There’s more than one way to make a budget. People with regular and abundant income can plan ahead and allocate income to various spending categories. But if your income is more sporadic or on the small side, another approach might help you spend less than you earn.
- Create a Three-Part Budget. Portion your annual after-tax income into three (unequal) categories based on your expected expenses: occasional, regular necessities and flexible.
- Make Required Payments On Time. Avoid late fees and a bad credit score.
- Track Your Spending As You Go. Monitor your money so you know when you're running out.
- Build Up Savings. It will help you fill in gaps and reach longer-term goals.
Create a Three-Part Budget
To make a plan for your money, you first need to know how much you have to work with. Estimate this amount for the budget period you have in mind. If you’re a college student, it might be a semester. If you live off of fairly predictable earned income (like from a job) or fixed income (like from Social Security), a year might make sense. That way you’ll be able to plan for the kinds of expenses that only happen every now and then.
Think first about how much you’ll owe in taxes and how you’ll pay them, because taxes are unavoidable and will haunt you for a long time if you fall behind. If taxes are taken out of your paychecks, you should be set. If you have to pay taxes yourself, as a self-employed person or someone living off passive income, figure the amounts you owe and the payment schedule into your overall plan.
Next, add up the occasional expenses you expect; these are things you will pay less frequently than once a month. These might include payments for car insurance or home insurance, property taxes on your home, your kids’ tuition, your college textbooks or sorority dues, vacation costs, holiday costs (for travel, decorating, gifts, etc.), or your health insurance deductible if you expect you’ll have to pay it.
Deduct this total from your after-tax income. It is the amount you need to put in a short-term savings account so you can pay your occasional expenses as they arise. Divide it by your number of pay periods over your chosen time frame and that’s how much you need to take out of each paycheck to cover occasional expenses. If your paychecks vary, you can calculate the amount as a percentage instead, as shown in the table below.
Add up any other expenses that are necessary and occur regularly. Make sure you are only including the kinds of things that you need to survive, work or study, and stay out of financial trouble. These might include housing, utilities, cell phone, transportation costs, debt payments and basic food and apparel. Deduct these from your after-tax-and-occasional-expenses income.
What remains is your spending money. These are the funds that you can blow on day-to-day desires and temptations, like movie tickets, fun clothes, dinners with friends and pricey lattes. Divide your annual amount of spending money by your number of pay periods (or figure it out as a percentage). In order to stick to your budget, you can only spend this much from one paycheck to the next. And you should track this amount carefully, so you know when you’re overspending, and when you’re due for a splurge.
Here’s how this approach would break down for a typical worker, earning $32,000 per year:
|Annually||Paid Monthly||Paid Bi-Weekly||Pay Varies|
Save for Occasional Expenses
Pay Regular Required Expenses
Use As You Wish
Total After-Tax Income
The formula to apply to your own income is this: Annual After-Tax Income – Occasional Expenses – Regular Necessary Expenses = Amount You Can Use As You Wish
Amount You Can Use As You Wish / Number of Pay Periods Per Year = Amount You Can Spend Between Paychecks.
Once you have these numbers in hand, here’s how you can help yourself stay on track.
Make Required Payments On Time
Late payments, and missed ones, can have all sorts of harmful effects on your credit score and beyond. They can lead to late fees, higher interest rates, dropped insurance, repossessed cars, even eviction!
Make sure you make required payments on time to avoid these outcomes. Create a calendar with all required payments listed a few days before their final due date, to allow for snail mail transit time or an electronic funds transfer. These might include your rent or mortgage payment, any insurance premiums, car payments, student loan and credit card minimums.
Track Your Spending as You Go
Once you’re down to the money you can use as you wish, you might think you’re home-free and can spend with abandon. Not so fast.
This is the money that can slip through your fingers the fastest, leaving you broke and counting the days until your next paycheck, or (worse!) going into debt. Track every dollar as you spend it, so you always know how much you have left to spend.
It’s easiest to do this with a web service or app that does the tracking for you. For example, Mint is free software that allows you to create a budget. For the simple approach recommended above, you could make three categories. Mint then pulls information on your income and expenses from all your accounts and categorizes them. The app uses bars and colors (green, yellow and red, of course) to show you how close you are to your limits at any given moment.
Level Money is an even simpler way to see if you’re overspending. This app begins the month with your spendable amount, and pulls information from your bank and credit card accounts so you always know exactly how much you have left.
The old-fashioned approach involves cash in an envelope. When you get a paycheck, pull out only the amount you can use as you wish until you get your next check. This way you can see exactly how much you have left. Don’t use credit cards at all if you’re using this method of sticking to a budget.
If you’re having trouble making your money last until your next paycheck, take a look at your regular spending and see if you can implement cheaper substitutes in areas where you often go overboard. In these places, your lifestyle priorities—like having fun experiences with your friends, or showing people that you care about them with generous gifts—might be overwhelming your financial priorities.
There are often ways to achieve both goals at the same time. If evenings out with pals are consuming too much of your income, invite them over to your house for game night or find free events in town you can attend as a group. If you’re spending too much on clothes for your kids, try to get hand-me-downs from friends or at thrift stores. If you’re overspending on gifts, see what you can make by hand—cards, baked goods or crafts—instead of buying at retail prices.
Build Up Savings
If your income is low and your expenses are high, you might not have any savings. But as soon as your budget is under control, this should be your next goal.
Start small, carving a little money off of each paycheck to put aside for a rainy day. Add to it any unexpected income—birthday money, rebates, cash back from your credit cards, work bonuses or unexpected extra earnings (like babysitting money, or overtime pay).
Don’t go out and spend this money as soon as you have enough for the next Xbox. Allow this to grow into your emergency fund, equaling about 10% of your annual income, which you should only use in a case of a true need, like a home or car repair, job loss or a major medical bill. A robust emergency fund should prevent you from putting surprise expenses on credit cards that charge high interest rates.
Whenever you dip into your emergency fund, make sure you replenish it back to the 10%-of-income level. Then, with any other money you can shave from your spending, keep saving for other life goals, like a downpayment on a house or your retirement.
Sticking to a budget requires some forethought, planning and monitoring as you go, but it’s essential for good financial health.