How to Make a Budget That Actually Works!

You probably know that you need a budget in order to help you reach your financial goals.

For many people “budget” is a six-letter dirty word, but it doesn't have to be.

You probably know that you need a budget to help you reach your long-term financial goals, but many people don't know where to start to create an effective budget.

A budget is one of the most critical financial tools for anyone. Everyone can benefit from having a defined budget, no matter the age or income.

According to a 2013 Gallup report, only one in three people creates an extensive budget (and less actually stick to it), which means that two-thirds of all Americans have no idea where their money is going.

*Not keeping track of your money is one of the most dangerous financial mistakes you can make.*

Some sort of plan for your money can help you keep on track — and help you avoid the pitfalls related to spending more than you earn.

So why is everyone not using a budget?

However, creating a budget can be a bit of a challenge, but it's easier than most people think.

1. Know what you have right now

The first step in creating a budget is understanding where you're at right now. Look at all of your banking accounts, credit cards, debts, buried jars of money in the backyard, and any sources of income.

You should also spend at least one month tracking all of your spending and see where you money is going. You can get a better idea of larger trends, though, if you follow your money for two or three months.

You can use a ledger or notebook to record income and expenses, but it might be easier if you use personal finance software, or sign up for a free budget application. Assign each expense to a category. Be sure to track the cash you spend, as well as purchases made with debit and credit cards.

If you have a smartphone (and who doesn't?) tracking your spending has never been easier. Apps like Mint and Personal Capital make budgeting as easy as looking at your phone. The apps will connect with your bank accounts and credit cards and automatically separate your spending into different categories. They will display your spending habits in and easy to read graphs.

2. Review Your Spending and Income

After you have taken the time to track your income and your expenses, it's time to review how your money is moving through your bank account. Look at the categories where you are spending the most, you might be surprised to see where a lot of your money is going.

Recognize that you might be spending more than you earn each month, don't worry if you are, it's a common problem. This will identify areas of concern before you make your budget, as well as help you realistically allocate where your money should go each month. If you are spending more than you earn, a review will help you see where you need to cut back as you make a budget and will get you back in the black.

Many people are surprised to see how much money they are spending in certain areas.

Paul Moyer, founder of Savingfreak.com one of the leading resources on money saving techniques says, “The two most common areas of overspending are food and entertainment like going to the movies.”

3. Identify Your Needs and Financial Goals

Next, you need to determine what your needs are. These are items that you can't live without (a new TV doesn't fall into the “needs” category). You should make sure that your budget first covers items like food, shelter and clothing, as well as transportation to work. Also, recognize your obligations and bills. Make sure debt payments are made, as well as utility payments and other important obligations.

You should also designate some financial goals. If you want to build your emergency fund or save more for retirement, it is important that you incorporate these things into your budget. Each person will have a different set of financial goals depending on their financial situation and their desires. Figure out what you want to do with your money so that you can incorporate these items into your plan. You will be more likely to stick with a budget that helps you reach your financial goals.

4. Start from the top

When creating a budget, it becomes obvious that you need to make choices. Before you budget in for wants like entertainment, you need to make sure that needs and financial goals are covered. List all of your needs and wants in order of importance. Your food, clothing, gas money, etc. will all be at the top, and things like buying a pool will be at the bottom. It is also important to be realistic about what “needs” are.

Yes, you need food. However, what you need are healthy foods. Junk food is not a need. Getting takeout twice a week is not a need. You can reduce your grocery bill by planning healthy meals and cooking at home. There are a number of other “needs” that are actually wants. Be honest about where your money is going, and be realistic about your adjustments. It is not always fun to do this, but it is necessary.

Some financial experts say that you waste as much as 15% of your income each month (did you really need to buy a cup of coffee every morning?). The money is probably there, and a budget can help you put it to better use, providing you with a solid foundation for a better financial future.

5. Make Changes

The good news is, you've created a budget. The bad news is, it's probably going to be wrong. More than likely you have overestimated in some spending areas and underestimated in other areas, but don't worry, the longer you stick with the budget, the better you will become and guessing how much you'll spend in all the categories.

After you have created your budget, it's should not be set in stone. Think of your budget as a fluid, living creature. Every month of your life is not identical; each month will bring different financial needs and wants. Some months you may have to budget for new tires or to replace an appliance. You should continue to review and adapt your budget as your life changes.

6. Go Automatic

If you have trouble saving money, the best way to ensure that you stick to your saving category on your budget is to make your saving automatic. With just about every bank account you can create an electronic money transfer that will take money from one account to add to a savings account. This is an excellent way to prevent you from spending the money that you should be saving.

You can schedule these transfers to happen at any time, but it's best to do shortly after your regular paycheck will be deposited. The sooner your money is put into savings, the less likely you are to spend it on a non-budgeted item. If you never see the money, you can't spend it.

7. Stick with it (and what to do if you're not)

Don't create your budget and then forget it. Creating a budget is important, but using it is more important. Put your budget in a place that you will see it every day. Print it out and tape it to the fridge or your front door. You don't have to review it every day, but knowing it's there is important.

It isn't always going to be easy to stick to your budget, but it can have excellent rewards. If you become frustrated with sticking to your budget or begin to feel deprived of enjoying certain things, remind yourself of the financial goals you've set. If you're saving for a new car, put a picture of the care to encourage you to stick with the budget.

If you're having problems sticking to your spending limits, it's time to start “cash envelopes” With the cash envelope system, all you'll need is several large envelopes to put money in. Designate each envelope as a different expense, i.e. a gas envelope, groceries envelope, entertainment envelope, etc. the money that you put in each envelope is the allotted amount you are allowed to spend on that category for the month.

Once the money is gone, you have nothing left to spend in that category. Cash envelopes are one the best ways to live within your budget. Moyer states that “any area that you continually overspend should be switched to cash envelopes.”

8. Build an emergency fund

One of the most common problems people face when making a budget is not having an emergency fund built in. Because you can't see into the future, it's impossible to budget for all of your expenses every month. You never know when a pipe is going to bust, your car will need repairs or a heater will go out. Having an emergency fund can provide the extra cash needed to cover any unexpected costs that could arise.

Many financial experts agree that an emergency fund should be around $1,000 to account for any financial surprises. Having a separate account for your emergency fund will help prevent you from spending it on accident (or on purpose).

9. Don't forget annual or semi-annuals

Budgeting for reoccurring expenses is easy. Things like power bills, gas money, and water bills are hard to forget, you pay them every month, but don't forget about those expenses that only come around once or twice every year. These expenses could be car insurance payments, health insurance, any membership fees, or much more.

If you have anything like this, build these costs into your budget but divide them into monthly payments on your budget. If you pay your car insurance bi-annually, then divide that number by six and start saving for it every month.

10. Learn the power of No

Being on a budget means you will have to say no to a lot of things. You may have to say no to your favorite type of junk food at the store, going to the movies, or going out to lunch with your coworkers.

Having a budget is great, but it's useless unless you stick to it. This is where many Americans struggle to follow their budget.

11. Allow some fun money

Who said budgets can't be any fun? Make sure that you include a few bucks at the end of your budget as “blow money” or “fun money”. This is a just a small portion of your income that you can use for anything you like. Having the extra spending money makes sticking to a budget a little easier. Learn to treat yourself from time to time with this extra money (but don't spend more money than you've budgeted).

Mistakes People Make that Blow Up Their Budget and How to Fix Them

If you've ever started a budget, you've most likely started with good intentions.

Sometimes your budget gets the job done, but other times, it’s a serious crash and burn that can leave you in worse shape than when you started.  Every time I've tried to budget in the past, I would always start with a pad and paper.

Unfortunately, by the time I got done trying to do my budget the sheet a paper looked more like a hardcore tournament of tic-tac-toe just took place.  Why? Because I HATE budgeting and even though I suck at tic-tac-toe it's a whole lot more fun than budgeting.

As much as I hate it, I recognize that it's a must if you have any hope of taking charge of your financial life.

That's where I got lucky. VERY lucky.

My amazing wife is the Queen B. in our household with “B.” standing for “budgeting”. She loves to budget and she does so like a rockstar.  Because of her our budget doesn't suck.

There are reasons that your budget sucks, and until you get that worked out, it’ll never help you reach your financial goals.

Here are 16 reasons that your budget sucks, and how you can fix it.

1. Your Budget Doesn’t Match Your Personality

In order for a budget to work, it has to fit your personality and lifestyle, and not just yours, but also your family’s. Setting up a budget and simply requiring yourself and every member of your household to adhere to it won't make it happen.

For example, if you have a more casual attitude about money, completely denying yourself any cash for free-spending purposes could doom your budget. You may have to accept that at least a small percentage of the budget will have to allow for discretionary spending.

This doesn't mean that you can spend whatever you want. This is a budget, after all, and the goal is to reform your spending habits, not give you a license to mow through every cent you've saved. However, if you know that you will be unable to stick to something that is very rigid, build a little bit of financial flexibility into the budget, and set yourself up for success.

Without going too far with it, you have to at least partially construct your budget around preferences – yours, your spouse's, and even your children's.

2. You’re a Yo-Yo Budgeter

Perhaps you’ve heard of the term yo-yo dieter.

That’s a person who has a long history of on-again, off-again dieting (I'm the perfect example of this since I go from being strict paleo one week to chowing down six doughnuts the next week.) Though they have a desire to lose weight, they lack the will or the discipline to stick to any diet for any length of time. What makes this even worse is the fact that yo-yo dieting can actually cause the dieter to gain more weight than they lose over the long-term.

The same could be true of you when it comes to budgeting your money. You have a strong desire to get control of your finances, but you lack the discipline and/or the commitment to implement a budget and stick with it for more than a few months, or even a few weeks. And, much like a yo-yo dieter, a yo-yo budget can leave you in worse financial shape than when you started.

Though you may be able to lighten your budget after a year or so, when you first begin you’ll have to be very strict – something like a Budget Boot Camp – that will force you to make radical changes in your life. But even if you get past the Boot Camp phase, you still have to retain the basic elements of your budget for the foreseeable future. No backsliding is allowed!

3. Your Budget Isn’t Flexible

Since expenses tend to rise and fall from one month to the next, your budget will not work if there isn’t a certain amount of flexibility built into it. That will mean that during the months when there is a surplus in your budget, you’ll have to bank it and have it available to shore up the months when your expenses are higher than normal.

You can count on there being a certain amount of inconsistency in your budget from one month to the next, which is why you absolutely must have a plan to even out those ups and downs. Some months simply have more expenses than others, and they seem to come out of nowhere.

In other months you can actually fall off the wagon – you spend more than you should, and it puts you in a bit of a hole. That’s actually normal, and as long as it doesn’t happen too often, and as long as your budget has enough flexibility to work around it, you'll be fine.

Just make sure you aren't constantly relying on the flexibility of your budget to continue those bad spending habits.

4. You’re Watching Too Much TV

This one might come as a surprise to you, but it is a major reason why budgets don’t work. If you spend a lot of time watching TV (I'll allow some exceptions like St. Louis Cardinals baseball, Shark Tank, and The Walking Dead), at least four factors come into play, and all work against you:

So if no one has told you this up until this point, you now know – having a budget requires that you spend a lot less time watching TV.

5. Your Budget Allocates Too Much Money for Some Expenses and Not Enough For Others

Any budget that you create has to have balance built within it. If you’re spending too much on certain expenses, and not enough on others, the imbalances can eventually cause you to abandon the budget entirely.

One common example is where too much money is being allocated to pay off credit card debt. Sure, credit cards are annoying and you want to get rid of them as soon as possible. But it’s usually a long-term process that will require that your budget is firing on all cylinders.

If you are allocating too much money to pay off credit card debt, and not putting any money into savings, or spending too little on groceries, you could be sabotaging your budget. If you want to make the payments you are making more effective, take out one of the best credit cards for balance transfers and zap that debt into oblivion with 0% interest for a year or more.

Yes, you can get along without balance for a few months, but if it takes a couple of years or more to pay off your credit cards, it’s more than likely that you will abandon your budget long before that happens.

6. You’re Staying Within Your Budget – By Borrowing to Cover Shortfalls

There are certain situations where a budget can become mostly an illusion. The most common example is where you are covering budget shortfalls by tapping credit cards. This is especially problematic if you have a history of over-using credit cards in the first place. You use credit to cover the shortage, telling yourself that you’ll just do it this one last time – at least until next time comes.

If you have to use credit to cover your budget, you're taking two steps forward to only take three steps back. This can only end in failure.

I, unfortunately, had to witness this first hand with my father. He struggled each month to pay his bills and the only way he make ends meet was to borrow from one card to make the minimum payment on another. It was a vicious cycle that he was never able to break.

7. You Haven’t Budgeted for Contingencies

It’s nice to think that all of our expenses can fit within a neat and consistent amount every month, but that’s also a fantasy. While it’s fairly easy to build a budget around fixed monthly expenses, like your house payment and debt payments, you still have to make an allowance for contingencies.

For example, if you are driving two cars and both are over five years old, you should make a monthly allowance for car repairs, even and especially in the months where none are required. The idea is to have the money available when one does happen; that way, you’ll be able to pay it within your budget.

8. You’ve Got an “Off-Budget” Category – Or Two

You might have an expense category or two that you’re keeping off budget – which is to say that you’re pretending it doesn't exist. It could be a cigarette habit, a monthly bar bill, or a heavy addiction to In-N-Out Burger. Whatever it is, it’s causing money to leave your home, which in turn causes your budget to come up short every month.

In order for a budget to be effective, it must also be comprehensive. If you’re holding certain expense categories outside of your budget – for whatever reason – you effectively have no budget. If it's truly something you can't – or don't want to – live without, just add it to the budget and save accordingly.

9. Not Enough Money Is Going Into Savings

And you’ll need to see your progress on a regular basis; otherwise, living on a budget is something like being on a diet for life.

Creating a growing savings account – that you will eventually put into investments – is the most tangible evidence of financial progress. For that reason, at least some of your budget has to be earmarked for savings, even if your primary purpose in budgeting is to payoff debt.

In addition to being able to track measurable progress, your savings will provide you with a cushion that will make you less reliant on credit in the future. That will help you to eliminate credit problems for the rest of your life.

10. You Haven’t Budgeted Enough “Blow Off Steam” Money

No matter what the reasons are that are driving your decision to create a budget, you are going to have to allocate at least some money for fun. Life is stressful, and that’s why this is necessary. Sometimes spending a little bit of money on fun activities can keep you from falling off the budget wagon completely.

Obviously you don’t want to go crazy here, but you are going to have to allow some extra cash to pay for an occasional movie, a dinner out, or a day at the beach. This might be just enough diversion in your life to keep you from abandoning your budget forever.

11. You Have Too Many Costly Hobbies – Or Too Much Blow Off Steam Money

Maybe you have the exact opposite problem: you spend too much time and money blowing off steam. Often this comes in the form of hobbies that you don’t exactly think of as expenses. But any activity that causes you to spend money on a regular basis is an expense, no matter how you choose to view it.

You might be going out to eat too often, spending too much on computer equipment, spending a little too much time on the golf course, or renting a few too many movies at the Redbox (those late fees add up!).

You’re going to have to track of these expenses – no matter how casually they may occur – and understand the full impact of the effect they’re having on your budget. In fact, these categories are easy places to slash your budget, if you don't get rid of them altogether.

12. You’re Too Easily Distracted

Living without a budget is easy, and that’s why it’s the default option for most people. Once you go on a budget, you seriously need to focus on your spending.

That will take a bit of work on your part, and that will require a large helping of focus. You’ll have to adopt a Scrooge-like mindset, at least until saving money becomes second nature to you and you no longer have to think about it.

13. You’re Unconsciously Rebelling Against Your Budget

Even if you are a certified free spirit, life is usually better when it includes at least some amount of structure. But some people have problems with the whole structure thing – if you’re one of them, living within a budget will be especially difficult.

People who don’t like structure tend to rebel against any sign of it. A budget is essentially structure for your finances. If you are an anti-structure type, you may consciously or unconsciously do everything that you can to ensure that the budget fails; that way, you can go back to your free-spending ways, telling yourself that you at least tried.

Don't kid yourself.

Nearly every endeavor in life involves a heavy dose of psychology. If you don’t quite understand where your head is at, it may be impossible to realize why your plan will never work. You may have to do some serious soul-searching to determine if you're in fact rebelling against your own budget.

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14. Your Basic Cost of Living is Higher Than Your Income

If you're spending more than you're making, creating a budget and trying to live within it is a complete waste of time. You have a more fundamental issue that will have to be resolved first.

If your expenses are higher than your income, you have three choices:

Once you get your income and expenses in balance, then you’ll be ready for a budget.

15. There’s a Black Hole in Your Finances

Sometimes there is a major expense in your budget that’s causing your expenses to exceed your income. Most often, it's an out-sized house payment, a ridiculously high car payment (or two), or an expensive prized possession, like a vacation home. Whatever it is, it is an expense that is too large for you to budget around it.

If this kind of expense is primarily responsible for the imbalance in your finances, you’re going to have to make some hard choices. You may have to sell your dream home and move into an apartment, at least until you get your finances under control. You may have to sell your late-model car(s) and buy a beater instead. Or you may need to sell your cherished second home.

It may be that your finances won't improve until you make one of these major changes in your situation. But as always, the sooner that you act decisively, the better and faster your finances will improve.

16. The Timing Just Isn’t Right

This is a factor that is completely beyond your control. As much as you may want to create a budget in your life, it may be close to impossible to implement if you just had a baby, or if you are going through a health related catastrophe, or a serious legal entanglement.

Sometimes your situation can be so severe that your only option is to tread water, minimize the damage, and wait it out. If that’s your situation, focus your efforts on minimizing the damage. That will help you to start a budget when the time finally is right.

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Budgeting – it isn't all bad

When people think about living on a budget, they think they will no longer be able to enjoy the things they love, but that's not true. It does not have to be the end of doing fun thinks like taking vacations or going out on the weekends. You can adhere to a budget and still do all of your favorite things, as long as they're in the budget.