How to budget your money

Understanding budgeting

Budgeting is about understanding how much income you have coming in, and what expenses you have going out.

Creating a budget can help you manage your money better, reduce your debts, and put you in a better position to deal with unexpected costs. You might be able to budget and save money for the future.

Setting financial goals

Setting some financial goals is a good way to focus your mind when choosing what to prioritise in your budget.

It may be easier to cut your spending if you know you’re saving for a holiday or a new car. Or your goal might be to build an emergency fund so you can deal with unforeseen bills, such as your boiler breaking down.

Split them into short-term and long-term financial goals. Short-term goals typically take up to three years to achieve, and might include paying off loans and boosting your credit score. Long-term goals take longer, such as saving to buy your first home. Writing a list of goals can help motivate you to stick to your budget.

Work out your net income

The starting point of an effective budget is working out your net income. This means the amount of money you receive in your current account, after any taxes, National Insurance, pension contributions or other deductions.

This could be wages from a job, a pension, benefits, child maintenance payments and any other regular income.

Add it up so you have a clear overview of how much money you receive each month.

Categorise your expenses

Now you need to think about your expenses. Categorising them can help you identify your biggest bills, and highlight where it might be easiest to save. There are plenty of budgeting apps and free budget spreadsheets available online that can help you. Moneyhelper has a useful budget planner. Your bank or building society may also sort your spending into categories when you log into your online banking.

Here are some categories you could use for your expenses:

Highlight which ones are fixed and which are variable. Fixed expenses include rent and council tax. Variable ones change from month to month, such as groceries and entertainment, and it’s here you might find opportunities to cut back and reduce your spending.

Allocate funds for needs versus wants

Another way to think about expenses is by splitting them into “needs” versus “wants”.

Paying your rent or mortgage is an essential “need”. So are energy bills, and paying to get to work. The “wants” are things that help you live more comfortably. These could include takeaway pizzas, cinema tickets and holidays.

You may like to split your budget between needs and wants. For more on this check the 50/30/20 rule.

Include a savings component

Don’t forget to include savings in your budget. While the main priority of budgeting is ensuring you don’t spend more than your income and get into debt, a good budget should also help you save money.

Allocating a small amount of your net income each month to savings is smart financial planning. It will build your emergency fund, and help you reach your goals faster.

Creating a realistic budget

It’s vital to create a realistic budget. If you over-estimate your income, under-estimate your expenses or think you can slash your spending by 50%, you’ll likely fail.

It’s natural to feel overwhelmed by the idea of budgeting, especially if you have little knowledge of finance. But it doesn’t need to be difficult or complicated. Budgeting and saving money can be done on an app, an online budget planner, a spreadsheet, in a note on your phone or simply with pen and paper.

The important thing is to keep track of your income and expenses. There are lots of budgeting techniques that can help you create and maintain a realistic budget.

Create a budget plan

To create a personal budget plan, gather together your most recent bank statements, payslips, debit and credit card statements, regular bills and any receipts for things you pay for in cash.

Then you can work out your net income and expenses, and have a go at categorising the expenses. If your expenses exceed your income – or even if they don’t, but you’d like to save more money – consider setting spending limits for each category of expenses.

You can also look at your personal finances in terms of wants and needs to help you focus on where to trim your spending. For example, a monthly music subscription may count as a want – you could potentially save £12 a month by cancelling it, or almost £150 a year.

Implementing your budget

It’s time to implement your budget. This means trying your best to stick to it, but also not being afraid to adjust it.

Maybe you’ve cut your spending by more than anticipated, in which case you could increase the amount you squirrel away in a savings account. Or, you’ve had a pay rise, but also your rent has gone up.

It’s important to change these figures in your budget and re-balance the figures so it continues to be an accurate, realistic budget focused on meeting your goals.

Tips for sticking to your budget

Sticking to a budget can be tricky. Here are some tips:

1. Make your budget goals realistic. Rather than aiming to clear all of your debts, why not concentrate on one credit card first? Debt reduction through budgeting can help you pay off the priority debts first.
2. Focus on your life goals. If you’re aiming to take the kids to Spain, stick a picture of the resort on the fridge to remind you what you’re saving for.
3. Don’t cut out all your non-essential expenses, as you need to enjoy life. Allocate some money every month to treat yourself.
4. Make a weekly or monthly food budget. If you have time, shop around for different items to get the lowest price.
5. With large and impulse purchases, sleep on it first. Think about whether you need it and whether you can afford it.
6. Budget with a friend. You can discuss your progress, share tips and hold each other to account.
7. Make it simple. Automate your payments.
8. Choose a budgeting technique.

Adjusting your budget as needed

Don’t forget to adjust your budget to reflect any changes to your personal situation. Any change to your benefits or wages, or fixed expenses like your rent or utility bills, will need to be recorded.

If you recently had a baby, have had a grown-up child move back home or are now caring for an elderly relative, this may increase your costs or reduce your net income – or both. So, make sure you re-assess your budget.

Automating bill payments and savings contributions

Automating your payments is easy to do and will save you time. You can set up standing orders or direct debits to automatically pay your bills, credit cards and any other regular payments.

It’s also worth setting up a standing order to send money into your savings account as soon as you receive your wages or benefits. This makes saving a priority and means you pay your “future self” first.

Tracking your progress

Tracking your progress is an important part of budgeting. Keep reviewing your budget, and adjust it when needed.

Setting realistic short-term goals can help you stay focused, such as clearing a certain debt or cutting your spending by a certain amount.

Monitoring your expenses regularly

Keep an eye on your expenses. It’s easy for them to creep up without you noticing. Watch out for April price changes, when bills such as council tax, water and broadband often go up.

Evaluating your budget performance

Ideally, you should reflect on your budget at the end of each month and use that information to plan next month’s budget. Try and assess your total budget and your overall financial goals at least once a year.

Exploring different budgeting methods

Different budgeting methods work for different people. There’s no one-size-fits-all approach when it comes to how to budget money.

Here are four popular methods:

The 50/30/20 rule for efficient budgeting

The 50/30/20 budgeting method divides your spending into needs, wants and goals:

• 50% on needs
• 30% on wants
• 20% on savings / paying off debt

You’ll need to think carefully about how you define “wants” over “needs”. For example, food is a need, but a weekly takeaway could go into the want category.

Envelope budgeting

Envelope budgeting (also known as cash stuffing) involves having an envelope (either physical or digital) for each spending category, such as food and clothes.

You put money into each envelope and can only spend what’s in each envelope per month. This could be a good technique if you need to be strict with your spending.

Zero-based budgeting

In this approach, you allocate every pound of your net income towards a different purpose – such as paying the rent, covering household bills, or spending on yourself.

If you overspend in one area, you must reduce your spending elsewhere. For instance, if your bills are £30 more than expected, you could spend £30 less on eating out. Once your income’s been accounted for, you’ll have zero left over.

Value-based budgeting

Rather than focusing on trimming your spending or saving up for expensive items, this method re-frames your spending to see the value certain things bring to your life. So, if you value family and the environment, you could categorise your spending in that way.

Common budgeting mistakes to avoid

The biggest budgeting mistakes to avoid include guessing your income, leaving out certain expenses and forgetting to save part of your budget.

Other errors include not tracking your progress or adjusting your budget as needed.

Budgeting through life's stages

The way you budget may depend on your life stage. If you are about to get married or have just had a baby, your expenses may be higher than usual, and debt management could be a key goal.

If you’re in mid-life you may be concentrating more on retirement planning.

Budgeting for young adults

Learning how to budget as a young adult is a key life lesson. It can help you save for the things you want, while building important financial habits that’ll benefit you throughout your life.

Think about your goals: do you want to move out of home, go on holiday with your friends or buy a car, perhaps? Use online budgeting apps and tools to make saving money as simple as possible.

Budgeting for families

Make sure you include everyone in your family (pets included) when creating a family budget. Consider the cost of food, clothing and other necessities. Don’t forget to adjust the budget as your kids get older – childcare costs may fall, but the food bill will likely go up.

Budgeting as a family can be a great way to teach financial literacy to children. For example, you can explain “needs” versus “wants” to them, and get them looking for special offers in the supermarket.

Budgeting for retirees

You’ll need to consider your various sources of income in retirement. Do you get a state pension, and how much is it worth? Do you have any other pensions? Are you doing any part-time work?

And what do you want to do in retirement? What you spend your money on will look quite different to when you were younger. Your heating bill may go up, but you’ll also benefit from discounts on things like public transport and prescriptions. So, your budget should reflect this.

Planning for the future

Budgeting will help you plan for the future. Whether it’s getting out of debt, or starting to invest, budgeting has the power to help you better manage your finances and achieve your goals.

Building an emergency fund

Building an emergency fund is one of the first things you should do once you notice your income is exceeding your outgoings. In other words, you have some spare cash left over at the end of the month.

Open an easy-access savings account and save whatever you can. Aim to build a fund worth three to six months of expenses. The money is for any unforeseen costs, such as car repairs or if you lose your job.

Investing in your retirement

Investing in your retirement is a great way to grow your money. If you invest your money in a pension, you’ll get free cash from the government thanks to tax relief.

However, investing does have risks (riskier than leaving your money in a bank account). You should also be happy to leave your money invested for at least five years so it has time to grow.

When and where to seek professional financial advice

If you’re thinking about investing, you may like to use a financial adviser. You can find one in the Unbiased directory. Ask what qualifications the adviser has, and their fees.

An adviser can also assist with tax planning and retirement planning.

Conclusion: How to budget effectively

Budgeting doesn’t need to be boring or complicated. And it doesn’t need to be about frugal living (unless you want it to be). It’s about managing your money better. Budgeting and saving money can boost your financial resilience and improve your wellbeing. Why not get started and create a budget today?