How to Create a Budget That Works for You

When it comes to personal finance nothing feels more daunting than making a budget. Whether it is the numbers, the fact that it is money or the honest look at what you are actually spending, most people cringe at the thought of making one. However, a budget isn't all that difficult. It's a matter of repeatedly doing addition and subtraction until the end result is zero.

Before that commences, take a month to write down everything you spend. Categorize each item to determine where your money is going. Use categories like dining out, food (grocery store items), entertainment, transportation, gift giving, etc. Doing this will give you an idea on how much you spend on gas for a month or if your trips to Starbucks are costing more than you thought.

During this time you will also want to make a list of all regular expenses that occur throughout the year. Make a list of membership dues, insurance payments, magazine subscriptions and anything else that you can anticipate in the coming year.

At the end of the month add up each category to find out how much you are spending. Now is a good time to think about this spending as well. Are you shocked that you spent $300 dining out last month? Did you realize that each quick trip to the store was costing you $25 or more? Think about your spending and consider where you can cut back.

A Four Tiered Budget

I visualize my budget like a four tiered cake. Each tier represents a portion of my budget. The largest tier can be into the most pieces or it can be cut up into many larger pieces, much like an actual wedding cake. I have plenty of room to manipulate it. The smaller the tier, the less room I have for cost cutting. The smallest, the top tier, like that of a wedding cake is the most important. It is the tier that needs to be protected and saved for the future.

Tier 1 – The smallest part of your budget, to begin with is your automatic savings. This is the amount of money you are going to take from your income immediately and send to a savings account. The percentage is up to you but it is best to shoot for 10% of your net income. This can be adapted some in the beginning but the goal is for you to work up to as high of a percentage as you can. Remember, this is a very precious layer to your budget.

Tier 2 – Your housing expenses falls into this tier. These have little room for cost-cutting. Your rent or mortgage payment is the same each month, as are your utilities (You are going to budget for the same amount each month based on your monthly average. You can get this from your utility company if you do not have a year's worth of bills available to you.) This tier is also important because it is the expenses that you will pay every month regardless of how much you spend in the other categories. This tier is always paid out of your income before anything else (and after sending money to your savings account.).

Tier 3 – The expenses that fall into this tier are important but not vital should your income change. There is more room for you to find cost-cutting steps and even eliminate some of the items that fall into it. This tier consists of cell phone bills, internet, automobile and transportation expenses, food, medical expenses, loan and credit card payments. This is one of the larger portions of your budget.

Tier 4 – This final tier consists of luxuries like cable, gym memberships, magazine subscriptions, internet, new clothing and entertainment. This is also the area to include your savings for future travel or gift giving, your dining out fund and allowances for your children. Many if not all of these items can be eliminated if they cause you to go over your budget. Some may be important to your life but they have large potential for cost-cutting. Your clothing budget, for instance can be culled a great deal if you shop only when items wear out and you stick to Thrift Stores and yard sales. The items in this tier can be added back in once debt is eliminated or your income increases.

Balancing the Budget

Now that you have the dollar amounts for all the categories, you can begin to formulate your budget. I really like to use Gail Vaz-Oxlade's interactive budgeting worksheet for this part.

*For the income, make sure you are using your net income (after taxes, employer 401K contributions, etc.).

Input the dollar amounts for each category. You are working for a zero balance at the bottom of the worksheet. If you end up with a negative number then you will need to cut back on your expenses. Start with items in Tier 4 first. Manipulate it until you get a zero balance.

If you have put in all the dollar amounts and ended up with a positive number, that is great! You are living below your means (or you forgot to include something). You can take the extra funds and increase the amount you are using to pay down debt or increase your savings percentage.

Utilizing the Budget

The truly difficult part, in my opinion, of a budget is sticking to it. It is important to put forth the effort and attention to stay within the dollar amounts you have outlined for each category.

To do this consider using the cash envelope system, shopping with cash only or even gift cards and prepaid debit cards to ensure that you do not go over your limits.

It is important to remember that your budget is not set in stone. If you find that you really need to have more money in the transportation category, it is fine to amend it but you'll need to determine which category will be reduced.

Budgets are fluid, they can be changed every single month in necessary. The important thing to remember about making a budget is that it is meant to be a tool. It is a tool that allows you to live the life you want to live.