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How to Build a Budget

5 min read

30 sec brief

Budgets often get a bad rap. They are held out as some form of financial drudge work that is all pain and no pleasure.

Budgets often get a bad rap. They are held out as some form of financial drudge work that is all pain and no pleasure.

That totally misses the tremendous upside of a budget. A budget is your personal road map to get where you want to go. It isn’t some off-the-shelf package that doesn’t fit your goals, your needs and your stress points. It’s by you, for you.  A budget works when you’re a thirty-something angling to join the FIRE (Financial Independence, Retire Early) revolution, or a 60-something ready to retire and live off your investments and sources of retirement income.

Here’s how to build a budget.

  1. Know where you are. For real.

No more guesstimating on what you’re spending each month. A budget starts with a line-item accounting of where your money is going . You can spreadsheet this yourself by pulling out three to six months of bank and credit card statements and tracking your spending. There are also  free online budget spreadsheets to get going, or check out the budget template in Excel. If you want to automate the process, Personal Capital and Mint.com offer free budgeting apps that connect to all your accounts and does the spreadsheeting for you.

You are just fact gathering in this first step: See where all your monthly income is currently going.

2. Focus on Your Three Buckets.

An easy way to tackle spending is to sort it into three buckets:

  • Fixed Living costs, such as the rent or mortgage, utilities, groceries, the car payment etc.
  • Living. What you spend on the pleasures. Drinks out after work, vacations, etc.
  • Saving and investing. An emergency cash account is a must, as is saving for retirement. You may also want to save for a home down payment, or a child’s future college costs.

Add up your current spending across those three categories.

Next, step back and think through what sort of bucket mix would help you reach your personal goals.  There is no single rule to follow here. One popular approach is to follow the 50-30-20 rule: 50% on housing and fixed costs, 30% on the living stuff, and 20% for saving.

But it really comes down to your personal goals. If you have yet to build up a six month emergency savings account, and also want to save for a home down payment while staying on track with retirement saving, you might want to consider allocating 30% to saving and investment for a few years, and scale back the living spending. If you’re committed to FIRE, you will want to reduce your spending across the board.

The one commitment you must make is that you save/invest at least 15% to 20%  for emergencies and your retirement. There is no give here. You can’t keep pushing off these two foundations of financial security off into the future. Don’t worry, with a budget you will likely be able to find the cash flow to make that happen. More on this in a sec.

3. Size up if your current bucket strategy is on target. Now is where your past runs into your future: If your current spending doesn’t jibe with the three-bucket goals you have set for yourself, you’ve just entered the active world of budgeting. It’s the rare household that magically has it all going exactly where they want from the get-go. The whole point of the budget is to help you see where you are at, so you can navigate your way to where you want to get to. Now you’re ready to engage in actual budgeting.

4. Every budget-and lifestyle has some give.

If you need to scale back spending to have more to save or put toward fixed costs, the first step is to go through every line item in your budget. On the first pass ask yourself if you can trim that expense. Not get rid of the expense, but reduce it. Think big (driving a less expensive used car that you can pay off, rather than buying or leasing a more expensive model) and small (scaling back the cell phone plan, gifting your time to friends (babysitting, helping with home reno projects, etc.) to reduce your spending.

If you’re still having a hard time making the numbers work, you likely have a housing cost issue. You are not alone. If you absolutely, positively can’t imagine reducing your housing costs (downsize, take in a roommate, move another 20 minutes out) then consider ways to boost your income; can you hit your bucket goals with a side gig?

5. Automate and Separate. One of the best ways to stick to a budget is to automate your bill pay and your saving/investing. And for any savings goals—emergency fund, down payment—use a separate savings account for each one. (Online banks offer the best interest rates.)  If your bank makes it possible to name an account, make it goal-driven. Labeling an account My Emergency Savings Fund or TheHouseDownPaymentFund will make it easier to stay committed to your goal.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

About the author

Carla Fried

Carla translates business and personal finance concepts into engaging content that helps individuals make more confident choices in how they manage their money. Her work appears in The New York Times, Money Magazine, Barron's and Consumer Reports.

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