Personal Finance 101: How To Create A Budget

Not sticking to a budget is one of the main reasons people get into debt. Once you’re in debt, climbing out is hard, as interest makes the balance grow.

Budgeting may not be fun, but it works. When you plan your income and spending, you’re less likely to spend money you don’t have. You live within your means, avoid new debt and can pay back what you owe.

A budget is a simple tool, but it’s essential for taking control of your money and building wealth. If you’ve never budgeted before, this guide shows you how in five steps.

Step 1: Calculate your income

First, you need to know you have enough coming in to cover your living costs.

Add up all the income your household receives, starting with your take-home pay. This is simple if you’re on a fixed salary. If you’re paid hourly or self-employed, estimate your hours and set aside money for tax and expenses first.

Include all other income too: benefits, investment income, savings interest and side hustles. If you share bills with a partner, budget as a household and include their income.

Step 2: List all your spending

Next, work out how much you spend. If you have no idea, log into your banking app and look at your last three months of statements. Use them to get an average. Most banking apps now group your spending by category, which makes this quicker.

Annual and quarterly bills

Plan for bills that don’t come every month, such as insurance, subscriptions, the TV licence and your car’s MOT. Search your emails and bank statements for past invoices and note when each one renews. Divide the yearly total by 12 and set that amount aside each month.

Maintenance and repairs

Home and car repairs are hard to budget for because they vary a lot from year to year. Check what you spent on them over the past year or two, divide by 12 and save that each month. If you don’t have past figures, make your best estimate.

Every home and car wears out, so always set something aside. Keeping this money with a different bank from your current account helps you avoid dipping into it.

Create a spreadsheet

Once you have all your costs, put them in a spreadsheet grouped by category, like the example below.

Seeing your spending laid out shows where your money goes. More importantly, it makes it easy to spot savings.

Prefer a ready-made tool? The free MoneyHelper budget planner does the sums for you.

Step 3: Set your budget

Now that you know your income and costs, set a realistic budget. Plan everything you’ll spend in the coming month.

If you’re not sure how to split your money, the 50/30/20 rule is a simple starting point: 50% of take-home pay on needs, 30% on wants and 20% on saving or paying off debt. On £2,500 a month, that’s £1,250, £750 and £500.

This is also the time to look for savings. Think in two ways: quick wins now and bigger changes over time.

Short-term savings

How fast you want to save or clear debt decides how strict your budget needs to be.

I’m ruthless about cutting costs. I get rid of anything I don’t use often or that doesn’t add value to my life. If I miss it, I can always add it back.

So, ask yourself: what have you bought recently that wasn’t worth it? What could you cut and not miss? A gym membership you hardly use? A subscription you never get round to? Could you eat out less, work out at home or switch your energy, broadband or mobile deal?

Long-term changes

Once you’ve had some quick wins, look at the bigger drains on your money.

For most people, the three largest costs are housing, transport and food. Changes here are harder because they affect your lifestyle, but they also bring the biggest savings.

If you dream of becoming a millionaire or being financially free at a young age, consider big changes such as moving somewhere smaller near work or going car-free. Even with smaller goals, it’s worth seeing what you could save on the big three.

Think carefully about long-term changes, because they’re harder to reverse.

Step 4: Automate your surplus

This step is often missed, but it matters if you want to build wealth.

Ideally, you’ll have money left over after covering your costs. If you spend more than you earn, treat it as an emergency. Stop all non-essential spending and focus on paying back debt. If you’re struggling, free debt help is available from StepChange and MoneyHelper.

If you do have money left over, don’t spend it. It’s your chance to build wealth. Use it in this order:

1. Debt: pay off the loan with the highest interest rate first.
2. Save: build an emergency fund and save for one-off costs.
3. Invest: put your money to work.

Set up a standing order on payday so you’re automatically paying off debt, saving or investing in that order.

Step 5: Monitor your spending

A budget isn’t something you set once and forget. Review it every week to check you’re on track in each category.

Track your spending in a notebook, a spreadsheet, your banking app or a budgeting app such as Emma, whichever suits you.

If you’re heading for an overspend, adjust your spending for the rest of the month. That takes discipline. You’ll face temptations every day, so keep your goals in mind, whether that’s getting out of debt or buying your first home.

If you’re always over budget, you may have been too ambitious. Go back and give yourself some slack. Getting it right takes a few months of trial and error.

Final word

Many people put off budgeting because they think it will take the fun out of life. It doesn’t have to. Budgeting is about knowing where your money goes and making sure the money you work hard for is used well.

Budgeting is a vital life skill that most people have to teach themselves. We hope this guide helps you build a budget that gets you to your goals.