How to Create an Effective Budget

An effective budget is essential for long-term financial health. Many people make the mistake of believing that budgets exist only to limit spending. But budgets aren’t about deprivation, they’re about prioritization, and they help you minimize stress and achieve your long-term financial goals. To create an effective budget, simply add up your income, subtract your fixed expenses, and divide up what’s left appropriately. The key to creating a budget that you can stick with, though, is adjusting your approach until you find what works for you. Below is exactly how to create an effective budget!

Add Up All the Money Coming In 

If you have a salary as your sole source of income, knowing how much money you have coming in each month is incredibly simple. All you need to do is figure out your take-home pay, which is how much you make once taxes have been taken out. For those with more irregular income, this process can be a bit more difficult.

People with irregular income fall into two broad groups. The first group is made up of individuals whose main income source is irregular, such as freelancers or those whose compensation is largely based on sales or commissions.

The second group is made up of those who have a regular salary, but also have additional income. Additional income in this second group can range from Uber driving on nights and weekends, to consulting or speaking engagements. 

No matter what type of irregular income you have, the process for adding up income is the same. Add up every source of income over the last few months, and then find the average amount you earn per month. If your monthly income varies greatly, it’s better to create your budget with a number from the lower range. 

Subtract Your Fixed Expenses  

The next step in creating a budget is to calculate the fixed expenses that cover your needs. This should include rent, utilities, car payments, etc. For items that vary from month to month, such as utilities, you should round up. This way, one high utility bill won’t completely throw off your monthly budget. In addition, if your taxes are not automatically deducted from your income, make sure to include taxes as one of your expenses. 

Once you’ve added up all your fixed expenses, subtract that amount from your total income. A good rule of thumb is that your fixed expenses should account for roughly fifty percent of your income. If you’re far exceeding that amount, you may want to consider ways to minimize some of your fixed expenses or find ways to increase your income. 

Divide What’s Left Between Wants and Savings

Now that you’ve added up your total income and have subtracted your fixed expenses, you’ll need to create a plan for how you will divide the rest of your income between wants and savings. This is where you get to prioritize and decide what matters most to you.

Track your spending for at least a month. Make sure you know exactly where every dollar goes. Then, write down your goals in the order that they matter to you, and compare this to your spending. Is your spending in line with your goals? For example, if your number one goal is paying off your student loans, but you consistently spend hundreds of dollars each month eating out for lunch, your priorities are not in line with your spending. 

At least some of your priorities, whether they be buying a house or retiring early, will require saving. If you’re not sure how much to save, a good rule of thumb is to put about twenty percent of your income towards savings. If you have difficulty consistently saving money, one of the easiest things to do is to make savings automatic. Consider automatically transferring a certain amount into your savings whenever you’re paid. 

Adjust Accordingly  

Make adjustments to the areas where your spending and your priorities don’t line up. To learn how to create an effective budget specifically for you, you’ll likely have to adjust as you learn more about what does and doesn’t work for you. In addition, keep in mind that the same approach to budgeting isn’t the same for everyone. For example, maybe you find it easier to stick to your budget when using cash instead of a credit card.

Seek Assistance from a Financial Advisor

The main goal of your budget should be to ensure that your spending matches your priorities. If you need further assistance in organizing your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to assist you in all of your budgeting needs! Contact us today to get your finances back on track.

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