I Want to Set Up a Budget

Laura Shin

Learn the 50/20/30 rule.

The first thing you need to know when you set up a budget is that your goal is to live on your net paycheck, the money that hits your bank account after all your deductions. That means your budget excludes any pre-tax retirement contributions such as those to an employer-sponsored 401(k) or 403(b).

Budget breakdownYou’ll divide that amount into three buckets according to what we call the 50/20/30 rule:

  1. No more than 50% goes toward Essential Expenses, which includes just four expenses: housing, transportation, utilities and groceries.
  2. At least 20% goes toward Financial Priorities, which are goals that are essential to a strong fiscal foundation. These include retirement contributions, savings contributions and debt payments. You should make these contributions and payments after you pay your Essential Expenses, but before you do any other spending.
  3. Lastly, no more than 30% goes toward your Lifestyle Choices, which are personal, voluntary and fun choices about spending discretionary income. They often include cable, internet and phone plans, charitable giving, childcare, entertainment, gym fees, hobbies, pets, personal care, restaurants and bars, shopping and other miscellaneous expenses.

If you’re not interested in doing a lot of math, you can set up a Smart Budget in the LearnVest Money Center, which will tell you how closely your budget adheres to this rule of thumb. The Money Center automatically pulls in new transactions and lets you slot them into the above categories and is also available on the LearnVest app for iPhone®. You gain access to the Money Center when you sign up to become a member.

If you’re not using the Money Center, we’ll explain how to calculate this on your own in the upcoming steps.

RELATED: The One-Number Strategy: A New Approach to Budgeting

Determine how much you make per month.

In order to figure out how much you have to spend, you need two pieces of information:
i.     How much one paycheck is
ii.    How many paychecks you receive a year

Let’s say your paycheck—after tax withholdings—is $1,000.

If you receive one paycheck a month, that’s easy: you receive $1,000 a month.

If you receive two paychecks a month, that’s easy, too: you receive $2,000 a month.

If you receive a paycheck every other week, rejoice! Budget as if you receive two paychecks ($2,000) a month, but then you get a bonus check every six months, which you can put toward one of yourFinancial Priorities—savings, debt or retirement!

Lastly, if you receive a paycheck every week, then let’s just pretend you get four checks ($4,000—lucky you!) every month. For the four months of the year that you get a fifth paycheck, put that toward one of yourFinancial Priorities: debt, savings or retirement.

When you set up your Smart Budget in the Money Center, it will ask you for your income, both salary and any other income you have.

Income budget setup

Determine your Essential Expenses.

As outlined above, you will decide how much you pay every month for:

  • Housing
  • Utilities
  • Daily transportation
  • Groceries

Again, these essentials shouldn’t be more than 50% of your budget. So if you have $3,000 in take-home pay every month, then your essentials shouldn’t add up to more than $1,500.

If you’re using the Budget Setup, it will prompt you to fill in these numbers, and also show you if you are over that 50% recommendation.

If you’re using a spreadsheet or a handwritten budget, just divide your monthly after-tax income by 2 to determine how much you can spend on this category total. Then add up all four categories to make sure you aren’t going over.

Allocate money between debt, your emergency fund and your other financial goals.

Your next step is to set up Priority Goals, which should be at least 20% of your budget. If your Essential Expenses take up less than 50% of your budget, then you can allocate a little more than 20% here, if, for instance, you have a large amount of debt to pay off, or are gunning toward a savings goal, for example.

To track your progress toward your goals in the Money Center, you’ll need to connect your savings and debt accounts. For example, if you would like to pay off your credit card debt, all your credit cards need to be connected. If you want to max out your IRA, your brokerage’s IRA account needs to be connected. This will allow you to track your progress toward your goal and remind you if you’re falling behind on what you promised to send each month.

If you’re not using the Money Center, divide your monthly after-tax income by 5 to find the minimum you should be sending toward your financial goals. Each month you’ll just need to manually input how much you’ve put toward your goals in your spreadsheet or document.

Allocate your leftover money to your financial folders for your Lifestyle Choices.

Again, Lifestyle Choices include shopping, entertainment, going out and other expendable expenses such as your gym membership and travel, and shouldn’t add up to more than 30% of your budget.

If you’re using the Budget Setup, input how much you want to spend on Lifestyle Choices, and it will show you how close you are to 30%. If you find yourself wondering how much you need per category, you can look at the transactions in your Financial Inbox and use how much you normally spend per category in a month as a guide.

If you’re using a spreadsheet or written budget, multiply your monthly after-tax income by 0.3, and add up all your lifestyle categories to make sure you’re not spending more than you should.

Try out your budget.

Chance are, after seeing how your own spending stacks up against the 50/20/30 rule, you had to make some changes. Try your new budget on for size for a month or two, to make sure it is realistic. Maybe you’re always going over on groceries, but you’re under on shopping. Tweak your budget to make it suitable for your lifestyle, while still helping you reach your goals.

Be warned: You might have to make some lifestyle changes to get to your ideal budget, like bringing lunch to work or unsubscribing from those tempting marketing emails. But that’s a good thing–budgets are made to keep your spending on track!

If you know you have a problem sticking to your budget, try a cash budget.

If you find that you’re consistently spending above your means and falling into debt or dipping into savings, you may want to temporarily try a cash budget in which all your lifestyle spending is done in cash.

You can do a cash budget two ways. One is to give yourself a weekly allowance. For instance, if you have $600 in spending money, you would divide it by four to see how much you can spend per week—$150. At the beginning of your week, you put $150 in your wallet, and live on that until the next week.

Another way to do it is to follow the folders in the Smart Budget. If you give yourself monthly allowances of $200 for restaurants and bars, $150 for clothing, $50 for health, $50 for personal care, $50 for home, $50 for gifts and $50 for charity, you can put those amounts into envelopes marked with those labels. Then, when you go clothes shopping, you only uses the cash in your clothing envelope, and when you go to the drugstore, you only use the $100 in your health envelope, and so on. You stop spending in any one category for the month when the money in that envelope runs out. (However, if you have leftover clothing money at the end of the month and you need that cash for health expenses, you can transfer from category to category.) The following month, you replenish the envelopes.

If you do revert to a cash budget while you get your spending under control, we still recommend that you use the Financial Inbox or LearnVest iPhone app to log your expenses. You can enter all your cash transactions there, and in fact, doing so provides an opportunity for reflection on whether that purchase was a good use of your money or not! If you’re really finding it hard to spend your money in worthwhile ways, check out our Purchase Appraiser, which will help you figure out when it’s worth it to spend and when you should save.

We only recommend a cash budget for people who are in the habit of spending beyond their means. For everyone else, debit and credit cards are better than cash for two reasons: they usually offer rewards, and, at least when it comes to credit cards, using them builds your credit history, which will someday help you buy a car or a home. Thus, a cash budget is a temporary, not permanent, solution.

If you don’t have enough room in your budget for expenses you need or want, consider cutting costs or trying to earn more.

There are only two ways to free up more room in your budget: decrease your expenses or boost your income.

1. To cut your costs
First look at all your regular expenses, from your rent to your utilities to your cell phone bill. Call your providers to see if you can negotiate for less expensive packages. Or cut the service if you’re not using it, whether it’s a gym membership, a cable TV subscription or a texting plan far beyond what you need.

Then analyze the recent lifestyle purchases you made. If you see that in the last month you ate out 10 times, perhaps you can cut that to eight times. If you regularly buy clothing, assess how much wear you really get out of every new piece and whether the items you buy are really different from others already in your closet.

For more tips on cutting your costs, check out our Cut Your Costs Bootcamp.

2. To earn more
Check out our tips on negotiating your salary here, and take our free Build Your Career Bootcamp to learn how to shine in your career, nab promotions and raises right and left … and plump up your bank account. Also, consider generating side income, perhaps from a hobby you love—whether that’s baking cakes, making jewelry, taking photographs or opening your own eBay store. Check out more ideas to make money on the side and how real people make extra money.

Monitor your Financial Inbox to make sure you are not going over budget.

Finally, the only way to make a budget truly work for you is to actually follow it. While you can set up a budget that, in theory, will keep you spending below your means, only by diligently adhering to it will you keep your costs down, pay off your debt, grow your savings and build real wealth.

To that end, the Financial Inbox and iPhone app are excellent tools for ensuring that you stick to your budget. Because each folder has a limit, you can easily see when you are spending beyond your means. Get in the habit of logging in every day to see how you stack up against your monthly spending goals. (If you haven’t yet connected your accounts yet, do so here.)

Lastly, remember that you can do it. A budget is the foundation of all your finances. If you stick to your budget, you can achieve any money goal you set for yourself.