When you treat yourself to a new pair of shoes or dinner at a restaurant, you want to know that you can afford the splurge – instead of worrying that you’re spending beyond your means. Unfortunately, debt is more common than you might think: 60 percent of Americans say they don’t have the freedom to enjoy life and make purchases because of their financial situations, according to a recent Prosper Marketplace survey on financial wellness.
The good news is that a well-planned budget can give you the confidence that you need to make financial decisions. Here are four steps to creating a budget that will become your monthly guide for spending and saving.
Step 1: Create a List of Monthly Expenses
Your expenditures should include all fixed monthly expenses like housing and student loans, as well as monthly expenses that vary, like groceries and gas. You’ll also need to add expenses that are paid on a less frequent basis, like quarterly car insurance payments. For those, simply divide the yearly amount by 12, so you can add in the appropriate number to your monthly budget.
For variable expenses, like utilities, dining, and personal care, pull out your bank statements or receipts to tally how much you’ve spent in the past in the last three months. That will help you come up with a number that’s in the ballpark. The trick is to be realistic about costs, which is why you need hard evidence – not just your own recollections.
Step 2: Use the 50/30/20 Rule
This budgeting rule calls for setting aside income in the following buckets.
- Put 50 percent toward “needs.” Needs include monthly essentials like rent or mortgage payments, food, utilities, student loans, and credit card minimum payments.
- Put 30 percent toward “wants.” Wants include new clothing, entertainment, and going out to eat.
- Put 20 percent toward savings and debt. This bucket includes paying down credit cards, building up savings accounts, or creating an emergency fund for unexpected expenses. It’s much easier to plan to set aside savings than to try to skim off a few dollars at the end of the month – at which point, there might not be much left.
The 50/30/20 method gives you the freedom to make choices about where to apply the money in each category. You’re not trapped in a dollar-by-dollar budget that may become too rigid to follow. Remember, the point is to be aware of these budget buckets so that every month you’re meeting obligations, whittling away debt, and having a little fun.
Step 3: Pay Down High-interest Debt First
Pay off the debt that has the highest interest rate first to save more money over time. Take money from the 20 percent bucket that you set aside for savings/debt (see Step 2, above), and decide how much money to allot to debt payments, beyond any minimums that you’re required to pay. Once that balance is paid off, start paying off the debt that has the next highest interest rate, and so on.
Step 4: Track Your Expenses
Shine a light on how much you’re spending – really spending. You can go old-school with a spreadsheet or use a money management app for a more convenient way to capture expenses. This DailyWorth list of the best budget apps can help you pick one that works best for your spending habits.
Paying off debt is a major milestone. In fact, 44 percent of people surveyed by Prosper Marketplace said that getting out of a debt is a top priority for improving their financial well-being. Unless you win the lottery, paying down debt isn’t an overnight process — but it can be done over time. With a realistic, workable budget in hand, a debt-free future isn’t just a dream.
This content was also published in Daily Worth.