A guide on how to create a basic budget

Starting a budget can be one of the most empowering steps towards achieving financial freedom and security. For anyone looking to save more, reduce debt, or simply feel in control of their finances, a budget provides a clear roadmap.

What is budgeting?

First things first: What is a budget? A budget is more than tracking expenses. It’s about creating a financial plan to effectively allocate funds, covering income, expenses, and savings.

Whether aiming to keep track of income, manage day-to-day expenses, or save for a dream purchase, budgeting allows for informed, intentional decision-making.

With a well-thought-out budget, it can be easier to take control of finances, making each pound count for the future.

The basics of creating a budget

Creating a budget doesn’t have to be complex — it’s about establishing a clear and personalised system for handling finances.

Here are important steps for how to create a personal budget that supports financial goals:

Calculate net income

Calculating net income starts with a clear understanding of actual monthly income after taxes and deductions. This involves gathering income from various sources — wages, bonuses, freelancing, or any side jobs — and subtracting taxes to see what’s available each month. This baseline lays the groundwork for spending within realistic limits.

List and categorise expenses

The next step is to track all expenses, from monthly bills to groceries and entertainment. Listing expenses and categorising them into variable expenses and fixed expenses reveals spending patterns and helps identify areas for savings.

• Variable expenses: These are costs that fluctuate month to month, like groceries, entertainment, or utility bills. Variable expenses are flexible but often harder to predict, so tracking is key.

• Fixed expenses: Recurring, stable costs that mostly stay the same each month — such as rent, mortgage payments, or insurance premiums — are called fixed expenses and can be easier to track.

Budgeting for both variable expenses and fixed expenses helps with managing monthly cash flow and preparing for changes in future spending.

Plan for irregular expenses

Some expenses don’t occur every month, like car repairs or annual insurance, and can disrupt a budget without planning. Setting up sinking funds — dedicated savings pots for specific irregular costs — helps prevent surprises. It’s also wise to create an emergency fund to cover unexpected expenses, providing a financial cushion and peace of mind.

Set financial goals

Financial goals are "the why" behind a budget — giving it purpose and direction. Identifying both short-term and long-term financial goals helps guide important decisions.

• Short-term goals may include saving for a vacation, paying down credit card debt, or building an emergency fund.

• Long-term goals often involve bigger financial targets like saving for retirement, buying a home, or paying off a mortgage.

Allocate income to each expense

Once expenses and goals are clear, it’s time to allocate income to each one. Distribute funds across spending categories based on needs and priorities. Different budgeting rules and strategies can provide various ways to allocate income effectively.

Track spending

Tracking spending helps a budget to remain on course. Regularly comparing actual expenses with planned amounts can reveal any overspending and help keep budgets aligned with financial goals. Tools like budgeting apps and spreadsheets — or even simple notepads — can simplify the expense-tracking process.

Adjust accordingly

Budgets aren’t set in stone — they should evolve as life and financial circumstances change. Regularly evaluating the budget reveals areas for improvement and allows adjustments to meet current needs.

Popular budgeting rules to consider

Budgeting rules provide straightforward frameworks to help manage and allocate income effectively. Here are three popular methods to consider:

• 50/30/20 rule. The 50/30/20 rule suggests dividing after-tax income into three categories — 50% for needs (like housing and groceries), 30% for wants (like dining out and entertainment), and 20% for savings and debt repayment. It’s a simple way to maintain a balanced budget while meeting essential needs and savings goals.

• 70/20/10 rule. This strategy works similarly to the 50/30/20 option but allocates 70% of income towards monthly expenses, 20% towards savings and investments, and 10% towards debt repayment or charitable giving. This rule can be helpful for individuals with irregular income.

• Zero-based budgeting. This approach assigns every pound of income to a specific expense, leaving a balance of zero at the end of the month, ensuring that all income is accounted for and directed towards savings, expenses, and debt repayment. This approach requires careful tracking and is ideal for those seeking tight control over spending.

Why are budgeting rules important?

Budgeting rules offer multiple advantages for those seeking to improve their financial security:

• Financial discipline. Budgeting rules foster a habit of saving and spending wisely, helping to avoid overspending.

• Improved decision-making. Budgeting rules simplify financial decision-making by offering clear spending and saving guidelines.

• Achieving goals. Budgeting rules help enable individuals to set, prioritise, and monitor progress towards financial goals, such as debt repayment or retirement savings.

• Long-term security. Budgeting rules encourage sustainable financial practices that support a secure financial future.

• Prioritises essential expenses. Budgeting rules help basic needs be met without incurring unnecessary debt.

Common budgeting mistakes to avoid

Creating a basic budget is just the start; the next step is following it consistently. Here are some common budgeting mistakes that can disrupt financial planning and tips on how to avoid them:

• Not tracking spending. Neglecting to track spending accurately is a common budgeting mistake that often leads to overspending. Using a budgeting app or spreadsheet can help track spending and make it easier to stick to planned expenses.

• Not writing the budget down. A written budget is easier to follow and adjust as needed. Whether using a budgeting spreadsheet or a budgeting app to track spending, documenting expenses is important to maintaining consistency.

• Setting unrealistic goals. One of the most common budget mistakes is setting unrealistic goals. Aiming for attainable financial goals, such as small monthly savings milestones, helps to avoid frustration and maintain motivation.

• Not having an emergency fund. The lack of an emergency fund can leave individuals unprepared for unexpected costs, which can derail budgeting efforts. Setting up automatic deposits into emergency savings helps to build a buffer for unplanned expenses.

• Not adjusting for income changes. Income changes require budget adjustments to align with new income levels. Income allocation should be recalibrated in line with any income shifts to help expenses and savings goals be balanced.

• Ignoring irregular expenses. Overlooking irregular expenses, like car repairs or seasonal bills, can throw a budget off course. Setting up a sinking fund is one way to be prepared when those expenses arise.

• Avoiding regular budget reviews. Without periodic budget reviews, it’s difficult to identify and address problem areas. Regular budget reviews allow for timely adjustments, helping to progress towards financial security.