How to Budget: The Ultimate Guide for Dividing Up Your Income

Keeping a budget is extremely important for your financial health. Without a budget, it’s hard to track how much you spend — and what you’re spending on. But with a budget? You have clear guidelines to keep your spending in line that can help boost your savings and even pay off debt faster.

Learning how to budget can be tricky, especially if you don’t know which strategy you want to use. Zero-based, 50/30/20, and envelope budgeting are just a few methods you’ve probably heard of, and we’d recommend each to a different type of person. The benefits of picking the right strategy and knowing how to create a personalized budget are well worth it. Here are some budgeting tips to save more without the headache, as well as some of the best apps to help.

What is a budget?

A budget is a financial plan that uses your income and expenses to dictate your spending. Most budgets calculate spending on a monthly basis and include housing, transportation, food, utilities, entertainment, debt repayment, and savings. Budgets can cover both predictable, recurring expenses and unexpected, irregular expenses.

How to budget: Six key steps

If you’re ready to give budgeting a try, here are the steps I recommend for getting started. Keep in mind, these are just the basic steps. What you end up actually doing may vary depending on the budgeting method you select (more on that below) as well as how serious you are about the process.

1. Review your monthly income

Before you can establish a budget, you’ll need to collect your monthly take-home pay after taxes and other deductions. That includes adding up your family’s monthly income from:

• Employment
• Side hustles
• Passive income
• Investment income
• And gifts

Your total take-home pay will be the starting point from which you subtract your various expenses, so don’t leave anything out.

If your pay varies every month because you’re a freelancer or don’t have a set salary, you might have a little more trouble with this. As a freelancer myself, I recommend calculating your average income over the previous 12 months and using that as a baseline. Then, recalculate it every quarter and adjust the average as necessary.

You’ll also want to be mindful if you work in an industry with seasonal fluctuations. For example, if you work in a beachfront community and make most of your cash in the summer months, calculate separate monthly income estimates for your “high season” and “low season.”

2. List your monthly expenses

You probably have a variety of bills you pay monthly. This might include:

• Utility bills
• Rent or mortgage
• Phone bills
• Cable/streaming services
• Student loan payments
• Personal loans

Add all of these up to get an estimate of your non-negotiable monthly expenses. Some of these may vary slightly each month — like your gas or electric bill. There are a few ways you can account for this. If it’s a cost that only fluctuates slightly, you might just take the average from your previous year of bills.

However, if you live in a place with extreme weather, it’s not uncommon to have higher heating and cooling costs in the summer and winter. For example, my gas bill is around $300 a month in the winter and $15 a month in the summer. It might make sense to have two sets of expenses — one for the winter and one for the summer — to account for these varied costs.

3. Track your spending

Down the road, you’ll want to set spending limits for expenses that can vary or aren’t strictly necessary. A good place to start is to track what you’re already spending and adjust.

Get into the practice of logging your expenses in each category. If you’re doing this manually, look at your credit card statements and categorize each purchase you made over the last few months. You can use whatever categories most fit your spending, but some common ones are:

• Clothing
• Entertainment
• Gas
• Groceries
• Pet supplies
• Restaurants
• Self-care services

To simplify this process, you may prefer to use a budgeting app that automatically calculates which categories you spend the most in. Rocket Money is one app that allows you to connect your banking services, such as a bank account or credit card, to automatically import and categorize your spending.

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4. Set goals

Once you have a picture of your income, expenses, and spending, set concrete financial goals. A good way to start is to make a list of both short- and long-term targets.

Short-term goals should have a timeframe of about one to three years. They could include things like:

• Paying off credit cards
• Starting an emergency fund
• Buying a new car

Long-term goals, on the other hand, can take decades to achieve and might include:

• Saving for retirement
• Building your child's college fund
• Paying off your mortgage

Try to be as specific as possible with your goals. For example, if you’re saving for retirement, what’s the exact age you’d like to retire? Or, if you want to start an emergency fund, how much would you like to have saved (most experts recommend enough to cover three to six months’ worth of living expenses)?

Answering these questions can help you know how much you need to contribute to your goals every month. For example, imagine your goal is to retire by age 65. If you’re 35, make $60,000 a year, have $30,000 already saved, and estimate that your monthly budget in retirement will be $2,500, putting away $500 a month won’t be enough to retire by 65. You’d need to put away closer to $1,000 a month instead, based on current rates of return.

5. Make a budgeting plan

Now that you know where your money is going and have identified your goals, you can create a budgeting plan to ensure you have enough money to make everything happen.

Below, we outline several different budgeting strategies you can use to manage your spending. I prefer the zero-based budgeting method because I know exactly where every dollar I earn goes.

However, another strategy may work better for your needs. You might even try a couple to see which one you like best. Just be sure to give each strategy a few months so you can adjust your mindset and spending habits.

No matter which strategy you choose, if you don’t have enough leftover money each month to meet your goals, you’ll need to cut down on expenses. For example, if you subscribe to multiple streaming services, you may have to cancel one or two to free up funds. You’ll have to be honest about your priorities and make sacrifices if you’re serious about making a budget work.

6. Track and review your budget regularly

Having a budget and sticking to it are two very different things. Part of your budgeting process involves regularly reviewing it to make sure you're keeping your spending within the limits you set.

Expenditures have a way of creeping up when you're not looking. Groceries get more expensive, the price of utilities rises, and you think adding one more subscription won't matter.

On the flip side, your income may change as well. Maybe you've gotten a raise (more money) or have to pay a lot for your company's health insurance plan (less money).

I suggest doing a budget audit at least quarterly to make sure you’re still on track.

5 budgeting strategies

There are a variety of ways to go about building a budget, and some are more stringent or complex than others.

Decide how much time you can devote to budgeting each month, and select a budgeting method you know you can be successful with.

1. The zero-based budget

The idea: Find a purpose for every dollar you earn

Who it’s best for: Beginners who have the dedication to follow a strict plan

Zero-based budgeting involves finding a purpose for every dollar you earn. You start by subtracting your necessary expenses from your income. That includes budgeted amounts for things like groceries as well as your car payment, rent or mortgage payment, and utility bills.

Next, move on to your financial goals. These might include retirement saving, getting out of debt, or funding a major purchase. With zero-based budgeting, you allocate funds to each goal.

Everything left over is “extra” that can be used for the things you enjoy but don’t necessarily need. Essentially, this is your budget for dining out, entertainment, and shopping for pleasure.

For example, imagine you have $3,500 in fixed monthly expenses, want to contribute $500 a month toward retirement, and make $5,000 a month. That leaves you with $1,000 a month to spend on fun.

2. The 50/30/20 budget

The idea: Allocate your income to necessities, discretionary spending, and saving using set percentages

Who it’s best for: People who don’t want to fine-tune their budget every month

The 50/30/20 budget requires you to allocate money to just three separate categories, like so:

• 50% of your income for necessities
• 30% of your income for discretionary spending
• 20% of your income for saving

Although this is super simple, it will only work if 50% of your income will cover your essential bills. If it doesn’t, you may have to make your own version of the 50/30/20 budget.

For instance, you might decide that only 15% of your income should be reserved for nonessentials, like dining out. You may also want to add a category for charitable giving.

3. The 80/20 budget

The idea: Separate your cash into just spending money and savings

Who it’s best for: Beginners who want to test out a budget before trying a more in-depth method

The 80/20 budget is an even simpler version of the 50/30/20 budget. It involves putting 20% of your income into savings (emergency fund, retirement account, future purchases, etc.) and spending the other 80% on everything else.

This budget works well with the pay-yourself-first rule of saving that many financial planners recommend. Every time you receive a paycheck, put 20% into savings. You’ll be able to spend only what’s left over.

It can also help to automate your savings through scheduled contributions to your retirement account and deposits into a high-yield savings account.

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4. The envelope budget

The idea: Set aside money for each spending category

Who it’s best for: Those who primarily spend in cash and require maximum budget control

Envelope budgeting requires the most effort but gives you the greatest control over where your money goes. If you tend to live paycheck to paycheck or spend more than you earn, you could benefit from this type of money management.

Envelope budgeting is traditionally a cash-based system. It’s similar to the zero-based budget but involves setting spending caps for every category, even discretionary spending categories. It can be great for beginners because it teaches the basics of budgeting, but a lot of experienced budgeters swear by it, too.

You start by adding up your income and subtracting any fixed monthly bills. If you have quarterly or annual bills, include the monthly amount for these. You’ll also choose an amount to save each month and subtract that.

All the cash that’s left over should be divided into envelopes labeled with various spending categories, such as:

Track your spending and keep a record in a physical or digital envelope. When the money's gone, you can no longer spend in that category. If you have cash left over anywhere at the end of the month, deposit it into savings or add it to one of next month’s envelopes. Many budgeting apps use a digitized version of the envelope method, including EveryDollar.

5. The bare-bones budget

The idea: Only spend on absolute necessities and put the rest toward your goals

Who it’s best for: People who are serious about retiring early

This monthly budget is ideal for someone who wants to join the FIRE movement and retire early. It can also work for someone who needs a low-income budget after losing a job or who is drowning in debt.

It’s very simple, at least on paper: You only buy absolute necessities. You pay your rent or mortgage, utility bills, car insurance, health coverage, and other fixed or variable expenses you can’t avoid. You buy only the groceries, household items, and personal care items you can’t live without. Anything left over goes to savings and paying off debt, such as credit card payments, medical bills, and more.

This is also sometimes called a spending freeze, and it can be helpful during times of financial hardship or while trying to achieve a lofty financial goal.

Benefits of learning how to budget

Although the word “budget” might not stir fond feelings in everyone, I love budgeting because it gives me full control over my finances. Here are some of the benefits you can reap when you start budgeting:

• Stop living paycheck to paycheck: Every dollar will have a purpose, so you won’t be scrambling to pay your bills.
• Work toward your goals: Even if you can only commit a few dollars each month toward your goals, it goes a long way.
• Build an emergency fund: You never know when you’ll have a medical emergency or need a new tire. Budgeting can help you build up your just-in-case savings.
• Reduce worry and anxiety: With a plan in place, you’ll feel more comfortable knowing you have the funds to pay rent, buy groceries, and live your life.

5 budgeting apps to help you stay on track

Budgeting apps take the hassle out of manually tracking your expenses on pen and paper. And the best part? You can track spending right from your smartphone and/or computer, which makes these solutions more convenient — and your budget easier to stick to.

Here are five great options for your personal budget. You can also check out more options in our guide to the best budgeting apps.

• YNAB (You Need a Budget): YNAB combines zero-based and envelope budgeting. You manage cash flow by assigning every dollar you get to a spending category and adjusting as you go. YNAB is known for providing a much more detailed view of your finances than most other platforms and is a favorite for people who like to be in control.
• Quicken Simplifi: Quicken Simplifi is a low-fee money management app that gives you an overview of your finances, from your budgeting and saving to your investing and debt. This app doesn’t use a specific budgeting method but is friendly with any of them, and it’s one of the most customizable apps we’ve tried for setting goals and tracking them.
• PocketGuard: PocketGuard is a free budgeting app that keeps track of your upcoming bills, automatically categorizes your spending, and connects all your accounts in one place. It’s an easy way to keep track of your net worth, and it’s one of the better options for paying down debt.
• Rocket Money: After you connect your accounts, Rocket Money can find and cancel unwanted subscriptions and negotiate expensive bills for you. The budget planning tool automatically tabulates your income and bills, so you know how much you’ll have left over for other expenses. It’s one of our picks for everyday spend-tracking.
• Goodbudget: Goodbudget is a budgeting platform based on the envelope system. You digitally allocate your income to different spending categories, and you can share your budget with your partner, which makes it simple to track your cash flow as a family. This one is best for anyone with a track record of overspending.

FAQs

Bottom line

Creating and sticking to a budget is essential for achieving financial stability and long-term goals. It can help you avoid living month-to-month and better control your finances.

By following these six steps — reviewing your monthly income, listing your monthly expenses, tracking your spending, setting goals, making a budgeting plan, and reviewing your budget regularly — you can gain a clear understanding of where your money goes and where you can tweak to improve your financial picture and focus on what matters, like saving for the future.

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