how to build your first budget
Updated November 27, 2020

How to Build Your First Budget in 5 Steps

Budgeting

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How to Build Your First Budget in 5 Steps

Today I want to talk to you about budgeting. Now the idea of setting up a budget can be overwhelming if you’ve never done it before, but it’s actually a pretty simple process if you break it into manageable steps. And that’s what this article is going to be all about—the concrete steps you need to take if you want to start a new budget and get your expenses under control.

Don’t want to read? Watch the video here!

In my view budgeting is one of the most effective things you can do if you want to improve your financial situation, but unfortunately only forty-one percent of Americans follow a budget. So I hope this piece helps you get started and kind of demystifies the stress of budgeting or confronting your spending habits.

1. Find a budgeting option that works for you

Step one in building your first budget is to decide how you want to budget. Do you want to budget like a grandma with pen and paper, like boomers with a spreadsheet, or like millennials with an app?

And there’s no right or wrong answer here, this is just personal preference. I prefer apps, and fortunately there are some excellent free and affordable budgeting resources both online and for mobile devices. I like YNAB, Mint, and Personal Capital, but really whatever app works for you will be fine.

In 2018, Bankrate found that almost two-thirds of smartphone users had at least one financial app on their device, and that number is probably even higher now. So even though you don’t need an app or a website to keep track of your money, a lot of these services make budgeting significantly easier by connecting to your accounts, automatically importing and categorizing transactions, analyzing your spending patterns, and in general just performing some tasks that would be complicated and time-consuming to do on your own.

Now even though every budgeting app is going to have its own features and its own settings, you can still apply many of the same principles regardless of how you’re managing your money. So the tips in this article will hopefully be helpful whether you’re using YNAB, Mint, Personal Capital, or even a notebook.  But overall you should just find something that works for you, that fits into your schedule, that you know you’ll be able to stick to. And you can always switch between different apps once you get a feel for budgeting, so you don’t need to put too much thought into this when you’re just starting out.

2. Review your transactions

No matter how you’re budgeting, the first thing you’re going to need to do is take a look at your transactions. You can find your transaction history in your bank and credit card statements, and I’d say you should check at least one or two months to get an idea of where your money is going.

Sometimes things can fluctuate from day to day or week to week, so a longer time period will give you a better understanding of your general habits rather than how much you happened to spend in a particular week. Of course under the circumstances your spending habits could change dramatically if lockdowns are lifted, so it might not be as simple as looking at transactions over the summer, and you might need to repeat this process if or when the economy goes back to normal. If we get a vaccine around the end of the year and you start spending three times more on gas, well that doesn’t mean you failed to follow your budget. So this is always contextual and it’s important to stay flexible as your situation changes.

If you’re using an app or a website, it should be able to link to your bank accounts and credit cards directly in order to import transactions. So in that case you might not have to take the time to enter transactions when they happen, but you may still have to categorize them depending on the service you’re using. On the other hand if you’re budgeting by hand you’ll need to go through your statements on your own and write down each transaction.

At the end of this process you’ll be able to categorize every purchase. Again some apps might do part of this for you, they might be able to recognize the merchant and sort it automatically, but the goal is to know exactly how much you’re spending on different categories each month. So you could be spending $500 on groceries, $250 on eating out, $50 on coffee, and $25 on subscription services.

And I’m not here to tell you how to spend your money, that’s not what this is about, I may cover my opinions on that in a video on my channel, but the point is that at this point you’ll be able to see what percentages of your money are going to these things. Of course you’ll also see how much you’re saving, and this is what motivates a lot of people to budget more seriously and start looking for ways to reduce expenses. I saw a Mint study that came out in May, they found that 65 percent of Americans didn’t know how much money they had spent in the previous month. So it’s like anything else, just evaluating where you are right now is often the first step toward making positive changes.

3. Set goals

Now that you know what you’re spending money on right now, the next step is to figure out where you want to be. Again this comes down to your own priorities, maybe in your first month you want to bring the $250 you spend eating out down to $200.

I don’t know, it’s up to you, but the point is that you want to find the categories where you tend to overspend, then try to set a realistic target and make the changes necessary to reach that goal. Don’t try to change your entire financial plan all at once, don’t expect to cut your expenses in half, just start with something that’s measurable and achievable.

And in general you should try to repeat this process at least once a month, maybe every two months if you’re busy. Check your statements or your budgeting app, see how your results compare to the goals you set at the beginning of the month, and adjust your budget for the next month based on that information.

If you managed to save that $50 on eating out, maybe you can push for another $25 the next month. Or maybe you spent $300 there but you were $100 down in another category and you need to create new goals. So even though getting started is the hardest step, it’s equally important to be consistent if you want to get the most out of budgeting.

4. Put your extra money to work

So far I’ve been talking about budgets as a way to reduce your expenses, and in my view cutting costs is one of the most important reasons to start budgeting. And if you’ve followed these tips so far you should be spending less than you were at first, which means you should have some extra money. But I haven’t really talked about what you should be doing with that extra money, so that’s going to be the fourth step.

If you already have a savings account, if you already have some money put away, you can start thinking about other goals. But almost half of all Americans have no savings at all, and close to 70 percent have less than $1,000. So if you’re part of that 70 percent, I would say that your extra money should probably be going to an emergency fund until you can give yourself more of a cushion. $1,000 is a good starting point, it’s not necessarily going to cover everything that could come up, but it’s a lot better than nothing. And once you get that put aside and have paid off your high-interest debt, maybe look at a three-to-six-month emergency fund.

Now you might be wondering where you should keep your emergency fund, and you have some options, but I typically recommend high-yield savings accounts. And the reason for that is that high-yield savings accounts provide reliable returns, and they’re also insured by the FDIC, so your money won’t be going anywhere.

Yes interest rates are down during the recession, so you won’t be earning as much as you could have a year ago. But Ally Bank for example, one of the most popular high-yield savings accounts, is still offering 0.6 percent. 0.6 isn’t going to make you rich, it might not even outpace inflation, but it’s a lot more than the national average of just 0.1 percent. And those rates should start climbing back to normal levels as the economy recovers. I’ve written an article on how to look for a good high-yield savings account, and you can check that out here  if you want to learn more about these accounts.

Once you’ve made some progress with your savings you can start thinking about other financial obligations, whether that’s paying off debts, putting money away for retirement, or saving for another long-term goal like tuition, a car, or a down payment on a house. But in most cases I think an emergency fund is the best way to use any cash you save through budgeting, at least at first.

5. Avoid lifestyle creep

So as I mentioned earlier, I think cutting costs is one of the main reasons to budget, but it isn’t the only reason. One of the main problems I see people have with money is that no matter how much they earn, they always find a way to spend it. And that’s really easy to do if you aren’t tracking your expenses.

Fortunately, you tend to develop more control over your spending habits once you start budgeting. So if you get a raise or a new job, sure you can relax some of your goals, maybe you add more money to a particular category, and obviously I’m not saying you have to live on the same budget for the rest of your life.

But on the other hand you’ll be able to avoid lifestyle creep, which is when you spend any additional income immediately instead of using it as an opportunity to save. For example if you get a raise of $4,000 per year, you could try to save 25 percent and add the other 75 to your monthly expenses. If you’re tempted to spend it, you might be able to have a percentage of your paychecks sent directly to a savings or investment account, which can help you keep that money separate from your monthly budget.

Like anything else it comes down to what you’re comfortable with. Some people save really aggressively in order to retire early, others are fine with saving 5 or 10 percent and spending the rest. But what happens when you start budgeting is that you start to see all the ways in which you’re wasting money, almost everyone does in one way or another, and you can really take the chance to reevaluate those habits and see if you’d be happier by shifting some of your money to savings, retirement, or other long-term goals.

So I want to emphasize that budgeting doesn’t mean that you shouldn’t have fun, it doesn’t mean that you shouldn’t spend money, it just means that you can gain more control over those tendencies and make sure your money is going to things that are truly important to you.

All right everyone I’ve covered a lot here, and obviously budgeting can get really complex depending on your approach.  Now one thing I didn’t get the chance to talk about is the psychological aspect of budgeting, and I know that can be a real challenge, so it would be great to read your comments on what methods you’ve used and what has worked for you.  As always, feel free to ask questions in the comment section, that’s where I get a lot of inspiration for future content, and thanks for reading to the end, hope to see you next time.

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Logan Allec, CPA

Logan is a practicing CPA, Certified Student Loan Professional, and founder of Money Done Right, which he launched in July 2017. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.

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