Budgeting is key if you want to gain control of your finances and spending. In the age of contactless payments and online shopping, it is all too easy to overspend and find yourself short of money, waiting for your next payday.
But, by assessing your expenses, prioritising your financial commitments, and creating a budget based on this information, you can start to improve your money management and begin saving for the future.
But what exactly is a budget?
Quite simply, a budget is a plan showing how you spend every pound of your income. You set the amount of money that you can afford to spend on certain areas, which should help you to build good spending habits.
Sticking to a budget is not always easy, but you should try to stay focused on your goals and remind yourself that a budget is there to help you in the long-term; it won’t make much of a difference if you only follow it for a month or so. When followed consistently, a good budget can help you to achieve more financial freedom and feel more comfortable about dealing with your finances.
Read on to find out how to create and manage a budget that works for your situation, whether you want to focus on clearing your debt or on building up your savings.
How to make and manage your budget
1. Work out your after-tax income
You need to know the money you have available for your budget. If you are on a company’s payroll and enrolled on the PAYE system, then your employer will deduct income tax and National Insurance from your pay. So, your after-tax income will be the amount you receive in your bank account each month and have available to spend.
If applicable, your employer will also deduct any student loan repayments and workplace pension contributions before you receive your pay. Even if the money doesn’t pass through your bank account, make sure you note these in your budget calculations to get a true picture of where your income is going and how much you are saving towards retirement, as well as the debts you are paying off.
If you are self-employed, you will pay your tax to HMRC after filing a Self-Assessment each year, so you would need to subtract this sum from your total income to work out your actual, post-tax earnings. Make sure you set aside a certain amount each month or every time you get paid for tax or else you’ll get caught out when it’s time to file your tax return. Your income may vary from year to year in which case you’ll have to make a decision on how much to put aside for tax each month or a percentage of your pay, based on previous tax bills.
When calculating your earnings, don’t forget to include any additional income you might receive, whether from investments, property, or from side gigs you’ve taken on to make some extra money.
2. Review your spending
Before making a budget, look at your spending from previous months, as this will help you to work out your typical expenditure and identify any areas where you may be overspending.
At this point you can see if there are any ways that you could save money. It could be as simple as cancelling subscriptions or spending less on eating out, to something more major like remortgaging your house to a lower interest rate.
Now would also be a good opportunity to see if you could switch to cheaper energy or internet providers and, when it’s time to renew your insurance premiums, you could see if there is a cheaper policy available on your car insurance or breakdown cover, for example.
3. Choose a budgeting plan
Your budget needs to cover all your spending, including bills and essentials, any debt repayments, any treats and ‘wants’, and any contributions to your savings. More detail on how to divide your budget between these areas is covered in the next section.
When you have your budget, you need to find a way of sticking to it. The envelope system, also called the jam jar approach, is a popular budgeting plan, especially for those who may struggle to control their spending and keep to a strict budget. Traditionally, people would have envelopes for each category and put the allotted amount of cash inside. Then they would pay for a particular expense using only the money from that envelope, stopping them from spending more than this amount and forcing them to stick to their budget.
It can help you to budget better by setting yourself weekly or monthly spending limits on categories like bills, clothing, travel and food, then allocating that amount of money to that particular expense.
If you don’t use cash, you can recreate this budgeting method on mobile banking apps such as Goodbudget and Monzo, which offer Pots and ‘envelopes’ to separate your money in your bank account. Find out more about the wide range of other available banking and budgeting apps.
Whether you use cash or an online banking app, by setting individual budgets for your different expenses you can easily see how much you have left to spend in each category. This helps to remove the temptation of using money intended for a certain category (like bills or savings) to cover a shortfall if you’ve overspent on another category, like food or clothing.
4. Track your progress
When you have a budget, don’t make it and then forget about it. You should set yourself realistically achievable short-term goals to help you stay focused on your budget, whether that’s to clear a certain debt, cut your spending by a certain amount, or reach a savings target.
Keep tracking and reviewing your progress to make sure you are sticking to your budget goals, adjusting them or setting new ones when needed.
5. Automate your bills and savings
Where possible, set up standing orders or direct debits to automatically pay your bills, credit cards, and any other regular payments. This will make it easier to send payments on time, which means you can then focus on keeping the rest of your spending on budget.
If you’re in a position to do so, it is also worth setting up a standing order to automatically send money into your savings account when you get paid. In other words, you pay your future self first. This makes building up your savings a priority rather than an after-thought, and ensures that the money intended for savings actually gets there, instead of it going on a shopping spree or to supplement other areas of your budget where you may have overspent.
6. Revisit and review your budget when needed
There will inevitably need to be some flexibility with your budget as your income, expenses, commitments, and priorities change over time.
The key here is to make sure you always have a budget. You shouldn’t use a change in circumstances as an excuse to scrap your existing budget, but rather as a time to review it and amend it accordingly to account for these new developments.
How to make a budget using the 50/30/20 rule
When you create your first budget, it is useful to apply the 50/30/20 budget rule as a starting point. Based on this guide, you would divide your take-home pay into the following categories:
- 50% of your income on essentials.
- 30% on wants and non-essential spending.
- 20% on paying off debt and/or savings.
It is a simple model that should be accessible to most people.
Adjustments will need to be made to suit your personal situation as you may spend more or less on basic necessities. However, if you aim for this income split and stick to it, you should ultimately be able to manage your regular expenses and debt repayments, cope with any unexpected costs, build up savings for the future and retirement, and still have some money left to treat yourself.
Allow up to 50% of your income for needs
You should aim to spend no more than 50% of your after-tax income on basic necessities, which may include:
- bills (water, electricity, gas, broadband, council tax, mobile phone)
- food (essentials)
- insurance payments
- commuting (petrol, vehicle tax, car MOT, public transport)
- child care
- minimum debt repayments
However, many people may find that they spend more than 50% on these things, even after cutting costs as much as possible. In this instance, you would have to make up the difference from elsewhere in your budget, which will most likely involve taking some money from your “wants”.
For those fortunate enough to spend less than 50% on essentials, they could use the leftover money to pay off debt, boost savings, and/or to treat themselves.
Use up to 30% of your income for wants
After you have paid for your basic needs, you can then budget for ‘wants’, adjusting the guideline figure of 30% to your circumstances.
For example, if you are facing high-interest debt, you would probably want to cut spending on non-essentials and spend more on clearing your debts to make your situation more manageable.
Budgets are intended to be a tool to help you manage your money, not a restrictive plan that stops you from doing the things you like. Setting aside money for fun and treats in your budget, however small, will help you to stick to your budget in the long-term and make more of a difference to your finances.
‘Wants’ will typically include spending on things like eating out, days out, hobbies, and theatre/concert tickets. However, it can sometimes be difficult to separate a ‘need’ from a ‘want’, as expenses like a gym membership or pricier organic food items could potentially be classed as either.
Only you will be in a position to judge whether something is a need or a want, and you will have to work out your budget plan based on your decisions.
Don’t forget to budget in advance for one-off expenses like Christmas, birthday gifts and holidays.
Aim to put 20% of your income towards savings and debt repayment
Finally, you should aim to use 20% of your income to increase your rainy-day emergency fund, build up your savings for the future, or make overpayments to clear your debts sooner (your minimum debt repayments would fall under “essential” spending).
However, if you have debts to pay and don’t have much in your savings, then you may be struggling to work out exactly what your financial priorities should be. There is a lot of emphasis on saving and rightly so, but does it make more sense to grow your savings or make overpayments on your debts?
The following section offers some guidance on how to prioritise your spending, according to the debts you have, their interest rates, and your access to funds should you be faced with an expensive emergency.
Prioritising your spending
Although everyone will have varying financial pressures and obligations, listed below, in order of priority, are some general guidelines to help you get to grips with your money:
1. Clear toxic debt.
If you have expensive debts like payday loans, overdrafts, or high-interest credit cards, you should focus on clearing these as soon as possible. You can end up paying significantly more than you originally borrowed with these kinds of high-interest debts, which could have a damaging long-term impact on your future finances. So, the quicker you pay them off, the less you will have to pay in interest, and the more money you will have to spend elsewhere.
Also, if you are behind on any payments, such as bills or your rent/mortgage, then concentrate on getting back up-to-date to avoid falling into even more financial difficulty.
Don’t be afraid to ask for help with your debt if you are struggling to make payments.
2. Save up a starter emergency fund.
Whether you have debt or not, it’s worth ensuring you have access to funds in an emergency to cover any unforeseen expenses like car or household repairs.
Although the ultimate aim is to save several months’ worth of expenses, the immediate priority is to save up a small and easily accessible sum of money. By having a financial cushion to fall back on, you are less likely to need to take out credit to deal with an emergency so you minimise the risk of getting into even more debt.
To begin with, anything you can afford to put aside will come in handy and give you some security. Start saving small but regular amounts, and from there you will get into the habit of saving and start to grow your fund.
3. Contribute to your workplace pension scheme.
All employers must offer a workplace pension, which would most likely be a defined contribution scheme. If you’re not already paying into your pension, you are missing out on free money as you will receive tax relief on your contribution and your employer is required to contribute too.
You can only benefit from these employer contributions and tax breaks by paying into the scheme yourself. So, unless you have more pressing needs like unmanageable, high-interest debt that urgently needs clearing, paying into a workplace pension is a wise money move.
4. Build up your emergency fund.
The goal should be to save up an emergency fund of around three to six months’ worth of living expenses, as this would act as a vital safety net should you have to pay for an unplanned expense or if you lose your main source of income. This emergency fund should be kept separate from any long-term savings you may have, and the money should be easily accessible ‒ not locked into an account.
Sometimes it may make more financial sense to repay some debts before focusing on saving up a larger emergency fund, as long as you do have access to money in an emergency, even if that’s from an existing credit card, for example. However, if your only debt is a mortgage, it would be useful to have a sizeable emergency fund so you don’t need to take out new debt to cover any unexpected expenses.
5. Repay your remaining debts.
After clearing your most toxic debts, you may want to increase your repayments on your remaining debts to clear these as soon as possible. This would be a less urgent priority than paying off higher-interest debts, so you may want to consider whether it is better for you to use any spare money to clear them or to boost your savings instead.
In many cases, paying debts off early could be more cost-effective than saving. This is because the interest on loans and credit options is often higher and would cost you more than the amount you could earn in interest from most savings accounts. So, the quicker you clear your debts, the less you will pay in interest, and the better off you could be overall than if you had saved that money instead.
Compare the interest payments on your debts with the interest offered by savings accounts to work out what the right decision is for you. You will also need to take into account any early repayment charges and make sure that the benefit of paying off the debt would still outweigh this extra cost.
If your only debt is your mortgage, read more on when it may be worth overpaying on your mortgage.
Student loans operate differently to standard loans as you only start repaying once you earn above a certain amount, so it often won’t make sense to repay more than the minimum. Read more to find out whether you should pay off your student loan early.
If you’ve reached this stage, you should be in a good, secure financial place! At this point you would have no high-interest debts hanging over you, have saved up a sizeable emergency fund, and be regularly contributing to your savings and pension scheme with money left over for some little luxuries.
You should have built up good financial habits and have more flexibility to spend your money how you choose. Should you get hit financially, whether by losing your job or by facing a major unexpected expense, you should be in a position to initially cope with this blow and not need to resort to debt to cover your immediate living costs.
It may be a long road to get to this point, but by creating a realistic budget and consistently following it, you can start to gain more control over your finances and improve your financial security in both the short-term and the long-term. You may then set yourself a new target of working towards financial independence and possibly even early retirement, but even if you are at this stage, budgeting will still be crucial to help you reach your goals.
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