Back to Basics: How to Build a Budget - NerdWallet

Back to Basics: How to Build a Budget

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My friends, your trouble with money begins this way: You’re afraid to look in the mirror.

That’s one takeaway from a study released this month by the National Foundation of Credit Counseling. The study gives Americans a low grade on financial literacy, beginning with the very basics: More than 60% admit to not having a budget.

Why do we hide from that hairy creature known as budget? Because it forces us to stare into the face of our own financial monsters.

“Budgeting is a basic building block to personal finances,” Gail Cunningham, vice president of public relations at NFCC, told Fox Business. “But too many people think ‘budget’ is a four-letter word and become restrictive. People are afraid to see their spending staring back at them in black and white and [worry] that it will force a behavioral change.”

Not having a budget is just wrong—let’s set you right.

Making a budget: The math

It couldn’t be more simple: 1. Figure out your monthly income after taxes. 2. Compute fixed expenses (like rent, car and student loans) and variable expenses (entertainment, food). 3. Subtract expenses from income and—presto!—you’ve got a good sense of your monetary situation.

If you have cash left over, that’s discretionary income: save it, spend it, use it to pay down debt, whatever you like. If you don’t have cash left over—in fact, you’re in negative territory—then you’re likely living on credit. And admit it: I’ll bet you’re not looking at your credit card statement regularly, are you? I thought not.

Take a hard look at expenses

The reason more than half of Americans don’t make or keep a budget is step 2—calculating your expenses. Unless you work on commission or are a professional baseball player or the like, chances are your income doesn’t vary much. So if you can’t make more, you need to spend less.

The math may be simple, but it isn’t easy taking a hard look at how you spend your money. You have to face the bogeyman, look under the bed and into your financial closets, and if you’re living beyond your means, you need to understand where you are bleeding cash.

Fixed expenses, where you consistently pay the same every month—rent or mortgage, utilities, car and insurance payments and the like—there is little you can do immediately to reduce those. That’s why it’s important to document variable expenses: travel, shopping, grooming, restaurants and such. These are the areas you have the greatest ability to bring under control.

Pay yourself first

Once you’ve got high-interest debt like credit cards under control, the most important thing to budget to get ahead of your game is to pay yourself first. That’s something that helped bootstrap self-made millionaires toward their riches: Come rain or shine, they put at least 10% (actually, they do closer to 20%) of what they earn into savings or investments. Just like credit card spending can slowly rise and become an ocean of debt, the reverse is true with methodical saving.

Financial author Dave Ramsey says saving only $100 per month from age 25 to age 65 at 12% growth will accumulate to about $1.2 million by retirement.  “Everyone should retire a millionaire!”

But if you dream of becoming a millionaire, the building blocks lie in making a budget—and the ability to stare down your financial fears.

Read More on NerdWallet:

9 Ways You Are Bleeding Cash Every Day

How to Budget and Cover Your Bases Like a Ballplayer

Everything You Need to Know About Personal Finance in 100 Words (or Less)

Illustration by Brian Yee.

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