How to Calculate a Budget that Works

September 14, 2020 by Susan Paige

If you had unlimited money, you wouldn’t need a budget. But if you’re like most people, you only have so much money to get you through your month. Without a budget, spending can easily get out of hand, and, the next thing you know, you’re having trouble making ends meet, putting essentials on credit cards that you can’t pay off, and spiraling the financial drain, so to speak.

But budgeting isn’t easy. A lot of people struggle with it, and it’s not hard to see why. You need a lot of discipline to track your spending, adhere to a savings plan, and pay down debt. But calculating a budget and sticking to it doesn’t have to mean using up every ounce of your willpower on a daily basis. When you calculate a workable budget, you can cover your expenses, work towards your financial goals, and spend your mad money guilt-free.

Calculate Your Income and Expenses

Before you can start budget planning, you need to know what you’re working with financially. Sit down and calculate your monthly take-home pay, after taxes, from all sources. Does your company take deductions from your paycheck for 401(k) contributions, health insurance, or a health savings account (HSA)? Go ahead and add those back in. You should also add back in any amounts that are automatically transferred into a savings account when you get paid. Then you’ll have an accurate picture of what your income, savings, and expenses look like.

Next, write down all your essential expenses. Include recurring monthly expenses, like utilities, rent or mortgage payments, car payments, insurance premiums, food bills, prescription drugs, and the like. Add all of these expenses up. For your first month’s budget, add about 15 percent to that number so you’ll have some wiggle room for items you forgot to put in your budget.

Don’t forget to calculate your irregular expenses, too. These are expenses that you know are coming, but that don’t occur on a monthly or weekly basis. Instead, they might occur seasonally, like Christmas gifts, Thanksgiving dinner with all the fixings, and landscaping costs. Others might occur quarterly, like self-employment taxes on your freelance income, or yearly, like income or property taxes, homeowners insurance premiums, or certain home maintenance costs. Some may even occur less often than that and maybe not even on a fixed schedule — for example, you know your car will break down at some point, but you can’t predict when. That doesn’t mean you don’t need to set aside money to cover it when it does happen. Tot up all these less regular expenses, divide them by 12, and plan to contribute that amount to a sinking fund every month so you’ll have the money to cover them when they come up.

Use the 50/30/20 Budgeting Method

Now that you know what your monthly income is and you’ve calculated all your expenses, you can start to budget. If you’re looking for a painless (or, at least, less painful) budgeting method that requires minimal expense tracking, use the 50/30/20 method. This budgeting rule asks you to allocate 50 percent of your income towards essentials, 30 percent towards wants, and 20 percent towards savings and debt repayment. Remember, 401(k) contributions and other automatic deductions and transfers that come out of your paycheck before you even see it can count towards your savings percentage.

What if your essentials require more than 50 percent of your income? Ideally, you would either cut down on expenses, or find a way to make more money, or both. But first, consider whether all of the expenses in the essentials category really are essential. Yes, you need food, housing, clothing, medical care, and transportation. But your Netflix subscription isn’t an essential (it may feel like it, but trust us, it isn’t). You can scoot that expense over to the “wants” category, along with any other items that may have erroneously found their way into the “essentials” column. 

You can also juggle the numbers somewhat. Maybe you need 60 percent of your income for essentials, leaving you with 20 percent for wants and 20 percent for savings and debt repayment. Or maybe you don’t have any high-interest debt to pay off — so you could allocate 60 percent of your income for expenses, 30 percent for wants, and 10 percent for savings. Use the method in a way that works for you.

Once you have your essential expenses covered and you’ve arranged automatic transfers to your savings account to reach your savings goals, you can spend the other 30 percent of your money any way you want. You should be able to calculate a dollar amount each month that you can spend frivolously without threatening your financial goals. That’s your monthly spending limit. Once you start getting close to it, you’ll know to dial back, without the need to track every dime. Budgeting apps can help you track your spending across multiple cards and accounts, or you can put everything on one card and pay it off in full every month. 

Budgeting doesn’t have to be a pain. With the simple 50/30/20 method, you can cover your expenses, reach your financial goals, and still have some fun with your money — all without feeling guilty about your spending.

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