Five quick steps to build a budget

While following a budget might seem limiting, when used as a guide, it can be incredibly empowering. The collective decisions you make on your everyday spending and saving have a material impact on your longer-term goals. Fortunately, a combination of tried-and-true practices and modern tools can help you find your way. And even if you’re already good about budgeting, it can be helpful to periodically revisit your plan and make adjustments to reflect your current situation.

First, determine your average monthly income. This may be a simple matter of reviewing your take-home pay on your paycheck—the amount left after taxes and other withholding. However, if your income varies by month, estimate by averaging the past six to 12 months of income. To be most conservative, work with the income amount from the month with the lowest income during that time. If you’re self-employed, be sure to deduct the estimated taxes you will owe and other business expenses from your total income.

A fixed expense is money you spend on items that don’t change much from month to month. Some of these may include rent or mortgage; utility bills such as water, electricity, internet, and cell phone; insurance premiums; transportation costs; and debt payments like student loans or car loans.

Consider contributing to your savings as a fixed expense. Decide on a percentage of your income that you’d like to save every month and treat it like a bill you must pay. Some food for thought: Consider setting up an automatic deposit to help you save a set monthly amount. Before you know it, you won’t miss that money at all.

A variable expense is money you spend on items that fluctuate from month to month, such as eating out, shopping, or travel. Look back at your past few credit card bills or bank statements to gain a sense of roughly how much you spend in each category on a regular basis. Total those up for a monthly average and figure out where you should be cutting back if necessary.

Remember to keep in mind those expenses that don’t happen every month like presents and vacations. To make sure that these one-offs don’t catch you by surprise later, try estimating how much they cost you on an annual basis. Then divide by 12 so you can budget for them and put that money aside throughout the year.

Add your fixed and variable expenses and deduct them from your monthly income after taxes. If you’re left with a negative number, you’re spending more than you’re making, and something needs to change. Your focus should be on making this number positive as soon as possible. Once you’re making more than you spend, you can start to think of your future finances.

List your top priorities to help you figure out how you'll use any extra funds in your budget after your necessary expenses. Depending on your goals, risk tolerance, and timeline, decide whether it makes more sense for you to save or invest your money. Some people may choose to put money towards their rainy day fund or retirement while others may look to pay down debt, fund their child’s education, or even buy a home.

Bottom line: Periodically monitoring your budget and having a good understanding of your monthly saving and spending habits can help you make smart financial decisions over the long run.

The source of this Morgan Stanley article, How to Create a Budget, was published on December 1, 2022.