What is a budget?

Imagine trying to steer a ship without a map or compass. That’s what managing your money without a budget can feel like: navigating the sea of finances with no clear sense of where you’re going or how to get there. A budget is a financial plan that outlines how you manage your income, expenses, and savings over a specific period. Many people rely on a monthly budget to plan and track their income, expenses, and savings. In this guide, we’ll explore what budgeting is, why it matters, and how you can start creating your budget today.

Here’s what we’ll cover:

• The importance of budgeting
• Budget components
• Budgeting methods
• How to start budgeting
• Budgeting tools
• Budgeting tips

Why budgeting is important

What is a budget’s purpose in managing your finances? It’s not just crunching numbers; it’s about planning for your financial future now and over the long term. A budget helps ensure you can cover your day-to-day expenses, as well as set financial goals, reduce debt, and prevent overspending. Benefits of regular budgeting include:

• Financial stability: Planning and tracking your spending helps ensure your expenses don’t exceed your monthly income. 
• Achieving goals: With a budget, you can set short- and long-term financial goals and create a plan to achieve them. 
• Reduced financial stress: Having a clear financial plan relieves stress and helps you feel in control of your finances. 
• Improved savings: Sticking to a budget makes it easier to put aside money for saving and investing.

Key components of a budget

While everyone’s financial situation is a bit different, most budgets contain four core components. You’ll want to consider each of these when making a monthly budget in order to manage your money effectively. 

1. Income

Income is all the money you receive each month. That includes your regular paycheck as well as funds from any other sources. You’ll need to understand your monthly income so you can plan how to spend and save your money. 

Regular monthly income

If you have a steady job, your paycheck is usually your primary source of income. In many cases, this is about the same amount each month, especially if you are a full-time salaried worker or, if you’re paid by the hour, you work about the same number of hours each week. Knowing your regular monthly income helps you understand how much money you have available to allocate to expenses, debt payments, and savings.

Other sources of income

Many people earn money beyond their regular paychecks. Examples include money you make from a side hustle, dividends from stocks, rental income from property, child or spousal support, government benefits, and freelance earnings. When calculating your income, you’ll want to include all your known income so you can plan accurately.

2. Expenses

Expenses are everything you spend money on each month, including necessities like rent and groceries, as well as discretionary spending such as entertainment or shopping for fun. One of the primary reasons to make a budget is to plan how you’ll spend your income on these expenses. When you decide how to allocate your money each month, you’ll want to be aware of both fixed and variable expenses. 

Fixed expenses

Fixed expenses are recurring, predictable costs like rent or mortgage payments, utility bills, monthly subscriptions, and ongoing prescriptions. These expenses are considered fixed because they remain constant from month to month, so you know exactly how much they cost. While many fixed expenses may be necessities (things you really need), they may also include discretionary spending (nice-to-haves you could choose to go without). In either case, these expenses can be easier to budget for because the cost is fixed.

Variable expenses

Variable expenses fluctuate month to month based on your consumption and life events. Examples of variable expenses include groceries, entertainment, and transportation costs. While you can usually anticipate which variable expenses you’ll have, you may not always know the exact amount you’ll spend in any given month. That said, you can get a pretty good sense of the average cost of variable expenses by reviewing your spending over the last several months and averaging how much you spend in each category.   

3. Debt

If you have debt, you’ll need to include your monthly payments in your budget. And if you’re working to get out of debt faster, you’ll want to include extra payments above and beyond your minimum payments when you make your monthly financial plan. 

Bad debt

“Bad debt” refers to borrowing that doesn’t provide long-term financial benefits and often comes with high interest rates. Examples include credit card debt and payday loans, which can quickly become unmanageable if not paid off promptly. When making a budget, many people aim to pay off credit cards and other high-interest debt as quickly as possible in order to lower your monthly expenses and decrease the amount of interest you pay over time. 

Good debt 

Loans that can improve your financial future, such as student loans or mortgages, are often classified as “good debt.” These types of debts are considered “good” because they can lead to increased income or asset value over time and often have lower interest rates. In some cases, having this type of debt can even provide some tax deductions and improve your credit score, as long as you don’t make any late payments. When paying down debts, many people focus on high-interest “bad debt” first, then consider paying extra on larger, lower-interest debts. 

4. Savings and investments

By including saving and investing in your monthly budget, you can set aside money from each paycheck to reach your bigger financial goals in the future. That might include short-term goals like funding a vacation or a wedding, mid-term goals like buying a car or house, or long-term goals like retirement. When building your budget, keep in mind that there are some key differences between saving versus investing. Both can be important for achieving financial goals and building wealth.

Savings

Savings typically refer to money set aside in easily accessible accounts, like high-yield savings accounts or certificates of deposit (CDs). These types of accounts let you earn interest, so that your money grows over time, but keep your funds fairly liquid so you can withdraw them when needed. Savings are usually used for short- or mid-term goals or building an emergency fund that can help you manage unforeseen expenses.

Investments

Investing involves putting money into an account where you can invest in securities like stocks, bonds, and exchange-traded funds (ETFs). Unlike savings in a bank account, investments aren’t FDIC insured, and investing comes with some risk. That said, you can often get better returns over the long haul compared to earning interest in a bank account. Investing is usually better suited to long-term goals like building up money for retirement or education. There are multiple types of investment accounts; the right one for you depends on your goals. 

Common budgeting methods

When you’re looking for the answer to “What is a budget?” you’ll likely come across many different definitions based on popular budgeting strategies. There’s no one right way to budget; the method that works for you depends on your preferences and financial situation. Learning about three of the most common approaches can help you start creating a budget that works for you. 

• The 50/30/20 rule: With this approach, you allocate 50% of income to needs, 30% to wants, and 20% to savings and investing. You can adjust the percentages to fit your lifestyle and needs over time.
• Envelope budgeting: In this budget strategy, you create spending categories and allocate cash into an envelope for each one. When an envelope is empty, you’re done with spending in that category for the month.  
• Zero-based budgeting: This is a very detailed method of budgeting in which every dollar is allocated to a specific purpose until the budget is balanced to zero. This can be useful for people who want to plan their spending very precisely.

How to start budgeting

Now that you know what a budget is, you may be ready to create one for yourself. Budgeting may seem daunting at first, but you can start simple and make adjustments over time. Here’s how to get started: 

• Assess your financial situation: Review the key components of a budget above and determine your financial landscape. Write down all sources of income, categorize every expense, determine how you want to pay off any debts, and consider how much you can afford to save or invest.
• Set clear and achievable financial goals: Decide on the things you want to achieve such as saving for a down payment on a house, building an emergency fund, or saving for retirement, and establish a realistic timeline for each. Being specific and realistic about your goals can motivate you to stay with your savings habit. 
• Choose a budgeting method: Determine the strategy that makes most sense to you and put it into practice. Plan your expenses, including money you’re putting toward paying off debt and building your savings/investments, and ensure you’re not spending more than you earn each month. 
• Monitor and adjust: Track your spending closely to make sure you’re not going over budget in any category. Review your budget at the end of each month, identifying areas where you can cut back, adjusting your approach if it’s not working for you, and reallocating resources to meet your evolving financial objectives.

Tools and resources for budgeting

You don’t have to figure out budgeting all on your own. Many tools and resources can help you create and manage your budget effectively.

Budgeting apps

A budgeting app can take some of the manual work out of budgeting. These apps can track your spending, categorize expenses, and alert you when you’re close to exceeding your budget. Your bank might also have built-in budgeting tools that allow you to create budget categories and savings goals, and then automatically categorize transactions so you can more easily monitor your spending.

Spreadsheets and templates

Some people prefer a more hands-on approach to budgeting and tracking expenses. You could create a spreadsheet for your monthly budget and update it regularly. Or you could use a spreadsheet to create a big-picture budget and then rely on a budgeting app to help track spending day-to-day. You can find many budgeting templates online for free, providing a structured way to track your income and expenses.

Financial advisors and planners

Financial advisors and planners offer personalized budgeting advice and strategies. They can help you create a budget that fits your financial situation and goals, making the process less overwhelming. If you have a complex financial situation, you might find it useful to talk with a professional. 

Tips for successful budgeting

Creating a budget is just the first step; maintaining it requires commitment and ongoing effort. Try these tips to help you successfully stick to your budget:

1. Regularly review and adjust your budget: When you first start budgeting, you might want to carefully review your budget every week or so, and make adjustments based on how your plan actually lines up with reality. And remember that your financial picture will change over time, so you’ll want to review your budget periodically to ensure it remains relevant and accurate to your income, needs, and goals. 
2. Be realistic with your plans and goals: Your budget is a plan for spending and saving; for it to work, you’ll need to be clear-headed about your expenses and goals. Make sure you’re allocating enough money to actually cover expenses each month. If you need to cut back on spending or save more, look for realistic ways to save money. And when you set savings goals, make sure they’re achievable and the timeline makes sense for your income and needs.  
3. Track your spending: If you make a monthly budget and don’t pay attention to your spending, it’s a lot harder to actually stick to your plans. Frequently track how much money you’re spending in each category. Some people like to check in on their spending several times a week to ensure they’re not getting off track without realizing it.   
4. Maintain your commitment: Making a budget is just the first step in managing your personal finances. Keeping up with your plans ongoing takes dedication and discipline. You might look for ways to bolster your commitment, like setting a weekly “budget date” with yourself to check in on your progress, celebrating your successes, and reading up on personal finances. Some people find that loud budgeting helps them maintain their commitment to budgeting because it creates accountability and a sense of community. 

Take the helm of your finances with a budget

What is a budget going to do for you? Instead of feeling adrift, you can seize the rudder and steer yourself through the financial sea with more confidence, even in choppy water. Ultimately, a budget can be a powerful tool to transform your personal finances now and set you up for future financial health. Start creating your budget today and take control of your money. 

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