• The best way to get a handle on your income and your expenses is to create and live by a budget. A budget is a simple tool to help you track the money you have coming in and going out so you can better control your finances and any money-related stress. It doesn’t mean denying yourself the things you want — it just means having the right information on-hand to help you make money choices.

What is a budget?

A budget is a spending plan that tracks the money you have coming in and the money that goes out for expenses and to cover your lifestyle.

Things you usually track in your budget are:

• Paychecks and other income you have coming in 

• Things you absolutely have to pay for, like: debt payments, rent or a mortgage, utility bills and loan payments

• Extra money you spend on discretionary things, like: travel, shopping, entertainment, restaurants and hobbies

• Money you’re setting aside for retirement or big purchases.

Why do you need a budget?

Knowledge is power. The more you know about your financial life, the more information you have to make sure you’re managing it well. A budget lets you know how much money you have coming in and how much you will need to cover your lifestyle. More than anything else, a budget gives you more information about your own lifestyle and how to manage it.

More than anything else, a budget gives you more information about your own lifestyle and how to manage it.

Even though budgets are easy to create and follow, the reality is that so few Americans actually take the time to make and use them. Ask anyone who does live by a budget, and you’ll hear that his or her financial life got a whole lot simpler after taking a little time to figure out how much was coming in, what needed to be paid for and how much extra there was for savings and fun.

How to create a budget

You can budget on paper, online or by using a spreadsheet. How you choose to do it is less important than just doing it — the sooner you budget, the sooner you'll have a spending plan that will simplify your money management and help you reach your financial goals.

The first thing you need to do to create a budget is track how much you are spending. Use the percentages below to gauge how much you should spend each month on common expenses. In most cases, the percentages reflect the maximum amount you should spend.

• Housing: 30%
  This includes mortgage payments, rental payments, taxes and insurance.

• Transportation: 10%
  Depending on your age, if you own or drive a car, this includes monthly car payments, insurance, maintenance and gas. If you commute using public transportation, this includes your total commuting costs.

• Retirement savings: 10%
  The earlier you start saving, the more you'll have for the long run. If you don't have any retirement savings, you may need to be saving a higher percentage, such as 15-20%. 

• Debt: 10%
  If you don't carry any debt, such as credit card, loan or other debt payments, then use this extra money to build an emergency fund or save more for retirement.

• Food: 10%
  This category is usually the biggest budget buster, so carefully track your grocery shopping bills and how much you eat out.

• Insurance: 5%
  You'll need health insurance or any other types of insurance to protect yourself.

• Utilities: 5%
  This is for household expenses, like electricity or gas, cable and phone bills.

• Miscellaneous: 20%
  This includes saving in advance for big purchases, having some "fun money," saving for short-term needs like a vacation or putting more toward debt and routine payments that aren't emergencies. 

• Emergency funds
  Anything left over should be put into building your emergency fund since you've already accounted for housing, food, utilities and fun money. For most people, the rule of thumb is to keep enough savings on hand to cover at least three to six months’ worth of expenses. 

If you are over-budget in some categories, try to find ways to cut your spending. Or if you aren't spending enough, such as for retirement savings or for an emergency fund, it's really important to try to find ways to save more. 

• See also: Loans, Retirement, Insurance, Emergency funds

To create a monthly personal budget, do the following steps:

1. Tally your income

If you're paid a salary and receive a regular paycheck, then you know exactly how much money you make each month. If your income varies, make a conservative estimate. Don’t forget to add any extra money you make on odd jobs, gifts or service-related tips.

Never count credit card and loan-related cash advances or withdrawals as income — that should always be counted as debt.

2. List regular expenses

Regular expenses are the daily payments that you can’t forget about — rent, a mortgage, utilities, insurance, loan payments, credit card payments, gas, groceries — anything you absolutely must pay.

It also includes income taxes, which for most people are deducted directly from your paycheck. What comes out of your paycheck should be close to what you owe, so you aren’t paying too much or too little in taxes each pay cycle. If you typically receive a big refund or owe at tax time, be sure to include that into your budget. Also consider adjusting your withholding so that doesn't happen.

• See also: Withholding and estimated taxes

If you work as an independent contractor or are self-employed, make sure to set aside enough money to cover income taxes and self-employment taxes each month so you have enough cash on hand to cover your estimated tax payments. However you pay them, taxes need to be included as one of your regular expenses.

• See also: Self-employment

3. Calculate your spending money

After you’ve accounted for your regular expenses, your goals, your bad debt payoff and your retirement savings, the money that’s left is your spending money. Come up with a budget for this fun stuff — how you break it down between meals out, concerts, a new television and whatever else. But avoid the temptation to spend everything extra you make — especially as your income goes up. If you have extra income, consider investing it instead so that it can grow — you'll end up with more money to spend in the future and have more flexibility with your career choices, since you’re not living paycheck-to-paycheck. 

4. List goals and the savings required to meet them

In this part of your budget, you decide on what’s most important to you so you can set aside enough money to cover those things. If your goal is to travel, you need to set aside money for it so that you don’t run up credit card debt by taking a vacation. For example, set aside $50 per month for travel if you typically spend $600 per year. If you plan to buy a house, start saving for a down payment and closing costs. Think ahead to retirement — we recommend you save at least 10% of each paycheck for that.

Figure out how much money you need to save each month to reach these goals and set aside money in your budget to help you reach them.

• See also: Save for a goal tool

5. Pay off debt

When you carry a credit card or high interest loan balance, you have to pay interest. The general rule-of-thumb for debt is don’t use credit cards and high interest loans to pay for things that quickly lose value — cars, clothes, vacations, furniture, etc.

If you have credit card debt, your budget must allow you to make at least the minimum payment each month so you don’t pay late fees and penalties. You don’t want debt collectors knocking on your door. But that's the bare minimum. Your goal should be to have $0 in credit card debt — which means you have to pay much more than the minimum. See if you can set up your budget so that you can zero your balance within six months or less. Focus on credit card debt payoff first, before anything else.

Student loans and home loans are generally considered good debt because they pay for things that retain value, plus you may get a tax break on the interest paid. You don’t have to include these as debt payoff items in your budget — just include them as regular expenses to make sure you can cover them every month.

• See also: Credit card payoff tool

6. Set aside emergency funds

You should always have a buffer of at least $1,000 in your checking account. This will help you deal with unexpected emergencies like home and car repairs or medical costs. It also will help you avoid using credit card debt or over-drawing your checking account, so you don’t get hit with bank penalties and fees. If you’re new to budgeting, you can build up to $1,000 buy setting aside $19 a week. In a year, you’ll have your $1,000 buffer.

Once you have your $1,000 buffer, it's probably a good idea to build up an emergency fund. The right size for your emergency fund depends on your job security and other factors, but for many people is an amount that could cover 3-6 months of living expenses.

• See also: Emergency funds

7. Set aside retirement funds

The earlier you start saving for retirement, the more you’ll have in the long run. If you want to stop working at some point, you should start putting aside at least 10% of every paycheck into a retirement savings account. If you’re closer to age 30 and haven't saved much yet, you may need to bump that number up to 15% or more to make up for time lost. The longer you wait to save for retirement, the more money you lose out on — due to the “magic” of compound interest.

We consider retirement savings an essential item in every budget, because everyone eventually stops working and needs money to cover expenses. Social Security will provide some of that for most people, but it probably won't be enough. Do you have other sources of money? If not, you need to start saving, even if you're paying down debt, too — every bit helps and your earlier dollars will have the most time to grow.

8. Know where you are and what you need to change

Your ideal budget will cover all of the above. Take a look and add up everything. If your income is enough to cover everything then your budget is going to be easy to create and follow. If your income isn’t enough to cover everything, decide on ways to cut back on extras until you’ve paid off debt and started saving.

9. Automate everything

You can increase your chances of sticking to your budget by automating as much of your money life as possible. Set up an automated deposit from your paycheck directly into your savings account and participate in your retirement plan at work if one is offered so your money gets transferred even before you see your paycheck. Use your budget to help you figure out how much to transfer from savings into checking, making sure you don't overdraw the account while also resisting the temptation to spend all your excess cash. Use your online banking tools to set up automatic payments and transfers.

How to manage a budget

Creating a budget just isn’t enough — you have to stick to it and manage it.

The great thing about budgets is that they put you in control. As your income and expenses change, you might find you need to adjust your saving and spending. Each year might mean a slightly different balance of earning, spending and saving.

• See also: Saving

You can check in with your budget as often as you’d like. We recommend creating and setting a plan in motion and checking in every three to six months to see how you’re doing and readjust if you need to. If you’re in the middle of paying off debt, create a monthly calendar notice to review how you are progressing on your debt payoff. Even if the amounts you’re paying off are small, they are worthwhile. Over time, small things add up. You should be proud that you’re taking charge of your finances and working toward a smart, savvy financial future. Soon you’ll be debt free and have much more money to put toward smart saving and spending.

And don’t forget — your needs and wants will change. Update your budget and adjust your plan as your financial picture changes. Always keep a budget and you will always be ahead of the game.

Words to know

Unsure about something you read? Many of the financial terms you came across in this article are defined in our financial glossary. A-Z Glossary

Links we like

Here are a couple online features you might find useful:

• Mint: www.mint.com
• YouNeedABudget.com: www.youneedabudget.com
• BudgetTracker: www.budgettracker.com
• Buxfer: www.buxfer.com