Creating a budget can seem overwhelming.
The categories often used to classify our expenses are too numerous to count — transportation, utilities, business, education, entertainment, financial expenses, food, gifts, and so on, plus all the subcategories within them.
On top of that, we don't always spend the same amount per month in each category. We might need $200 in our electronics budget one month for a new smartphone purchase, but none the next month. We might need $20 in our health budget one month and $220 the next.
Since we can never be that exact and consistent by category, and since the overall goal anyway is to stay within one's means, over the five years that I've covered personal finance (during which I paid off debt and saved up enough money to start freelancing), I have come to prefer a simplified method of budgeting that uses the 50/20/30 guideline of budgeting (or numbers tailored to your situation) in which a certain percentage of your budget is allocated to certain large categories, and weekly allowances to keep you on track.
This strategy allows you flexibility while also making sure you reach your financial goals and that your spending aligns with your personal values. Here's how to make it work for you.
1. Tally your necessary expenses, aiming to keep them under 50% of your take-home pay.
After you've paid taxes and made your employer-based retirement contribution, such as to a 401(k) account, there’s a certain amount that you take home every month. If you're paid monthly, it's equal to your paycheck. If you're paid biweekly, your take-home pay will be slightly more than two paychecks, because every six months you will receive one extra paycheck. In that case, multiply each paycheck buy 13 and then divide by 6. That's your take-home. If you get paid weekly, it will be slightly more than four paychecks, because every three months, you will receive an extra paycheck. In your case, to get your monthly take-home, multiply every paycheck by 13 and then divide by 3. (Alternatively, if you get paid weekly or biweekly, you can budget as if four or two paychecks equaled your monthly budget and then treat the extra paycheck that would come every quarter or half year as a bonus that you could put towards savings or debt or another goal.)
After you've determined your monthly take-home, divide it by 2. For most people, the number that you calculate is the upper limit of how much you should spend on all your "necessary" expenses. These include housing, transportation, groceries and utilities. If you don't typically use a set amount for your groceries, allocate a reasonable amount now, a number that you can easily stick to.
If you can get the sum to be less than 50%, it leaves you more room for paying off debt, accumulating savings, or having more play money. In particular, because housing and transportation costs tends to be our largest expenses, if you can keep these low, you can keep the portion of your budget devoted to necessary expenses low overall. Here are 101 ways to save money on everything from housing and transportation to travel and eating out.
2. Aim to allocate 20% or more of your take-home pay to your financial priorities.
This is the section of your budget devoted to your big goals. Financial priorities include paying off debt, saving for retirement, saving for any big financial goals such as buying a house, taking a dream vacation, or starting a business. If you're paying off debt, make sure that this amount can at least cover your minimum debt payments, preferably more. (Check out this guide for more information on paying off debt, and this article to see how to prioritize between debt payments and retirement contributions.) If you don't yet have emergency savings, start small by building a "curveball fund” of about $1,000 or $2,000, which could cover any unexpected car repairs or health expenses. Then, contribute regularly to an emergency fund with the goal of saving at least three months’ worth of your necessary expenses (though most people — again, and the exact amount depends on your personal circumstances -- should aim to eventually reach six months’ worth).
Once you've determined how much you can put toward your debt payments and savings contributions, put those on auto-pilot, so that the debt is being paid and the savings is accumulating without requiring you to manually transfer the money every week. For your savings account, choose a bank such as Ally or Smartypig that allows you to have sub-accounts, so you can divide your savings between emergency fund, a trip to Patagonia, and the down payment on your house.
The way that each person splits up their financial priorities money depends on their own personal situation. But if you don't have debt payments and have enough of an emergency cushion, you can devote this area of your budget toward your own retirement accounts such as a traditional or Roth IRA. If you can, max out those accounts, which have a contribution limit of $5,500 a year for the year 2016 ($6,500 for those 50 and older), and do so through weekly, biweekly or monthly automated transfers. If you max out both your individual IRA as well as your employer-sponsored accounts, you can put additional money toward a brokerage account. Just don't forget that for any investment account, not only should you set up auto-transfer of money into the account, but also the automatic purchase of the investments.
If you can't imagine putting 20% of your budget toward savings or paying off debt, start with whatever percentage you can manage now, and then increase it by another percentage point or two at regular intervals as you find ways to cut costs or make more money. For instance, if you receive a 2% pay raise (here are the mistakes to avoid when asking for one), continue living on the same amount, but increase the financial priorities section of your budget by two percentage points. If your necessary expenses are below 50%, such as 40% or 35%, you should more easily reach the 20% goal and even surpass it to, say, put 25% or more of your budget toward your financial priorities.
Note that because this calculation is based on your take-home pay, retirement contributions that you are making to an employer-sponsored account such as a 401(k) are not included, and so your total retirement contributions should be even greater than the dollar amount that you are contributing from this part of your budget.
3. From the remaining 30% or less of your budget, set yourself a weekly allowance.
This part of your budget, which is devoted to discretionary lifestyle expenses such as dining out, shopping, entertainment, charitable donations, gym memberships, electronics, etc., should be no more than 30% of your take-home pay. Since some months are longer than others -- unless you've decided to treat that extra paycheck per quarter or half year as a bonus -- in order to determine the weekly allowance, tally up the total of your take-home paychecks for the year — multiplying by 12 if you get paid monthly and by 26 if you get paid biweekly. Then divide by 52 and multiply it by 0.3 (or, if you are able to put more toward your financial priorities, perhaps you are living on a smaller percentage, such as 25%, in which case you would multiply by 0.25) to determine your weekly allowance. This is the amount that you can use at your discretion every week for all your other expenses. Knowing this number will help you plan for big expenses. If, one week, you know you'll spend a large portion of it on, say, your sister's birthday, you can plan in advance and enter that week knowing that you'll need to ratchet down your other spending to make room for that.
In order to be sure you stick to the weekly allowance, if you're in debt and need to be especially careful about adhering to this number, start by taking out that amount in cash every week. For those who feel they can be a little more relaxed, track your expenses with an app, on a Post-it note in your wallet, or on a spreadsheet.
You can also use your allowance to save up for larger than normal purchases, by, for instance, taking $50 out of your allowance every week for four weeks to save up for a $200 purchase. And, if you ever go over your budget one week, you can then just cut your allowance for next week and vice versa.
Is 50/20/30 doesn't work for you, come up with your own guideline, but stick to it.
If you have a budget that falls out of the norm for some reason — perhaps you're fresh out of college and are saving on housing costs by staying at your parents’, but have high student loan payments, or perhaps you are a new parent that has high child care costs, you may find that a completely different ratio of necessary expenses to financial goals to discretionary expenses works for you. If so, then follow that. The 50/20/30 guideline does not, and is not meant, to work for everyone. The point of the overall exercise is to determine what's necessary, what your financial goals are, and what's discretionary and the best allocation toward each of those buckets — and then to stick to those amounts.
If you find it difficult to stick with your budget, look for ways to cut costs and to make more money, and then tweak your budget again. Every time your financial picture changes, revisit this calculation in order to keep your spending in line with your current situation. However, once you've determined that you're living within your means and automated your good financial behaviors, the only other ingredient you need to achieve your goals is time.
Read full article at Forbes.com