How to Start a Budget

Budgets begin by understanding your income and expenses.

The basic principle of any budget is that your income minus all expenses equal zero.

Step 1: Identify all income sources

To start a budget, you need to understand all your income.

There are many sources of income, the most common being your paycheck.

Other sources of income include dividends, interest, bonuses, freelance work, and any other money that goes into your bank account.

Gross vs. Net Income

When talking about income from a paycheck, whether that is from a salaried or hourly job, you have your gross income and your net income.

Your gross income is your hourly rate times the hours you worked or your salary divided by the number of times you get paid annually.

Your net income is your income after all taxes and deductions. This is the income that you will use for your budget.

Step 2: Track your expenses

After you identified your income, which is the maximum amount of money you can spend on expenses, you must track all your expenses.

Feeling overwhelmed? We break it down below.

Identify categories and subcategories for your expenses.

Basic categories that apply to almost everyone is housing, transportation, and food.

Housing includes rent or mortgage, rental or homeowner insurance, property taxes, and utilities. Some break out utilities into their own category or a sub-category. There is no right or wrong way, as long as you account for it!

Transportation includes car payments, gas, car insurance, car maintenance, and any vehicle registration fees.

Food includes groceries and eating out. Don’t forget your snacks!

Other categories include entertainment, personal care or beauty, clothing, vacations, any debts (student loans, personal loans, outstanding credit cards, etc), and savings.

Yes, savings is an expense category since your budget must break out the entire income amount into an expense. We talk about savings basics in the savings section.

How to track expenses

There is no right or wrong way to track expenses, but you do need to find a way that works for you consistently.

Index cards that they carry around with them. Older generations would use a checking balance sheet.

Apps exist where you can track your expenses. Some are free, and others with more advanced features may require a subscription fee. The convenient allure of some apps is that you can link to your bank account or credit cards to automate some of the tracking. If you struggle with discipline to track your expenses, this might be a great option.

Excel sheets can be used to track expenses. Google Sheets is a great way to access an Excel sheet anywhere from your cell phone or portable electronic device.

Remember when tracking your expenses: every transaction must be accounted for and each transaction must be placed into a category or sub-category.

Step 3: Budget Plan

Now that you identified all your income and expenses, you need to create a plan for your money for in the future. There are multiple methods to plan.

Zero-based Budgeting

All the budgeting basics above use the principle of zero-based budgeting where every dollar of your income is allocated to a specific expense or savings so that your total budget equals zero.

What if you have a negative or positive when you take your income and subtract your expenses?

A negative budget means you are spending more money than you are bringing into your budget. This will result in debt and you are likely living paycheck to paycheck. (Anywhere from 33% to 78% of Americans live paycheck to paycheck.)

A positive budget means you are bringing in more money than you are spending. This means you have money left over that you can save. We cover saving basics in another section.

50/30/20 Rule

The 50/20/30 rule is simple: 50% of your income goes to needs, 30% of your income goes to wants, and 20% of your income goes to savings.

Each category is classified as a need, a want, or savings.

A need is the basics: housing, transportation, and food.

A want would be the other categories: entertainment, personal care or beauty, clothing, vacations, etc.

Savings include retirement accounts, brokerage accounts, 529s, high-yield savings accounts (HYSA), etc. In another section, we cover saving basics.

For those who don’t want to think too hard about how to budget, this could be a great option!

Remember when calculating 50%, 30%, or 20% of your income to use your net income.

Envelope System

The envelope system is just how it sounds. Your budget uses cash in envelopes. Each category has its own envelope.

The envelope system is particularly good for those who lack the discipline to keep their expenses within their income.

Fixed expenses that are taken out electronically might not have a cash envelope but should be set aside in an account (virtual envelope) to ensure that money is spend on the category it was assigned.

Step 4: Track and Monitor

With any budget, especially when starting out, monthly (or even weekly), monitor your income and expenses (particularly your expenses) to ensure you are sticking to your budget.

If your actual expenses are off from your budget, adjust your budget accordingly.

It’s not uncommon to have to adjust your budget for the first 3-6 months to get to the goal of a zero-based budget.

It’s okay to modify your budget! In fact, it’s encouraged.

If you are consistently spending $500 on groceries, but only budgeting $300, you will be discouraged that you are overspending and that it’s causing your budget to go negative. Change your groceries to what you realistically spend and adjust your budgeting accordingly.

Alternatively, if you budget $300 for groceries and are consistently spending $500, but don’t have $200 in your budget to reallocate, take a look to see how you can spend less on groceries.

Food is one category that often causes people to have a negative budget and go into debt.

We will cover tips for reducing your grocery or food bill in a later section!