The Complete Guide to Budgeting Methods
When it comes to money, it's always good to have a plan. That's why when someone is struggling financially, the first recommendation is to make a budget. Even if you don't have money worries, a budget will keep you on the financial straight and narrow.
Since there are many different budgeting methods available, it helps to learn about how each of the most popular methods work. That way you can decide how you want to put together your budget in a way that works for you.
Whether this is your first time budgeting or you're looking for a new way to do it, you'll find all the best options in this guide.
The traditional way to make a budget is to record your income and your expenses, decide where you want to cut back your spending, and set savings goals based on your disposable income.
You need accurate expense numbers for traditional budgeting, so it's a good idea to average out your monthly expenses from the last six months to one year. This will account for the monthly fluctuations in certain bills, such as utilities. It also ensures you record any expenses that you don't pay monthly, such as property taxes or insurance premiums. If you put aside money for these annual expenses each month, you'll be ready when the bill comes in.
If your income fluctuates, then you should calculate an average monthly income as well. Once you have a clear idea of your spending and income, you can compare the two and use the information for your financial planning.
This type of budgeting lets you see where all your money is going, so it's great for reining in your spending. The disadvantage is how time-consuming it is, especially to get started.
If you're detail oriented, then you may love traditional budgeting. Otherwise, you'll probably want to go with a simpler method.
With this method, you assign a portion of your take-home pay to different expense categories. A well-known example of proportional budgeting is the 50-20-30 budget, where you'd divide your income as follows:
- 50% to your needs, such as housing, food, and transportation
- 20% to savings (this includes investments and retirement funds)
- 30% to your wants, such as drinks with friends, concert tickets, and Netflix
If you take home $3,000 per month, you'd use $1,500 for your essential expenses, $900 for things you want, and you'd save $600.
Proportional budgets are popular in part because of how flexible they are. You can use whatever proportions and categories you like. For example, an easier alternative to the 50-20-30 budget is an 80-20 budget, where 80% of your income goes towards expenses and 20% goes into savings.
A zero-based budget involves finding a specific purpose for all of your income and not having any leftover cash at the end of the month. For that reason, this method is often described as giving every dollar a job.
Your zero-based budget may involve putting $800 towards housing, $200 towards a car payment, $300 towards your retirement account, and so on. Savings, investments, and retirement accounts do qualify as "jobs" for your money here, so you won't literally be spending every dollar.
Budgeting this way can be complicated, especially if your expenses or income fluctuate often. However, it works very well if you've had trouble keeping track of your spending in the past.
A value-based budget is a bit different than your typical budgeting method. Here's how it works:
- You make a list of the things that you value most in life.
- Based on that list, you allocate portions of your disposable income each month to what you value.
If your biggest passion in life is to travel, then you'd put that at the top of your list and set aside money every month for a travel fund. Then, you'd allocate a little less money to the next passion in line, and so on.
This type of budgeting is great if you feel like you've been wasting money on things you don't want or need. By creating a list of what's truly important, you can stop buying things that don't bring you any joy and start putting your money towards the things that make you happy.
Pay yourself first
This method is an easy, effective option to ensure that you save money. Every time you receive a paycheck, you first transfer a portion of it to your savings. A convenient way to do this is by setting up automatic transfers. After you make that deposit to your savings account, you then use the rest of your income for all your expenses.
If you never seem to have any money left over at the end of each month, the pay-yourself-first method can help you fix that. Consumers often treat their savings as an afterthought that they'll focus on when they have the extra money. Paying yourself first makes your savings a priority.
The envelope method
For the envelope method, you take multiple envelopes and write an expense category on each one. You then set a monthly spending limit for those categories and put the equivalent amount of cash in each category's envelope.
Let's say your limit for food spending is $400 per month. You'd write the word "food" on an envelope, put $400 in it at the beginning of the month, and take that envelope with you whenever you went grocery shopping.
This method has two big benefits:
- It prevents you from overspending.
- It forces you to pay with cash, and studies show that consumers spend less this way compared to paying with a debit or credit card.
The envelope method is not without its flaws, though. It can be a hassle, since you need to withdraw cash every month for all your expenses. It's riskier to keep money in envelopes at home or on your person instead of in a bank account. And even though paying with cash can be good motivation to spend less, it also means you'll miss out on the purchase rewards and security that credit cards offer.
With a reverse budget, you focus on completing one goal with your income every month, such as adding to your savings or paying down debt. As long as the rest of your money is enough to cover your monthly expenses, you don't worry about it.
Here are a few examples of monthly goals you can use in a reverse budget:
- Adding $700 to your savings.
- Putting $400 towards your credit card debt.
In each of those examples, after you complete your monthly goal, all you have to do is at least break even on your other expenses.
The biggest advantage of reverse budgeting is its simplicity. You won't need to spend much time managing your finances every month if you use this method.
But this budget also has a significant drawback in that you won't be tracking where the rest of your money goes. You could overspend in certain areas without knowing it since you'll only be focusing on that one financial goal.
Designing your budget
As you can see, there are several budgeting methods out there, and there is some overlap between certain methods.
So how do you choose a budgeting method? It all comes down to your current financial situation and personal preference, but you can narrow it down by asking yourself two questions:
What's your biggest money problem? Some budgeting methods work exceptionally well at solving specific money problems. If you've been having trouble saving money, the pay-yourself-first method would be a smart choice. If you overspend, traditional budgeting or the envelope method could help.
How much time do you want to spend budgeting? Those who don't want to devote any more time than they need to on their budgeting should stick to simpler methods, including the pay yourself first and reverse budgeting methods. If you're willing to put more time into your budget, then you can look into more detailed methods, such as zero-based budgeting.
Remember also that you can mix and match elements you like from multiple budgeting methods. The point is to find a method you can stick to that also helps you reach your financial goals.
These savings accounts are FDIC insured and could earn you 12x your bank
Many people are missing out on guaranteed returns as their money languishes in a big bank savings account earning next to no interest. Our picks of the best online savings accounts can earn you 11x the national average savings account rate. Click here to uncover the best-in-class picks that landed a spot on our shortlist of the best savings accounts for 2023.
Our Research Expert
We're firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.
The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters.
Copyright © 2018 - 2023 The Ascent. All rights reserved.