Rhiannon Philps
Amy Knight
Adam French
Budgeting is key if you want to gain control of your finances and spending, but if you’ve never made a budget before the process can feel intimidating.
Contactless payments and online shopping mean it’s easy to fall into overspending, leaving you short of money, waiting for your next payday. If this is something you’d like to change, creating a budget can significantly improve your money management, making it easier to become a successful saver.
It all starts with assessing your expenses and prioritising your financial commitments.
What exactly is a budget?
A budget is a plan showing how you’ll spend (or save) portions of your income. Deciding in advance what you can afford to spend in different areas of your life makes it easier to ensure you meet all your immediate financial needs and responsibilities. Budgeting can also support you to achieve longer-term financial goals.
Sticking to a budget can be easier said than done. But, when followed consistently and reviewed regularly, a good budget can help you to enjoy more financial freedom and feel more confident dealing with your finances.
Read on to find out how to budget in a way that feels manageable and works for your situation, whether you want to focus on clearing your debt or building up your savings.
How to make and manage your budget
1. Work out your after-tax income
If you’re employed, you probably know your gross salary and have a good idea of what your take-home pay is, but do you know the exact amount? If you get paid through your company’s PAYE system, your employer will deduct income tax and National Insurance, so your after-tax income will be the amount you receive in your bank account each month. Your employer may also have deducted any student loan repayments and workplace pension contributions.
Check your bank statement or look at your payslip before you start building your budget. This is important because if you’ve accidentally rounded up the amount you earn, you could find yourself allocating money you haven’t actually got, which won’t help if you’re trying to pay off debts.
Everyone can benefit from having a detailed budget. But, allocating set amounts to spend or save is trickier for those whose income varies month-to-month because they work different shift patterns, are self-employed or have a side hustle business.
If you are self-employed, you will pay your tax to HMRC after filing a Self-Assessment each year. Remember to subtract the income tax you expect to pay from your total income to work out your actual, post-tax earnings. Make sure you set aside money for tax each time you get paid, to avoid getting caught out when it’s time to file your 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. While it’s perfectly possible to handle your own self-assessment, you could consider seeking advice from an accountant. 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
Some of your costs will be fixed, such as rent, whereas others will fluctuate. Before making a budget, look at your spending from previous months to work out your typical expenditure and identify any areas where you may be overspending. Start by going through your bank statements for the last 3 to 6 months and taking an average of what you’ve spent in categories such as bills, travel, food, clothes and socialising.
You’ll quickly spot areas where you’re spending more than you realised and see ways that you could save money. It could be as simple as cancelling subscriptions or spending less on eating out. Or, you may spot a major opportunity to reduce your outgoings, such as remortgaging your house to a lower interest rate.
If some of your bills went up in April, now could be a good opportunity to switch energy supplier or shop around for a cheaper broadband or mobile phone provider. 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, nonessential ‘wants’, plus 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 cash stuffing or the jam jar approach, is a popular budgeting plan, especially for those who struggle to control their spending and are at risk of falling into so-called lifestyle debt. 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, forcing them to stick to their budget.
If you don’t use cash, you can recreate this budgeting method on mobile banking apps such as Goodbudget and online only banks such as Monzo and Starling, which offer digital Pots and ‘envelopes’ to separate the money in your bank account.
» MORE: banking and budgeting apps.
Whether you use cash or an online banking app, setting individual budgets for your different expenses makes it easy to see how much you have left to spend in each category. This helps to remove the temptation of using money intended for one category (like bills or savings) to cover a shortfall if you’ve overspent elsewhere.
4. Track your progress
Once you know how to budget, you can set yourself short-term goals to help you stay focused. That might be to clear a certain debt, cut your spending by a certain amount, or reach a savings target.
Even if your budget is working well, it’s critical to keep tracking and reviewing your progress regularly to make sure you are on track to meet your money 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. Many people find it helpful to do this as soon after payday as possible. Automating payments makes it easier to make sure your bills are paid on time, giving you the freedom to focus on other aspects of your budget.
If you’re in a position to do so, it is also worth setting up a standing order to automatically transfer some 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.
» MORE: Habits of Successful Savers
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. However, a change in circumstances is not an excuse to scrap your existing budget, but rather an opportunity to review it and amend it to better fit your financial situation and your goals.
How to budget using the 50/30/20 rule
When you create your first budget, the 50/30/20 budget rule can be helpful as a starting point. Based on this guide, you would divide your take-home pay into the following categories:
- 50% of your income on ‘needs’, or essentials.
- 30% on ‘wants’ and non-essential spending.
- 20% on paying off debt and/or topping up your savings.
You can adjust the ratio to suit your personal situation as you may spend more or less on basic necessities.
Once you’ve decided how you’ll split your income and know that you can stick to it, you should be able to manage your finances more easily. Over time, you may be able to build up savings for the future and retirement
50/30/20 budget calculator
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:
- Rent/mortgage
- Bills (water, electricity, gas, broadband, council tax, mobile phone)
- Food (essentials)
- Insurance payments
- Commuting (petrol, vehicle tax, car MOT, public transport)
- Childcare
- 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. For example, if you’re currently in rented accommodation this could take up a third of your take-home pay, or more, so the ‘needs’ category may need to be more than 50%.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”.
If your income increases or your costs go down, for example as a result of changes to the energy price cap, you can review your budget and decide whether to clear your debt, increase your savings or use the extra money to treat yourself.
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 could spend less on non-essentials and prioritise clearing your debts to make your financial 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 luxuries, however small, will help you to stick to your budget in the long-term.
‘Wants’ typically include spending on things like takeaways, meals, coffees and days out, hobbies, and theatre/concert tickets. However, it can sometimes be difficult to separate a ‘need’ from a ‘want’, as some outgoings 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. For example, if you consider the gym essential for your wellbeing, weigh up whether you’re getting value for money from your membership.
Don’t forget to budget in advance for one-off expenses like Christmas, birthday gifts and holidays. Since these come around every year, you could start a regular savings pot that you contribute to each month, taking the pressure off expensive occasions.
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, it can be difficult to work out exactly whether to prioritise growing 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.
If you’re self-employed, explore personal pensions.
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 where you will be charged for making an early withdrawal.
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, consider increasing your repayments on your remaining debts to clear these as soon as possible. If the interest rate on your remaining debt is low, you may choose 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.
6. You!
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 experience a financial shock, such as, redundancy or a major unexpected expense, you should be in a position to cope without resorting to debt to cover your 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, whatever stage you’re at in life and in your financial journey, budgeting will always be crucial to help you reach your goals.
Image source: Getty Images
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