Lesson 1: How to Do Budgeting
Step 1: Calculate Your Net Income
Net income is the amount of your salary that remains after deducting taxes and retirement contributions. Taxes include Federal Income Tax, State Income Tax (although not all states impose this), and FICA Taxes (~7.65% in totoal). Additionally, any income from investments, freelance work, and benefits or bonuses also contributes to your net income.
While retirement contributions such as 401(k), 403(b), and Roth IRAs are tax-deductible, it’s important to remember that you must contribute to these accounts before reaching the age of 59.5. Therefore, budgeting for retirement contributions is essential.
Step 2: Track Your Current Spending
You can start by reviewing bank statements, credit card transactions, and e-wallet or payment app histories to obtain a comprehensive view of your monthly spending. Next, you should categorize each expense. Here are some categories for your reference:
Step 3: List All Fixed & Variable Expenses
You should categorize your expenses into two main types: “Fixed Expenses” and “Variable Expenses.”
Fixed Expenses are those that remain mostly the same each month, while Variable Expenses fluctuate from month to month. If you want to cut your budget, it is generally easier to control the Variable Expenses.
Step 4: Set Your Goals (Short-term & Long-term)
You might be wondering: “How much should I save or have?”
To start, it’s helpful to set some short-term goals that are easy to achieve. After that, you can focus on establishing long-term goals, which are more likely to help you reach your dreams.
Step 5: Adopt a Budgeting Method
A good rule of thumb for budgeting is the 50/30/20 Rule: allocate 50% of your income for needs, 30% for wants, and 20% for savings or debt repayment. This guideline is a useful reference, but you can determine the best proportions for your own needs through trial and error. The 50/30/20 Rule has been effective for many people.
There are also additional methods that can help improve your budgeting:
- Zero-Based Budget: Ensure that every dollar you spend has a specific purpose. This means each dollar should receive “approval” before it is spent to avoid unnecessary expenses.
- Pay Yourself First: Set up automatic savings or investments as soon as you receive your paycheck.
Below is my favorite chart illustrating the relationship between annual savings and age of becoming a millionaire:
Step 6: Create Your Monthly Budget Plan
First, you need to establish a budget for the money you plan to spend in the upcoming month. Then, make sure to track your actual spending throughout the month. At the end, you can compare what you actually spent with the budget you set.
Consider using a budgeting app (e.g. YNAB or Mint) to assist you. These apps can simplify the budgeting process and provide detailed charts to help you visualize your progress.
Step 7: Monitor & Adjust Weekly + Review Monthly & Improve
Sometimes, you may find that you’ve overspent in certain categories. Don’t worry—this is perfectly normal! All you need to do is make a small adjustment by transferring money between different categories. (e.g. If you’ve overspent $10 on “Dining Out,” you might consider reducing your “Coffee” budget by the same amount.) Budgeting is flexible and can even be fun! The key is to continuously monitor your spending and ensure you’re keeping an eye on the bigger picture.
At the end of each month, revisit your budget and align it with your goals while tracking your progress. Take the time to reflect on what you can improve for the future, and fine-tune your budget plan to account for inflation.
If this is your first-time budgeting, you’ll gain a comprehensive view of your monthly expenses. From there, focus on allocating your budget across different categories and identifying areas where you can reduce spending.
2 Parts of Budgeting: Income and Expenses
Know what comes in vs. what goes out. Understanding these 2 core parts is the first step to taking control of your money. By tracking both, you’ll unlock smarter spending and real savings.
There are two fundamental components to creating an effective budget: increasing your income and lowering your expenses. Improving either of these aspects can be beneficial.
If you are dealing with significant debt, focus on eliminating your wants before addressing your needs. Additionally, you should seek ways to increase your income. The priority should be to pay off the debt first.
“What you do today is going to change your tomorrow”
Next, we’ll dig deeper on how to save/lower expenses in a more effective way.
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