month, in a tax-efficient manner.
Tip #3: Pay Off Loans and Credit Cards
You can’t build up your savings if you’re in debt.
On top of that you’re paying interest on those loans. And usually at a much higher rate than you could earn on your money.
Tip #4: Use Virtual Cards to Manage Spending
Did you know that us Brits waste over £250 a year on unused subscriptions. By setting up payments for subscription based services using a virtual card, you can avoid paying for unwanted subscriptions.
Conclusion
That’s it for our budgeting tutorial.
Remember to be flexible. Life is unpredictable so try to review your budget and your spending if there’s a change in your personal finances. And at least every couple of months.
And if you’d like to review your personal financial situation with one of our financial advisors, go ahead and book an appointment for a FREE consultation.