There’s nothing wrong with spending your income as you like. However, there are many benefits to planning a monthly budget that can make your life easier. Unfortunately, it’s not always easy to plan a budget that you can easily stick to, which may be why only one in three Americans plan household budgets in detail.
This article walks you through all the fundamental steps of planning a monthly budget that works in the long term. So without further ado, let’s get started.
1. Calculate Your Net Monthly Income
Your net monthly income is the money you earn every month for spending. It’s also called “take-home pay.” This is the sum of the amounts you get from all your sources of income. However, some liabilities such as taxes, retirement plan contributions, and employer-provided health insurance are automatically deducted from your payroll. That amount is not available for you to spend, so it’s not included in your net monthly income.
2. List All Your Monthly Expenses
The next step is to list all your monthly expenses, including your bills and other liabilities. This list can include your mortgage or rent, loan payments, utilities, groceries, transportation, insurance, self-care, entertainment, and other expenses. You can’t always list every single thing you spend money on. Grouping expenses together, such as groceries, can make things easier. Still, not all expenses are the same. That’s what we talk about next.
3. Separate Fixed Costs From Variable Costs
Fixed costs are expenses that you need to spend every month. You spend roughly the same amount of money on your fixed costs monthly, which makes them easier to include in your budget. Fixed costs include rent or mortgage, bills, loan payments, monthly insurance premiums, and monthly subscription services.
Variable costs are expenses you don’t need to pay the same amount every month. Examples include groceries, eat-outs, transportation, etc. Variable costs include expenses you might not need to spend every month, such as gifts.
Fixed costs are fairly easy to include in your budget, but variable costs need an extra step. That’s what we’ll learn now.
4. Calculate The Average Of Variable Costs
It’s hard to figure out how much you’ll need to spend on variable costs in any given month. By definition, these costs vary from month to month. The only way to include these costs in your budget is by calculating how much you spend on variable costs on average.
The amount you spend on some variable expenses, such as fuel, may not vary much from month to month. Still, it’s good to include your valuable experience from the past three to four months in your average. If you have data from more than four months before, feel free to include those numbers in the average calculation. If you haven’t been keeping receipts, track your expenses for the next two or three months before finalizing your budget.
When making a budget for your variable costs, keep some margin of error for your first few months on the budget. There will be months when you spend less on the variable costs than the budget. Save this extra money for months when you need to spend more than the budget.
5. Make an Emergency Fund
You can’t include emergency costs even in your variable expenses. This is because you never know which month you’ll have to spend on which emergency. This type of expense can easily throw you off your budget and completely abandon the idea of financial planning.
An emergency fund is a pool of money separate from your budget that you keep just for unexpected expenses. This keeps your monthly budget from suffering the consequences of expenses you couldn’t see coming. All you have to do is set aside some money from your income for the emergency fund. You can also use the emergency fund to pay for variable expenses exceeding your budget.
6. Sum It All Up
Write down all your fixed costs, average variable costs, and the money you set aside for the emergency fund, and you have your budget plan! You can also do all this on a spreadsheet to make it easier. If you have some money left, you can start saving monthly with a savings account. You can also cut costs at different places and increase budgets for other expenses any way you want. As long as you follow all the steps, you’ll be good.
About the Author
Francisco Faraco, the author of this guide, is a CFA Charterholder who has worked for various organizations worldwide. FINRA Brokercheck Francisco Faraco currently works at the University of Chicago as a Teaching Assistant for the Master of Science in Financial Mathematics.