Planning a Yearly Budget: Creating a Yearly Budget


By Jean Folger | Investopedia

There are a number of ways to approach creating a yearly budget. Some may prefer to add up all income for the year and all expenses for the year, and divide each category by 12 to come up with a monthly average. Others may like to see each month individually, with specific monthly income and expenses. Before you begin your budget, you may want to think about which system will work best for you.

When making projections it is important to understand how a budget works. If you write down that you will spend $100 each month on groceries and you continually go over budget, you don’t get to bump up that amount unless you pull that money from somewhere else in your budget. In other words, you can’t simply react to the actual grocery spending and change the budget to $500 a month without switching money away from some other expense area. Next year, you can start your budget with the $500 a month for groceries – but for this year, you’ll have to move money around.

When made realistically, a yearly budget is a tool that can help you set and reach financial goals. With some effort on the front end, your budget can be a source of inspiration to keep your spending on track and your goals in sight. Here are step-by-step instructions for creating your own yearly budget.

Step 1 – Gather Your Tools

There are a number of methods by which you can create your yearly budget, including:

  • paper, pencil and calculator

  • a spreadsheet program, such as Microsoft Excel

  • free online budgeting software (such as

  • commercial budgeting software (such as Quicken and Microsoft Money)

Best Budgeting Software for 2018 has more details about tools to investigate. All these methods work; just pick one and get started.

Step 2 – Research Past Income and Spending

Gather your past bank statements, paycheck stubs, credit card statements, utility bills, canceled checks, receipts and anything else that will help you figure out how much you earned and spent last year (or ideally over the past several years) so you can make better projections about the coming year.

Step 3 – Make Income Projections

Figure out your expected annual income from all sources:

  • alimony

  • bonuses

  • child support

  • disability benefits

  • interest and dividends

  • rents and royalties

  • retirement income

  • salaries

  • sales (if you sell crafts or other products)

  • Social Security

  • tips

  • wages

Step 4 – Make Expense Projections

This entails mapping out what you expect for next year in terms of your fixed and variable expenses, and your discretionary spending.

If you are not sure how much of your money should be going where, one method is to aim for the 50/30/20 budget introduced by Harvard bankruptcy professor Elizabeth Warren (now Senator Warren, D-Mass.) and her daughter Amelia Warren Tyagi in their 2005 book “All Your Worth: The Ultimate Lifetime Money Plan.” With the 50/30/20 budget, you aim to allocate 50% of your after-tax income to needs, 30% to wants and 20% to savings and debt repayment:

Figure 1: Yearly Budget Circle Graph

Using last year’s documents for reference, project your fixed and variable expenses for the year. Some expenses are known: your mortgage, for example, will be the same each month. Others require you to make a best guess based on history. Your expense categories will be unique to your situation. For example, not everyone will have professional dues to pay, or a student loan payment to make. Just make sure you cover all your expenses with enough separate categories to be useful (i.e. one category called “bills” won’t really help you figure out where your money is going). You may find that you need to adjust your expense categories in the future, or create sub-categories so that you can see more details. Here are some common categories to get you started:

  • debt payments – car loan, student loan, credit card

  • education – tuition, daycare, books, supplies

  • entertainment and recreation – sports, hobbies, movies, DVDs, concerts, Netflix

  • food – groceries, dining out

  • giving – birthdays, holidays, charitable contributions

  • housing – mortgage or rent, home maintenance, HOA fees or other payments

  • insurance – health, home/renter’s, auto, life

  • medical/healthcare – doctors, dentist, prescription medications, other known expenses

  • personal – clothing, hair care, gym, professional dues

  • savings – retirement, education, emergency fund, specific goals (i.e. vacation)

  • special occasions – weddings, anniversaries, graduations, Bar/Bat Mitzvahs

  • transportation – gas, taxi, subway, tolls, parking

  • utilities – phone, electric, water, gas, cell, cable, Internet

List each expense category and sub-categories (remember to list categories that work for you – there is no set way to do this) and enter your budget projection for each. Many people like to use separate lists for “Fixed Expenses,” “Variable Expenses” and “Discretionary Spending” because this will be helpful if the budget has to be tweaked.

A word about taxes: you will have to account for income taxes somewhere in your budget. If you use your pre-tax income, you will need to add an expense category for taxes. Alternatively, you can simply use your take-home pay in the income section and omit taxes from the expense side of the budget. With either method, you can include any expected income tax refunds in the income side, or any anticipated tax payments in the expense side of the budget. You may not know if you will get a refund or end up owing this year, but make your best guess based on your tax return history.

A word about credit card debt: If you have outstanding balances on your credit cards and make a certain payment each month, count this as a debt payment. If you pay off your credit cards in full each month, however, the bills are not considered debt payments. Instead, each expense that is on the credit card bill is assigned to the appropriate category.

Step 5 – Examine Your Cash Flow

Subtract your expenses from your income. If you have money left over, you have a surplus and you can decide how to spend, save or invest the money.Put that amount into your budget under the proper category. If you do not have enough income to cover your expenses, you will have to adjust your budget (see Step 6).

Step 6 – Balance Your Budget

If you subtract your expenses from your income and come up in the red, it’s time to do make adjustments to your budget. You can either increase your income – adding more hours at work or picking up a second job, for example – or you can decrease your spending. Most people find it’s easier to decrease spending since this is something you may have more control over (i.e. your company may not give you extra hours).

Trim Discretionary Spending

Sometimes the best place to start is by curbing some of your wants. This is where it is important to be honest about your needs versus wants. You probably cannot eliminate any needs from your budget, but you likely have room to cut some of the wants, including those that are currently disguised as needs. This may entail completely eliminating some expenses and reducing others. For example, you may decide to eliminate your daily coffee splurge (saving about $3 each day), while cutting back on the number of days that you go out for lunch while at work. Or you may decide that you can stop highlighting your hair and go longer between haircuts. Perhaps you could carpool to work two days a week, or take public transportation or ride a bike. With a little creative thinking, most of us will be able to find ways to reduce our expenses.

Trim Variable Expenses

If you reduce spending for wants and it’s still not enough to balance your budget, you can reduce regularly occurring variable expenses (many of these are still wants). For example, you can:

  • switch to a higher insurance deductible (resulting in lower premiums) – unless you have health issues that makes this unwise

  • cancel unnecessary subscriptions, such as magazines, Netflix, DVR, XM/Sirius radio, premium TV channels, etc.

  • opt for less expensive service packages, such as fewer TV channels, limited cellphone plans, slower Internet service, etc.

Trim Fixed Expenses

If you need to drastically cut expenses, you may have to consider things like:

  • refinancing your mortgage

  • moving to a more affordable rental

  • finding a roommate

  • trading in your car for one with a smaller payment

One other step is to look at your budget categories against the 50/30/20 model and see how close you come. If you’re way off, see if you want to readjust anything.

Step 7 – Make Monthly Budgets Based on the Yearly Budget

Once you have a yearly budget that is both realistic and balanced, you can create monthly budgets to provide a more manageable and timely view of your finances. The easiest way to do this is to divide each category by 12 (for the 12 months in the year). For example, if your annual take-home pay is $36,000, divide that figure by 12 to determine your monthly income (in this case, $36,000/12 = $3,000 each month). Alternatively, you can customize each month to reflect actual income and expenses.

Step 8 – Keep Track of Your Income and Spending

You spent all that time creating your budget, now it’s time to put it to work. An important step is to keep track of your actual numbers and compare them to those on the budget. Did you spend too much on groceries this month? If so, you will need to cut back next month to bring your budget back in line – or you will need to reduce spending in another category to make up for the overspending. Did you spend much less than you expected on your heating bill (perhaps due to warmer-than-usual weather)? You can decide how to use that “extra” money. By keeping tabs on your budget on a regular basis throughout the year, you can stay on track and meet your financial goals. Budgeting software will enable you to do this easily. If you use pen and paper, you may want to buy a ledger.

Step 9 – Plan for Next Year

Your budget is a work in progress. It would be unusual to completely nail it the first time around with expense categories that fit perfectly into your life and projections that are spot on. Instead, you will find that one thing you did worked well, and something else didn’t work at all. Keep written notes so that you can be better prepared to tackle next year’s budget.

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