When choosing the best budgeting method for yourself, there is no one-size-fits-all answer.
You may have tried one method of budgeting but found it restrictive, tedious, or difficult to stick to for the long term. If you haven’t found one budget to work for you, try experimenting with different budgets – yes, there are more than one way of budgeting!
Read on for more information about six common budgeting methods and see if one of these will speak to you.
Classic Line Item Budget
When most people think of a budget, they are most likely thinking of the line item budget.
With this budgeting method, each category has a specific amount allocated to it. The objective is to track your actual spending against planned line item expenses to make sure that you do not overspend within each category.
You will start with predetermined categories such as housing, utilities, food, transportation, and entertainment. Assign a target spending amount for each category. This is a great starting point for budgeting beginners, since it is relatively simple and aims to keeps your spending in check.
For those desiring a a budgeting system that prioritizes saving, debt payoff, or reaching other financial objects, they may want to look into other budgeting systems.
PROS:
+ Good starting point for beginners
+ Simple to create
+ Focuses on not overspending
CONS:
– Does not prioritize objectives beyond tracking spending
– Tracking expenses at the transactional level can be very tedious
Zero Based Budget
The overall idea of the zero based budget is to start with your planned income and assign a purpose to each dollar until you reach zero.
When you are designing your budget, your total planned income should equal your total planned spending. This means that every dollar is put to work, whether that’s paying for your essential and discretionary expenses, paying down debt, or adding to your retirement savings.
If your total planned spending is less than your total income, then that is an indication that you still need to budget the remainder. If you find yourself in this situation, increase your planned savings or debt pay down.
PROS:
+ Encourages intentional spending – every dollar has a purpose
CONS:
– Can be tedious to keep track expenses by various categories
50/30/20 Budget
Instead of tracking your spending by category, the 50/30/20 budget divides your spending within three broad categories: needs, wants, and savings. You would allocate your take home pay as follows:
50% – NECESSITIES
These are your essential expenditures, such as shelter, food, utilities, and transportation expenses.
Examples: rent, mortgage, groceries, gas and electric bill, subway pass, insurance
30% – WANTS
These are your discretionary expenses, such as entertainment.
Examples: eating out, travel, movies, trendy clothing
20% – SAVINGS & DEBT
This would be money going towards your savings account or paying down your debt.
Examples: growing your emergency fund, contributing to an IRA, and paying down your student loan
Keep in mind that the focus of the budget is the allocation towards savings, and it doesn’t really matter how the rest of your money is allocated. The 50/30/20 budgeting method is merely a guideline, and you can modify the percentages and breakdown to suit your personal situation or to meet your financial goals.
PROS:
+Prioritizes savings and debt payoff
+Provides a big picture snapshot of your finances
+Less tedious work since you’re not tracking by individual categories
CONS:
– This specific percentage allocation may not work for everyone (but can be adapted to fit your needs)
– May not emphasize enough savings
Pay Yourself First Budget / Reverse Budget
The Pay Yourself First Budget ensures that you are prioritizing saving and prevents you from overspending in other areas that would eat away at savings.
To get started, determine your savings goal and how much you want to set aside for each goal. When you are setting up your monthly budget, subtract your targeted monthly savings from your income. Automate your paycheck so that the amount is deposited into a savings account that is separate from your checking account.
The remaining amount can be used towards your both your essential and nonessential spending – it doesn’t matter what you are spending on individual line items as long as you are reaching your savings goal.
PROS:
+ Prioritizes saving towards your goals
+ Requires less maintenance
+ Less tedious since expenses are not tracked at the category level
CONS:
– Risk of over drafting if you have irregular income or do not account for unexpected expenses
-May not provide enough granularity for those who want to track their expenses in detail
Envelope System
Similar to the line item budget, the first step with the envelope budgeting system is to determine upfront how much money you want to allocate to each expense category. Get several envelopes, withdraw the total amount of cash you will need, and allocate the cash to each applicable envelope, labeled with a specific category.
Throughout the month, take out the cash from the envelopes to make the purchases you need. You are allowed to use the cash in the envelopes until they are gone.
This method prevents you from overspending, since you have a concrete visual cue of when you are running out of money for each category.
PROS:
+ Clear, visual indication of how much you can spend
+ Helps with overspending
CONS:
– Dealing with cash may be cumbersome
– Holding large amounts of cash may feel unsafe
Value Based Budget
With a value based budget, let your core values and life goals drive your spending and saving. You are managing and growing your money in a way that will help you live out your values and goals. This gives context and meaning to your budgeting.
Start out by determining the values that you hold at the current phase of your life. How do you want a day in the life of yours to look? Where do you want to live? What activities do you enjoy? What job do you want to have? What brings purpose to your life?
Then think about your long term goals – how you want your life to look in the future?
Once you have identified your values, you can examine your expenditures from past months and determine what does or does not service the life you want to live. The expenses that you can cut can go towards the savings that help build the future that you envision for yourself.
PROS:
+ Your cash flow plan is focused on aligning your spending with your values
+ It will encourage intentional spending and allow you to reflect on what your core values are
+ Psychologically, it can feel less restrictive that other budgeting methods because it focuses on adjusting your money to fit your life, rather than the other way around.
CONS:
– You may not know what your values are. It may take some reflection and soul searching before you are able to identify what is important to you.
– It may not help you with overspending
– It may take more time since you need to analyze past expenses and do some soul searching as a starting point
The bottom line is that budgeting is a framework that can help you understand where your money is going every month, help you with your savings goals, and prevent overspending with money you don’t have.
There are many budgeting methods out there, and finding a budget to integrate into your lifestyle for the long term is an ongoing process.
The best way to figure out which one will help with your financial objectives and work with your psychology is to experiment with different methods until you find one that speaks to you.