Budget Categories How To Build A Better Budget

This page may include affiliate links. Please see the disclosure page for more information.

Getting your income and expenses balanced out for your budget can be difficult. The devil is in the details, and it starts with your budget categories. It’s all about the things that you spend money on without even really thinking about it, like your social life. That’s where it’s important to keep track of your spending.

Now, for most people, having a personal budget just isn’t something that we think about. And it definitely is more work than just creating a list of your income and expenses. There’s a lot that you need to pay attention to and keep track of so that you can create a quality budget.

Of course, once you’ve had a chance to look at all of these things, you’re going to set yourself up for better success and even wealth.

But first, you’re going to need to know how to define budget categories, make a budget and what type of budget you want to create. We’ll help by examining the options. Where one might be the perfect fit for your situation, another might be better for someone else. So, take a look at how to create budget categories that make a reasonable budget and decide which budget is going to be the best way to go for you.

We review three different budget options to choose from. But first, let’s dig in on how to define your budget categories.

Building Blocks – Budget Categories

All budgets begin with your income, i.e., the amount of money you have available after taxes and other employee deductions have been taken out of your paycheck. Income could include money from side hustles, part-time, or full-time jobs. This is your disposable income and is what you use to take care of your family’s most essential needs each month, including housing, transportation, food, utilities, insurance premiums, and other necessary costs. 

  • Housing – Anything spent towards keeping a roof over your head should be considered a housing expense. This includes rent or mortgage payments, property taxes, home maintenance costs, and HOA dues. This category is usually the biggest. 
  • Transportation – Regardless of the number of wheels it takes to get you from point A to point B, you need to capture its cost in your budget. This category should include car payments, registration, DMV fees, gas, maintenance, parking, tolls, and public transit. 
  • Food – Groceries, of course, are an essential expense for everyone. This budget category can vary widely depending on family size, how you shop, and eating out. You’ll also need to determine if you need to break out separate categories for things like household items, alcohol, work lunches, food delivery, etc. A good rule of thumb is if the spending on these other items equals 50% or more of this bucket, it should be broken out into its own. 
  • Utilities – Water, electricity, heating, ventilation, and air conditioning all should be captured. It should also include cell phones, cable, streaming services, and high-speed internet expenses. 
  • Insurance – This category depends on your budgeting style. Many budgeters prefer to categorize things like health insurance under “Healthcare,” renters insurance under “housing” or auto insurance under “Transportation” or completely valid, it just depends on how you want to categorize these cost, please just make sure they are documented.
  • Medical & Healthcare – This category includes whatever you spend on healthcare that does not include insurance premiums, such as co-payments, specialty care (dermatologists, psychologists, etc.), dental care, urgent care, prescriptions, and medical devices. 
  • Saving, Investing, & Debt Payments – Ever hear the phrase “pay yourself first?” Many believe saving and investing should be at the top of your list. Debt repayments, too, because once you clear your debts, it gives you the ability to increase spending in other categories throughout your budget. At the bare minimum, everyone should have an emergency fund for when unexpected expenses pop up. You should be investing in retirement in accounts like a 401(k) or IRA. If you work for a company, make sure you are receiving 100% of the company match in your retirement account.
  • Personal Spending – This category is a catchall bucket that can include anything not already captured. Personal spending can include memberships, grooming products, new clothes, shoes, home decor, furnishings, gifts, subscriptions, personal hygiene supplies, dry cleaning expenses, etc.
  • Recreation & Entertainment -Ever hear the term “fun money?” This category can include vacations, concert tickets, sporting events, movies, video games, hobbies, really anything that constitutes fun and entertainment in your life.
  • Miscellaneous – This category is designed for anything you may not have already budgeted for or categorized. It’s the last stop to collect any spending not already accounted for.

Now here the good news, it’s your budget, and these are the top suggested categories. How you document your budget is totally up to you, just be sure you capture all income and expenses. One good way to make sure you’ve done that is to review bank statements for the last 2-3 months to see if something you’ve overlooked jumps out.  

How to Make a Budget – Three Methods

Now that you have all your categories set let’s review three different types of budget methods.

50/30/20 Budget Method

Started by Elizabeth Warren, a Harvard bankruptcy expert, this budget is meant to be simple and easy. She actually created it for her daughter, and it breaks everything that you purchase into three different categories, either a need, wants, or debt and savings.

Keep in mind that for this budget to work, you need to have a similar income from month to month. If you don’t… you’ll struggle to make things work, and another budget might be the better way for you to go.

How does it work?

Now, the first thing you need to do is balance out the different categories of your budget that we already mentioned.

The money you’re using is your income and should be after your taxes have been taken out. You should be able to figure this out pretty quickly because it’s generally the amount that’s deposited directly into your account each week or two weeks (or written on the check that you’re given).

  • 50% to Needs – The first section of this budget is for your needs. Half of your monthly payment is going to go to things that you need, like your house, the utilities, gas, electricity, groceries, your car, medications, and any other things that you need to get through the month. These are necessities.
  • 30% to Wants – These are things like going out with friends, going to the movies, taking a trip, buying something special for yourself. Basically, anything that you want but don’t need to have got 30% of your income. That’s a little over half of what you have left after taking out needs.
  • 20% to Debt and Savings – Finally, the rest of the money goes to your savings and your debt. These are things that you need to pay off or need to prepare to be ready for the future. For example, paying off your credit card debt, set an emergency fund, or simply allocate it for saving. You can multiply your total income by 0.2 to get 20%, and this will tell you how to divide up the money in this part of your budget.

The Reverse Budget

The second option on how to make a budget is called a reverse budget, and this one means that you put every single dollar that you bring in to work. That means you’re going to know precisely what it’s for at any given time, and you won’t have to worry about if you’re spending your money the wrong way.

Similar to the envelope system (which we’ll discuss in a minute), this method means that you need to budget out your categories and only use the money that you’ve allocated to the group in that category. You can’t use other cash, and you can’t use credit cards to get there.

Unlike a traditional budget where you subtract your expenses from your income and start from there, with this budget, you’re going to start by defining how much money you’re going to put into retirement and investments. 

You start with this budget by looking at the more important things in your life and budgeting those before anything else. It’s the opposite of the budget that you might have seen before, but it definitely works well for those who seem to struggle to make things fit.

With this type of budget, you’re going to focus on how much you can save, and then you have to work your spending around that savings. That means you have to prioritize everything that you’re doing and make sure that you aren’t spending on things that aren’t as important to you. Instead, you end up saving a whole lot more than you might have thought.

Plus, you’re not going to have to worry about how to keep this plan up. Once you set it up and especially if you can set up automatic transfers to your savings, you don’t have to come back to it again unless your income changes dramatically or you have a new important expense.

Envelope Budget

The third option on how to make a budget is quite a simple and popular method of keeping track of your money and making sure that you always have enough. You would create an envelope for each expense that you have as well as any other areas where you want to spend money (like going out to eat or to the movies). You divide out the amount of money you have into each envelope, and that’s all you have for that area until the new month.

With this type of budget when the money in the envelope is gone, you don’t spend any more money in that area. This forces you to think a little bit harder about how much money you spend on different areas and what is most important to you.

You would generally use the envelope method after you’ve already paid for your bills for the month. So, you take out the required expenses, and any money left can be divided out into different categories that you would typically want to spend your money on.

Create Your Budget Categories

Keep in mind that an envelope system is a zero-based budget. That means every single dollar that you bring in has a purpose and goes somewhere.

Based on the categories created above remove the fixed expenses from your monthly income like a car payment or a mortgage. 

Go All Cash or Full Digital

You can choose whether you’re going to go with cash in paper envelopes or a debit card with digital envelopes. Either way can work, but you need to make sure that you’re sticking to it and that you feel comfortable with it.

If you’re getting ready to organize, however, you need to make sure that you know what categories you spend the most in and where you want to be able to spend more. Label out your envelopes, figure out how much money you have to allocate, and start putting the money into the envelopes based on how much you currently spend or how much you would like to have.

You may have to adjust as you go along if you find you don’t have enough money to get all of the envelopes filled. Keep working with it until you have some in each envelope.

What’s Left

If you have any money left over in your envelopes at the end of the month, that’s the time when you should be putting money toward savings and debt (there should also be a category for this at the beginning of your month). Empty the envelopes every month and then start from nothing again.

Bottom Line

Overall, you will have to put some hard work and time into figuring out how to make a budget. You’ll need to work through these steps a few times to find the right option for you, and you may find yourself struggling. Keep in mind that just because it doesn’t work the first time doesn’t mean it won’t work at all. You can start documenting your budget on paper, then move to a spreadsheet or even a budget app.

The best thing you can do is take a look at your lifestyle and your income and see how a budget will fit into your life. You may realize you need to earn extra money or spend less. You can absolutely do it more easily than you think if you’re willing to put the time in at first. After all, once your budget is set up, it’s going to be a whole lot easier for you to stick with it.