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How Personal Budgets Work


Personal Income and Expenses
You have to keep a close eye on your income when you create a personal budget.
You have to keep a close eye on your income when you create a personal budget.

While you can certainly create a successful personal budget with nothing but a pencil and paper, many people find it very helpful to use financial software. Whether you use software or go "old school," the first step for creating a personal budget is to calculate your average monthly income.

To keep things simple and honest, only include fixed earnings like paychecks from your job, alimony payments, legal settlements, royalties or dividends from investments that you don't plan to reinvest [source: Yahoo! Finance]. Don't bank on uncertain income like raises, bonuses or a particularly fruitful trip to Las Vegas.

Tracking your income is the easy part of creating a budget. It's much harder to pinpoint your spending. This is why personal finance software is so helpful. Programs like Quicken or Microsoft Money can access your online banking records and download all recent transactions for detailed analysis.

With a complete list of all of your bank deposits, outgoing checks and transfers in front of you, you can begin the important task of categorizing all of your income and expenses. With a few clicks of the mouse, you can label a $2,500 deposit as a paycheck, a $500 transfer as a credit card payment and a $1,500 check as a rental deposit.

In addition to specific categories like rent or groceries, personal finance experts recommend that you organize all of your expenses under two broad labels:

Fixed expenses are those expenses that stay the same every month. Not everyone has the same fixed expenses, but here are a few of the most common examples:

Discretionary spending is a broad category that includes every expense that changes each month. Not all discretionary spending is unnecessary. Take a look at the following examples:

  • Groceries
  • Eating at restaurants
  • Clothing
  • Entertainment
  • Travel
  • Hobbies
  • Gifts

In addition to using personal finance software, it might also be helpful to carry a small notebook with you to track your cash expenses. This can be especially helpful if you find yourself taking money out of the ATM more than once a week [source: CNN Money]. Every time you use cash to buy a newspaper, pay a toll or buy lunch, make a note of it.

Now that you've created a detailed worksheet of your income and expenses, you're ready to analyze the data and start drafting a better budget.