Create a Budget That Works for You in 5 Easy Steps
Does the thought of getting an unexpected bill in the mail send sweat down your spine – you know you wouldn’t have the funds to cover it if it came? Are you living paycheck to paycheck, yet crave financial freedom? Do you dream of the day when unexpected bills don’t phase you because you know there’s money in the bank to cover it? At ARQ Wealth Management, we work with a lot of young people who are just getting started with a solid financial plan, and I can assure you, you’re not alone.
The financial freedom you crave starts with a rock-solid budget. Creating a budget may seem daunting, but it’s actually easier than you think. We’ve broke the process down into 5 easy steps. Simply follow the steps, and you’ll create a realistic budget that works for you.
Step 1: Calculate Your Income and Expense
You can’t repair your financial house if you don’t know what’s broken to begin with. Step 1 in this process may take you a few hours to complete, but it lays the foundation for every step to come.
Start by reviewing what your finances look like at this very moment in time. This isn’t a time to be ashamed or embarrassed. It’s a time to pull back the curtain so you can create a budget tailor-made just for you.
Here are 5 things to calculate when creating your budget:
- Total income (salary, child support, alimony, interest, rental income)
- Monthly expenses (mandatory fixed expenses, mandatory irregular expenses, optional expenses)
- Debt (auto loans, student loans, personal loans, credit card debt, etc.)
- Savings account (the amount you currently have in your emergency fund)
- Investment and retirement accounts
Then answer these 3 questions based on the information you gather:
- How much money do I spend per month on average?
- Am I spending more than I make?
- How much debt do I have compared to my assets (savings, investments and retirement)?
This step may seem tedious, but it’s important in creating a budget that works for you. Once you have all this information in hand, you can move on to Step 2.
Step 2: Set Financial Goals
The reason many people stop sticking to their budget is because they don’t have clearly defined goals to work toward. Goal setting is the most forgotten step in creating a budget, yet it’s the most important.
Ask yourself this question: If you had all the money in the world, what would you do with it? Would you use it to pay off your debt? Save for your children’s college? Maybe buy a house at the beach and retire? Then use your answers to create short-term and long-term financial goals using the SMAC acronym – make sure your goals are Specific, Measurable, Achievable and Compatible.
There are four stages of creating a SMAC goal:
- Specific: Make your goal as concrete as possible. (Example: Pay off $10,000 in credit card debt.)
- Measurable: Add a metric that defines success. (Example: Pay off $10,000 in credit card debt in one year.)
- Achievable: Make sure you can accomplish it. (Example: I’d need to pay $833 a month to have my credit card debt paid off in one year. I know if I cut down on spending and increase my income (Step 4), I can achieve this goal.)
- Compatible: Make sure it aligns with your overall financial plan. (Example: I want to be debt-free as soon as possible. This goal aligns with my financial plan.)
A SMAC Goal: In one year, I’ll have $10,000 in credit card debt paid off because I will pay $833 a month toward my debt.
I believe that mapping out these baby steps (like figuring out exactly how much you need to save per month to reach your goal) is the key to financial independence. When life presents you with a trade-off, such as going on a cruise or paying off your credit card debt, we’ve found that it’s easier to choose the latter when you have a crystal-clear vision of what you’re working toward.
Step 3: Track Expenses
Budgeting usually looks something like this: You sit down at the end of the month, add up all your expenses, realize you went wayyyy over budget, and promise you’ll do better next time. The next month, you add up all your expenses (again) and realize you’ve gone way over budget (again). Even though your head is about to explode with frustration, you promise you’ll do better next time. But every month looks the same and nothing ever gets better.
There’s a difference between actively tracking your expenses and passively waiting to see how you did at the end of every month. I believe that most budgets crash and burn because people aren’t actively managing where their money goes.
Instead, track every single purchase you make (no matter how much you don’t want to). It’s the only way to get a truly clear picture of what you can change in Step 4. If you’re looking for tools to help you track your spending, check out You Need A Budget and Tiller, or look up free budgeting spreadsheet templates online. You may also want to read these tips from a millionaire’s financial advisor.
Step 4: Cut Spending and Increase Income
Using the data in Step 3, you can now make a list of all the “extra” purchases you make every month. This could be dining out, clothes shopping, Netflix and gym memberships, vacations and so on. Then decide what you can do without. Be ruthless in eliminating these things, but remember, the purpose of budgeting is not to deprive yourself of everything that brings you joy. If you’re a foodie at heart and love dining out, don’t cut this out of your budget completely. Give yourself a set amount of money to eat out each month and stick to it. Since dining out brings you joy, you may cut other things out of your budget like concerts or Netflix.
Next, look for ways to increase your income. If you’re strapped for time and can’t pick up a side hustle or second job, consider these 5 forms of extra money you may be able to save throughout the year:
- Extra paychecks (if you’re paid weekly or bi-weekly, you get an “extra” paycheck every few months)
- Tax refunds
- Birthday and holiday money
- Credit card rewards points
When you simultaneously cut down on spending and increase your income, you exponentially increase the amount of money you have every month. Take this extra money and use it to reach the financial goals you defined in Step 2.
Step 5: Stick With It
You won’t become an “expert budgeter” overnight. The truth is, there will most likely be times when you fail. But that’s OK. The most important thing is that you keep yourself focused and stay on track. No two months of budgeting look the same. If you have one month where your budget gets derailed by an unexpected emergency, stay the course. Adjust your budget for the following months until things get back on track.
If you need help creating a budget and financial plan you can stick to, reach out to a trusted financial advisor. No matter what step you’re on in the process, having a financial advisor as an accountability partner can help you create a long-lasting financial strategy that helps you reach financial freedom.
Working with a financial advisor can also parlay your newly established budget into a larger, overall financial plan. At ARQ Wealth Advisors, we recommend new clients use this convenient and free financial assessment tool to see where they are at on their path to financial freedom.