In this guide, you’ll learn how to create a spending plan that really works for you, no matter your financial situation or goals.
Collect Your Expenses
The first step in the process is to see what you are spending your money on. “Look at the last three to six months of discretionary spending patterns and average it out per month to create a sustainable spending plan,” said certified financial planner (CFP) and author Gary Grewal in an email to The Balance. To do this, you must first collect bank or credit card statements if you pay with a credit or debit card on most purchases. If you mostly pay with cash or checks, you’ll need to gather receipts and bills. Include periodic bills and expenses that are paid annually, quarterly, or bimonthly, such as tuition, taxes, or insurance, as well as those payments that can change, like grocery receipts.
Categorize Your Expenses
When taking a look at your spending habits and patterns, split up your expenses into categories that match your lifestyle. For example, a simple “home” category could include rent, utilities, and insurance. Or you can lump restaurant expenses and groceries together in a “food” category. If restaurant meals are an occasional treat, though, you might consider placing those expenses in the “entertainment” group. Common categories might include:
Home expensesCredit card or loan paymentsEating outGroceriesTransportationHealth careKids and/or petsGifts or donationsEntertainment
Expenses can be classified as fixed or variable expenses. Fixed expenses don’t fluctuate much—for example, rent or monthly auto insurance bills—while a variable expense changes weekly or monthly. For example, monthly grocery runs or clothing purchases are considered variable expenses. When reviewing your spending, be sure to look closely at the fixed and variable expenses. Variable expenses will likely change more often, and they could have a significant impact on your budget. Within this category of expenses, you will typically be able to identify more areas for cutting back or saving.
Evaluate Your Expenses
Assess expenses with three simple categories: needs, wants, and savings. Tori Dunlap, founder of Her First $100K and an internationally recognized money and career expert, assigns motivational names for these categories, as described in an email to The Balance.
Needs: All the Adulting Expenses You Can’t Escape From
“This money is for the expenses in your life that you need to eat, live, breathe, and all things survival,” she said. According to Dunlap, this includes monthly rent or mortgage payments, groceries, utilities, insurance payments, and loan and credit card payments.
Wants: Fun Spending
These are often entertainment expenses like Netflix subscriptions and dinners out. “Spending doesn’t mean deprivation,” Dunlap said. “There are certain things in life that bring us true joy and happiness. For example, I really enjoy spending money on food, travel, and nesting. By prioritizing contributing money into my other two buckets, I can spend guilt-free on my three value categories."
Savings: Big-Money Life Goals
“I take my ‘big money’ life goals very seriously,” Dunlap said. Goals might include three- to six-months of living expenses in an emergency fund, paying off debt, or investing for retirement. She suggested contributing to goals by setting up automatic transfers from checking to goal-oriented high-yield savings accounts or retirement accounts.
Create a Spending Plan
To create a budget for your next month’s take-home income, you have several options. Some people prioritize spending with the 50/30/20 rule, popularized by U.S. Senator Elizabeth Warren, D-Mass., in her book All Your Worth, written with her daughter, Amelia Warren Tyagi. In essence, 50% of your income should go to your needs, 30% to wants, and 20% to savings. Not everyone is going to find that the 50/30/20 rule syncs up with their situation. Grewal points out you may want to save more than 20% if you’ve set a goal to buy your first house, for example. Also, a single software engineer living with family could spend much less than 50% on necessities, allowing them to save more—versus an hourly retail worker paying rent on an apartment. Another method to consider is zero-based budgeting, in which you assign a “job” or expense category to every dollar coming in, based on your priorities. Grewal uses this strategy, with help from the free expense tracker Mint, to set amounts and watch his spending over the month. With this method, Grewal has automatic payments and deductions set up for retirement funds, credit card, home, car, and travel savings accounts, and three months of fixed expenses in an emergency fund. Other approaches to budgeting include 80/20 budgeting, where you put 20% into savings and spend the other 80%. With envelope-based budgeting, weekly or monthly spending is determined by a system of cash or electronic envelopes—when the cash is gone, it’s gone. This may help you slow down and check your accounts before spending.
The Bottom Line
Whichever method you choose, remember that there is no one-size-fits-all approach to budgeting. What works for you may not be the best method for your mother, for example. It’s important to keep up with your spending plan and check in on your progress. If one approach is not working for you after you’ve reached one financial goal, for example, test out another. As you set—and reach—new goals, your spending plan will likely change and adapt, too.
