If I have a take-home pay of $2,000 a month, how can I pay for housing, food, insurance, health care, debt repayment, and fun without running out of money? That's a lot to cover with a limited amount, and this is a zero-sum game.
The answer is to make a budget.
What is a budget? A budget is a plan for every dollar you have. It's not magic, but it represents more financial freedom and a life with much less stress. Here's how to set up and then manage your budget.
How to budget money
- Calculate your monthly income, pick a budgeting method and monitor your progress.
- Try the 50/30/20 rule as a simple budgeting framework.
- Allow up to 50% of your income for needs.
- Leave 30% of your income for wants.
- Commit 20% of your income to savings and debt repayment.
- Track and manage your budget through regular check-ins.
Understand the budgeting process
Figure out your after-tax income: If you get a regular paycheck, the amount you receive is probably it, but if you have automatic deductions for a 401(k), savings, and health and life insurance, add those back in to give yourself an accurate picture of your savings and expenditures. If you have other types of income — perhaps you make money from side gigs — subtract anything that reduces it, such as taxes and business expenses.
Choose a budgeting plan: Any budget must cover all of your needs, some of your wants, and — this is key — savings for emergencies and the future. Budgeting plan examples include the envelope system and the zero-based budget.
Track your progress: Record your spending or use online budgeting and savings tools.
Automate your savings: Automate as much as possible, so the money you've allocated for a specific purpose gets there with minimal effort. An accountability partner or online support group can help hold you accountable for choices that blow the budget.
Practice budget management: Your income, expenses, and priorities will change over time, so actively manage your budget by revisiting it regularly, perhaps once a quarter.
Try a simple budgeting plan.
We recommend the popular 50/30/20 budget to maximize your money. You spend roughly 50% of your after-tax dollars on necessities, no more than 30% on wants, and at least 20% on savings and debt repayment.
We like the simplicity of this plan. Over the long term, someone who follows these guidelines will have manageable debt, room to indulge occasionally, and savings to pay irregular or unexpected expenses and retire comfortably.
The 50/30/20 budget
Allow up to 50% of your income for needs
Your needs — about 50% of your after-tax income — should include:
- Basic utilities.
- Minimum loan payments. Anything beyond the minimum goes into the savings and debt repayment category.
- Child care or other expenses you need so you can work.
If your absolute essentials overshoot the 50% mark, you may need to dip into your budget's "wants" portion for a while. It's not the end of the world, but you'll have to adjust your spending.
Even if your necessities fall under the 50% cap, revisiting these fixed expenses occasionally is smart. You may find a better cell phone plan, an opportunity to refinance your mortgage, or less expensive car insurance. That leaves you more to work with elsewhere.
Leave 30% of your income for wants.
Separating wants from needs can be difficult. In general, though, needs are essential for you to live and work. Typical wants include dinners out, gifts, travel, and entertainment.
It's not always easy to decide. For example, are restorative spa visits (including tips for a massage) a want or a need? How about organic groceries? Decisions vary from person to person.
If you're eager to get out of debt as fast as possible, you may decide your wants can wait until you have some savings or your debts are under control. But your budget shouldn't be so austere that you can never buy anything just for fun.
Every budget needs both wiggle room — maybe you forgot about an expense or one was bigger than you anticipated — and some money you're entitled to spend as you wish.
Your budget is a tool to help you, not a straitjacket to keep you from enjoying life, ever. If there's no money for fun, you'll be less likely to stick with your budget — and a reasonable budget is one you'll stick to.
Commit 20% of your income to savings and debt repayment
Use 20% of your after-tax income to put something away for the unexpected, save for the future, and pay off debt. Make sure you think of the bigger financial picture; that may mean two-stepping between savings and debt repayment to accomplish your most pressing goals.
Priority 1 – emergency fund – experts recommend several months but start with at least 500, enough to cover minor emergencies and repairs.
Priority 2 – employer matching 401(k) – if the employer offers a match, max it out on contribution.
Priority 3 – toxic debt – pay off high-interest CC debt, personal and payday loans, title loans, and rent-to-own payments. Interest rates are so high that you are repaying 2-3x what you borrowed.
Priority 4 – savings for retirements – Aim to save 15% of gross income once your toxic debt is gone. Consider a Roth IRA.
Priority 5 – emergency fund – regular contributions can build 3-6 months' worth of living expenses.
Priority 6 – debt repayment – payments beyond the minimum required to pay off your remaining debt.
Priority 7 – you – once you've reached this point, consider saving or irregular expenses that aren't emergencies, such as a new roof or your next car. Saving for something is better than borrowing for it.