A couple of years ago, I decided I needed to learn how to create a budget for myself. Well, what did I do? I deferred to our best friend Google and searched “creating a budget.” What I found was information about knowing what your net pay is and “figuring out” how much you can afford to spend on this and that monthly. This led me to take “educated guesses” on how much I could spend on food, entertainment, subscriptions, etc. per month. Long story short, this did not work out at all. “Educated guesses” are not a good pass; you need factual evidence. Follow my 11-step guide to learn how to properly create a budget.
Table of Contents
Step 1: Create an Excel Doc to Track Expenses
Open up Excel or Google Sheets and create a column with all your fixed expenses. Title it FIXED EXPENSES. For example, rent, car insurance, car payments, utilities, phone bills, student loans, and any other bills that you have to pay each month. This doesn’t include subscriptions that you like, but don’t need to have, like Netflix or Stitch Fix, etc. We’ll get to those expenses in a bit. Also, do not include food or gas just yet even though these are necessities each month
Title the next column over COST. Fill in the costs of each of these fixed expenses by looking at old mailed bills, logging into your online accounts, or looking at your credit card statement. Perhaps there’s some expenses you only have to pay every other month or every few months. For example, I only pay my department of water and power bill every other month. For these, divide the total cost by the number of months covered to get the average per month and type it in the chart. Now add up all those costs to get your total fixed monthly costs. If you highlight all the boxes and use the Σ (sigma) symbol, it will add everything up for you.
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Step 2: Figure out your Monthly Net Pay
So, part of what Google instructed me to do was correct. You do, indeed, need to know what you net pay is monthly for any of this to work. This is the amount you actually take home after taxes, 401k, and healthcare costs are extracted from your paychecks.
If you’re an independent contractor, work in a service field, or work a lot of overtime where your take-home pay changes month to month, you can look at this a different way. First, figure out what your fixed take-home pay is. So if you make $10/hour before tips or OT, calculate what you make after taxes on average monthly.
Then, look at the last 4 months of additional pay and average that amount. Once you have the average, divide it by 50%. For example, if you make $300 on average monthly of additional pay, divide that by 1/2 to get $150. Add the $150 to your total fixed net pay. Why? This allows for some padding in months that are a deficit, so aren’t running thin on cash and having to pull out of your savings. On good months, you’ll have extra money to use as fun money or put into your savings.
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Step 3: Invest in your Company’s 401k or 403b
If you already invest in your company’s 401k or 403b, this is still important info to read. If your company doesn’t offer a retirement plan, you can skip this section for now as I will show you an alternative later in this article.
If your company offers a 401k or 403b, INVEST IN IT! Most companies offer a matching program up to a certain amount. Let’s say your company offers 5% matching. This means that if you invest at least 5% of your paycheck into your 401k, your company will also put 5% into your account. But, if you only invest 3%, your company will only invest 3%. You’re giving away free money, so PLEASE PLEASE PLEASE contribute at least the maximum amount that your company matches.
I recommend contributing a little more than what your company matches monthly. I promise, it will pay off in the long run! But, this contribution amount can always be changed. Maybe you start at the minimum for month #1 and add more once you hit your numbers. In all transparency, I put 22% of my monthly paycheck into my 401k and max it out annually. 2021’s max 401k contribution amount is $19,500.
Now that you’ve signed up for a retirement fund, calculate how this will affect your monthly net pay. How do you do this? Look at the gross (pre-tax) amount of your paycheck and multiple that by whatever percentage you’ve decided to contribute. Then, subtract that from your monthly net pay.
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Step 4: Subtract your Fixed Costs
Just as the step says, now that you know both your monthly fixed costs and take home pay, you have to subtract the former from the later. In my example, my fixed costs are $1,610. After taxes and 401k deductions are taken out, my take home pay is $3,775, so I’m left with $2,165 monthly.
Step 5: Create an Expense Tracking Spreadsheet
Go back to your excel sheet and add a separate page for category columns to track your flexible expenses. My columns include: food, gas, entertainment, self care, and miscellaneous, but yours might be completely different. For me, Partial Fixed Expenses are Food and Gas because I need them each month but the cost will vary. Do you have another other Partial Fixed costs to include? Perhaps you have medication you have to buy each month but the price varies. If so, make sure to create a separate column for that expense.
Under food, I only include groceries. I keep going out dinners for entertainment, but if you never cook at home then part of your Food bucket can include eating out or take out food. Gas is self-explanatory. Entertainment can be going out for dinner with friends, going to a football game, traveling, etc. Under self care, I include medical, beauty products, getting my nails done, a new outfit, etc. However, medical might be a bucket you want to create on its own if you go to the doctors a lot. And misc. is anything that just doesn’t fit into one of these buckets, like if I had to buy a new charger or a product that isn’t exactly fit under entertainment or self care.
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Step 6: Add up Expenses for the Past 4 months.
Here comes the fun part… 😉 Now, you need to add up all your flexible expenses month by month for the past 4 months, breaking them into your new categories. These are all your expenses that aren’t your fixed monthly bills you already accounted for. Use a different graph for each month so you can get an idea of how much you’re spending each month.
Do this by looking at your credit card statements, bank accounts, and receipts. I know, it’s very tedious and will be time consuming upfront, but you have so much valuable data right at your finger tips to figure out what budget works for you. After this first calculation, get into a habit of tracking your expenses monthly to make sure you’re still on pace.
Once you have these tallies for each category and each month, my guess is you might be shocked by how much you’re spending on at least one area. Maybe you immediately see where and how you can cut back. If so, that’s great!
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Step 7: Partial Fixed Expenses
Let’s first focus on your Partial Fixed expenses (e.g. food and gas) – the things you need to pay for each month, but costs vary. Add up the totals from the 4 months for each category separately, and divide by 4 (months) to figure out how much you’re spending on average.
Now, I challenge you to make your budget for each Partial Fixed category about 10% under the average, at least for the first month. Chances are you can probably spend less on food monthly than you are right now. This gives you a goal to strive for and will leave you feeling extremely accomplished once you hit that number at the end of the month. And maybe the second month, you’ll feel comfortable dropping that budget by another 10%.
Let’s say you calculate $400 for all your Partial Fixed expenses per month, after you reduce by 10%. Using our previous example, you’d subtract $400 from the $2,165 that was left over after taking out fixed expenses. We’re now left with $1,765.
If you’re wondering how to save money on food, check out my guide on Grocery Money Saving Tips.
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Step 8: How Much Money Are You Saving?
Now that we’ve figured out what all our Fixed Costs and Partial Fixed Expenses are, we’re going to step away from our Expense Tracking sheet to focus on additional monthly savings. You’ve already created a 401k account, so you’re well on your way to building up savings for retirement. But, there’s still more work to be done. What about saving up for those short and longterm goals, like taking a vacation, buying a home or buying a new computer? While there are loopholes to pulling money out of your 401k to invest in a home, you shouldn’t resort to going that route.
I recommend putting at least 10% of your take-home paycheck into a high-yield savings account. Keep your money here to slowly compound, while you figure out which stocks, bonds, and funds to invest in. This will make your money work even harder for you and get you closer to those financial goals even faster.
The other thing about having more money saved up is that you have money for incidentals or unexpected costs. What happens if your car breaks down or you have to buy a new fridge? Big costs like these are usually unexpected and can seriously eat away at your finances, so it’s important to be prepared for these capital expenditures before you need to be.
Start out with 10% in month #1, and maybe by month #2 you can add another 10%. I currently have my after paycheck contributions set to 20%. Using our example, we decide to invest 10% of our take-home paycheck into an HYSA which leaves us with $1,010. Note, this is not 10% of what is left over after you remove the Fixed and Partial Fixed costs; this is of your total take-home net pay.
Why not account for savings before we calculate our Fixed and Partial Fixed? This is because I want you to have a general idea already of how much money you have left. Shoot for 10%, but if this doesn’t leave you with a single penny after your fixed expenses, then save less than 10% per month.
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Traditional IRA vs. Roth IRA
Now if you skipped Step #3 (investing in your company’s 401k or 403b), read this! If your company doesn’t offer a 401k, you should sign up for either a Roth IRA or a Traditional IRA. You can still consider one of these for additional savings even if you invest in your company’s retirement account.
Investing in a Traditional IRA will give you a tax incentive because it’s considered pre-tax money so it will lower your taxable income. You can’t pull money out for 5 years and once those 5 years are up, you will be taxed on the retrieval of money + a 10% fee if pulled out before the age of 59.5.
A Roth IRA is considered after tax money so you don’t receive a tax incentive the year you contribute, but you don’t have to pay taxes when you pull money out after the age of 59.5. You can pull money out before the age or 59.5 for certain loopholes, but you may have to pay taxes or penalties.
Learn more about high-yield savings accounts here.
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Step 9: Fun Flex Expenses
From here, let’s jump back to your Expense Tracking sheet. Decide which of your monthly costs are the most important to you. For me, I love getting my nails done each month and going to the gym, so I calculate my averages for these each month and include these into my budget.
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Step 10: What to do with you Leftover Cash
After calculating all our expenses, we still have $300 leftover in our example. So what do we do with this additional capital?
You’ve done a great job at creating a budget for yourself so far, so you deserve to treat yourself with some Fun Money and spend on whatever your heart desires. However, if you still have some money leftover, put it into your high-yield savings account or IRA to grow for your future.
Step 11: Continue Tracking your Expenses
Create a habit of tracking your expenses every month to make sure you’re still on track with your new budget. If you start making more money, adjust the numbers. If you find yourself stretched for pennies at the end of the month, put a little bit less into your high-yield savings account. If you have more money than you know what to do with at the end of the month, put more into your pre-tax 401k savings. There are lots of ways to adjust these numbers, so figure out what works for you.
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RECAP: Learn How to Create a Budget the Right Way
- Step 1: Create an Excel Doc to Track Expenses
- Step 2: Figure out your Monthly Net Pay
- Step 3: Invest in your Company’s 401k or 403b
- Step 4: Subtract your Fixed Costs
- Step 5: Create an Expense Tracking Spreadsheet
- Step 6: Add up Expenses for the Past 4 months.
- Step 7: Partial Fixed Expenses
- Step 8: How Much Money Are You Saving?
- Step 9: Fun Flex Expenses
- Step 10: What to do with you Leftover Cash
- Step 11: Continue Tracking your Expenses
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