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The Definitive Guide To Creating A Budget That Works

Molly Grace11-minute read
July 01, 2021

Creating a budget can feel like an impossible math problem. With so many costs that need to be accounted for, it can be hard to get the numbers to add up correctly no matter how many cuts you make.

It might even feel easier to just give up on budgeting and continue with your method of not thinking too much about your money strategy or loosely keeping track of spending in your head. But having a budget that tells you how to spend and save your money in an intentional way is an important step to having healthy finances.

How does one go about creating a budget that actually works? Let’s go over all the things you need to know to create a successful budget that works for you and your finances.


To be able to create a budget, you first need to know how much money you have to work with.

Generally, you want to be at least a little bit pessimistic about how much money you have coming in, especially if your income varies significantly. That way if you have a month where you make less you won’t be scrambling to make up the difference.

Start with your regular take-home pay. Check your recent paystubs to see what your after-tax income was before insurance, retirement or any other automatic deductions were made.

If you don’t make a fixed amount each pay period (if you’re paid hourly, if you have a commission-based salary, if you’re a freelancer, etc.), look at several months of pay documents to get an idea of what the lower and higher ends of your pay spectrum are. Basing your budget on the lower end of that spectrum will keep you from overspending in leaner months and give you a nice buffer when you bring in more than expected.

Don’t forget other forms of income (after tax and other costs) such as earnings from a side job, rental income or child support.


Next, take a look at what you’re spending every month. If it helps, separate your spending into categories.

How you categorize your spending is up to you, but all your expenses can usually be put in one of three buckets: things you need, things you’re saving for and things you want.


These are the basic things you need to survive and stay afloat like housing, transportation and groceries.
The specific items and categories that belong in the “needs” bucket will vary slightly from person to person, so take some time to think about what your basic necessities are.

How you allocate funds to various items within this bucket depends on your circumstances. For example, 30% is often cited as the ideal percentage of your monthly gross income you should spend on housing, but the feasibility of that largely depends on the housing market you’re in. Someone in a large high-cost city is generally going to have to spend a larger portion of their income on housing than someone who lives in a rural area. And if you’re a high earner, following the 30% rule could mean you end up paying way more than you need to.

Instead of basing your budget on rules of thumb, figure out what works for you and let areas where you spend less supplement areas where you spend more.


This bucket includes saving, investing and debt payments.

Having solid savings is a big part of being – and staying – financially healthy. Saving your money allows you to plan for both the expected and the unexpected.

If you currently have no savings, your first goal should be to build an emergency fund. This is a savings account that holds 3 to 6 months’ worth (or more) of basic living expenses. This fund will help keep your lights on if you suddenly lose your income.

Next comes retirement. No matter how young you are, it’s never too early to think about retirement. Decide what percentage of your income you can comfortably allocate to this goal.

If you have debt, you want to at least make enough space in your budget for your minimum payments to avoid hurting your credit. How you decide to prioritize debt payments with other savings goals is up to you; we’ll talk a little more about prioritization further down.

Other savings goals (such as setting up a sinking fund to save for a down payment on a home) are included here as well.


Everything else in your budget goes into this bucket, sometimes referred to as personal or discretionary spending. It includes things like new clothes, eating out, entertainment (concert tickets, video streaming services, video games, etc.), gifts and other items and services that aren’t essential to your survival but are necessary or pleasing to you in some way.

Deciding how much to spend on the categories and items in this budget is a highly individual decision, and will come down to what’s important to you and what you can afford.

Tracking Your Spending

Before you decide how to spend money going forward, you should get an idea of how you’ve been spending it so far. That way you’ll know what you tend to spend money on and what areas you could be cutting back on.

Go back over past months’ spending. Dig up receipts or take a look at your recent bank statements. If you have trouble retroactively tracking your spending, spend a month or two keeping track of what you spend your money on. Write everything down or, if that’s too much of a hassle, enlist an app or service that will track your bank account activity and show you what you’re spending the most money on.

Audit Yourself

As you list the things you’re spending money on, it’s a good idea to make sure that every item in your budget deserves the space it takes up.

There are two ways to make room in your budget: cutting and adding. Because it’s easier to cut than add (for example, it’s generally easier to eat out less than it is to get a better paying job), you should scrutinize your budget for areas where you could be spending less.

Making Smaller Cuts Count

People often turn to their discretionary spending first when looking to make budget cuts. While it makes sense to cut back on nonessentials first, these costs tend to make up a smaller portion of your budget and thus make less of an impact.

So how can you make an impact with smaller cuts? Look to your habits. Cutting out restaurants might not make a huge difference if you’re only eating out once a month, but if you’re eating out multiple times a week, you’ll probably save quite a bit of money by cooking at home more regularly.

Find expenses that you won’t miss. If you rarely (or never) watch live TV, get rid of your cable subscription. If you don’t fully utilize your unlimited data, switch to a cheaper cell phone plan.

Spend Less On Needs

Only you can decide if you’re spending too much on the “needs” portion of your budget, but it might be worth taking a look at. If your costs in this category are way out of proportion with what you’re making, you may be living beyond your means and find it necessary to make some lifestyle changes.

For example, you could consider whether it would be possible to downsize on housing. If your grocery bills tend to be on the high end, look into ways you could cut costs. Otherwise, create a weekly spending limit. If you spend a lot of money on gas, see if there are any cost-saving alternatives available like carpools or public transportation.

It may be that you’ll find you can’t spend less than what you already are spending on your necessities. That’s OK. But it’s always a good idea to keep an eye on what you’re spending your money on, especially if you’re prone to lifestyle inflation.

Prioritizing Goals

Planning for your savings goals can feel overwhelming. What should I be saving for? How much should I be giving one goal versus another? Should I save for retirement while paying off debt?

The goals you want to include in your savings budget is up to you. However, most healthy savings budgets focus first and foremost on the three savings goals we mentioned: having an emergency fund, saving for retirement and paying off debt.

Of these big three goals, there’s a lot of debate over which one should come first. To figure out what makes the most sense for your situation, let’s look at some things to consider.

Emergency Fund

Having a solid emergency fundcan not only help you stay afloat if you lose your job or encounter similar financial trouble but it can also prevent small inconveniences from becoming big problems. If your car ends up needing an emergency repair, having money in your savings account means you can pay for it without having to take on debt.

Life is unpredictable; having an emergency fund gives you a little cushion for when you have a bout of bad luck. Just be sure to define for yourself up front what constitutes an “emergency.”


Due to compounding interest, the earlier you start investing in your retirement, the better. It can be hard to make up for a late start when it comes to saving for retirement, especially if you’re missing out on a company match.

If your company offers a 401(k) with some sort of match (i.e., your employer contributes money to your 401(k) based on a percentage of your own contributions), not taking advantage of that means you’re leaving money on the table.

Paying Off Debt

If you’re spending lots of money each year on high-interest debt, it might make sense to focus all your financial energy on paying that off. You might want to look into debt reduction methods to find a plan that can help you pay down your debt quickly and efficiently.

However, if your debt is fairly manageable, it may be more sensible to make smaller payments on your debt while also building your retirement savings or contributing to your emergency fund, if you’re able to do so.

If you have a lot of debt or you’re really not sure how to prioritize your debt payments, it may be worth speaking with a financial professional.

Other Goals

Once you’ve figured out how you want to prioritize the big three goals, you can start thinking about other financial goals you want to achieve and when you want to achieve them by. This includes things like buying a home in 5 years, having a wedding in 2 years and going on vacation next summer.

Since it’s likely that you’ll have more than one goal you want to save for, the key is to strategize how you save for them. Longer-term goals often cost more, but because you have more time to save for them you probably don’t need to save as aggressively.

With shorter-term goals, figure out the math of what you’d need to save each week or month to achieve your goals and identify some areas of your budget you’d temporarily be willing to cut back on while you save.

Budgeting For Variable Or Irregular Expenses

What about costs that change from month to month or ones that only come around a few times a year? Things like birthday gifts, insurance premiums, the electric bill after a heat wave, your family’s annual school shopping trip – how do you prepare your budget for rare or unexpected costs?

When you’re making your budget, looking at what you’ve historically paid for certain variable expenses (such as groceries or electric bills) can help. You can base how much you budget for these expenses on the average amount you spend, plus a small buffer if you want to be safe. If you end up spending less than average, save the extra money for future months when you might end up spending more.

To budget for irregular expenses (ones you don’t pay each month, like car maintenance or insurance premiums) it might be helpful to open a savings account specifically for these costs and contribute a little bit each month. To figure out how much you should contribute, add up the yearly costs of all your irregular expenses and then divide that number by 12. That’s how much you should save every month.

Now that we’ve gone over the elements that go into making a budget, it’s time to get into the nitty-gritty of actually creating one.

There are many different types of budgeting systems and styles to choose from; you just need to find the one that works for you. In general, that means you want something that’s going to be easy for you to use and keep up with.

Let’s take a look at some of the different types of budgets you can use and go over some other tools, methods and resources you can enlist to help you stay on track.

Pen And Paper

If you want to keep things simple (and offline), a good old-fashioned pen and paper budget is the way to go.

This works well if you want to really personalize how you keep track of your budget, as the possibilities are limited only by your creativity. You can use a pretty journal and lots of colorful pens or a simple notebook with a few hand-drawn data tables. You can even find free budget templates online that you can print out.

Budget Spreadsheet

If you want someone else to do the math for you, a budget spreadsheet lets you fill in your information and does the math for you.

Google Sheets has a couple helpful budget spreadsheet templates with both a monthly and annual budget option. The Federal Trade Commission website also has its own simple, easy-to-use budget worksheet that makes it easy to foreshadow how changes in your budget would affect your bottom line.


The 50/20/30 budget is a formula for how to allocate your budget spending. It works like this: 50% of your income goes towards needs, 20% to savings and 30% to everything else.While these specific percentages might not work for you, finding a ratio that does make sense for your income and needs can help keep your different areas of spending in check while allowing for some flexibility within the categories.

The Envelope System

The envelope system works by forcing you to stop spending when you’ve reached your budget limit for a particular category. You can use it for just a few categories that you have a tendency to overspend in (like groceries or entertainment) or for most of your budget.

For every category you want to budget for, fill an envelope with the amount of cash you’ve determined you can spend on that category. Once the envelope is empty, you can’t spend any more money on that category for the rest of the month.

Automate Everything

The fewer decisions you have to make when it comes to your money, the less likely you are to be tempted to “cheat” on your budget.

Set up automatic deposits for all your accounts. That way when you receive your paycheck you don’t have to stop and decide how much to put into your savings and investment accounts. Not only does this ensure that you stay on track with your savings goals, but you’re less likely to miss money you never even get to see.

Setting up automatic bill payments for your accounts can help provided you have enough in your checking or savings when the money is withdrawn. When you automate bill or subscription payments, you don’t have to worry about getting hit with late payment fees or dinging your credit.

Go Online

The internet is chock-full of resources to help you create and maintain a budget. There are many services and apps available for free that can easily show you exactly how much you’re earning and spending just by connecting to your bank accounts.

You can also search for budget templates and worksheets as well as check out government-provided resources that aim to increase financial literacy and provide advice on how you should be spending and saving your money.

Keep Going

So you’ve created a budget for yourself. Congratulations! You’re all done now, right?

You’ve done the hard work, but it’s still important that you continue to keep an eye on your finances and not get complacent. Don’t let all that hard work go to waste.

Take some time to regularly go over your budget and make sure it’s still working for you. If you go through any big changes that affect your income, go back and adjust accordingly.

Budgeting might seem like a tedious task that requires a lot of planning and math, but it’s really just a way to be more purposeful about something you’re already doing (that is, spending money). By being conscious and goal-oriented in how you handle your money, you’re helping to ensure your financial health and provide security for your future. And that’s priceless.

Having a budget is just one important aspect of improving your financial health. Another big one? Getting your credit score in line. To see where you’re at right now, check your credit score for free with Rocket HomesSM.

Molly Grace

Molly Grace is a staff writer focusing on mortgages, personal finance and homeownership. She has a B.A. in journalism from Indiana University. You can follow her on Twitter @themollygrace.