Which budgeting technique is right for you?
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Budgeting may not be the most exciting activity for a lot of people, but it is one of the most important for your financial health.
When you hear “budgeting,” you may think of a tedious process of creating a spreadsheet to figure out how much you’ve spent during the month. But it’s more than just a spreadsheet. Budgeting is a powerful personal finance tool that helps you:
- Identify excessive spending
- Calculate how much your emergency fund should be and how much income to save for the future
- Be aware of upcoming expenses so that you can apply for new credit cards when you know you’ll be able to meet the minimum spending requirements
- Stay within your financial lane so that you can accomplish your goals (like traveling the world)
There’s no one-size-fits-all approach when it comes to budgeting. It may take some trial and error to figure out what works best for you. Even if you’ve been budgeting for years, it’s good to consider whether a new technique might be useful. And if you’re creating a budget for the first time, use these four budgeting techniques as guidance to help you get started on the right foot.
Related: The best apps for money management
With a traditional budget, your goal is to figure out how much you’re spending and where your money is going. The idea is to build a budget around your lifestyle using this simple formula: income – expenses = net income.
To create a traditional budget, you’ll need to calculate how much you earn and how much you spend. If you use credit cards to pay for most of your expenses, this will be easy. You can download your spending activity from the last few months and consolidate everything into one Excel sheet.
Here’s an example:
Income: $4,000 (after taxes)
Total Expenses: $3,200
Net Income: $800
Based on this example, that’s a savings of 20% of the monthly income (the general recommendation). This excess can be set aside for emergencies, used to pay off debt, or invested. If you want to increase your savings, you’ll have to figure out how to reduce your expenses.
Categorizing your expenses can give you a blueprint of your spending habits and help you spot unnecessary or excessive purchases. If you find your expenses are frequently going over the amount you’ve budgeted, you can identify which categories might be problematic (restaurants, entertainment or hobbies, for example) and work on spending less in those categories in future months.
Related: Ways to use a credit card responsibly
This method may take a little more time than the others, but if you like detail and want more insight into your spending habits, the traditional budget might be for you.
The zero-based budget allocates every dollar of your income into buckets. A zero-based budget is based on a different formula: income – expenses = 0 (hence, the name). In this format, your savings are treated like an expense.
Total Expenses: $4,000
Net Income: $0
Similar to building a traditional budget, start by compiling your expenses into one spreadsheet. Next, label each expense – but this time, be more specific.
Don’t forget to include infrequent expenses that may not come up every month, but still need to be accounted for — such as insurance, car repairs, holiday gifts and new clothes. You’ll either need to include a miscellaneous expense category as a catch-all or have sinking funds, where you set aside money every month for these types of expenses so you’re not caught off-guard when they pop up.
The zero-based budget is best for people who (a) have plenty of time to budget and (b) want as much detail into their spending habits as possible.
If time is a concern, the 50/30/20 budget might be better for you.
The 50/30/20 budget splits your expenses three ways: 50% for needs (such as rent and groceries), 30% for wants (Amazon shopping, anyone?), and 20% for saving. No need to set individual limits for every expense. The goal is to stay within the percentages.
Sticking with our example, you’ll see that the 50/30/20 budget is much simpler.
Needs: $2,000 (50%)
Wants: $1,200 (30%)
Savings: $800 (20%)
When you start using this technique, you’ll need to define your “needs” and “wants.” Needs should be vital to your livelihood, like rent, utilities, groceries, bills, and so on. If Netflix is a staple in your life, sure – throw it in. But keep in mind the total size of your necessities bucket doesn’t change. If you make room for Netflix, you’re taking away from something else that might actually be important.
If you’re prudent and want to reap the rewards of saving down the road, you can flip this budget to a 50/20/30 format. You’ll save 30% of your income each month and spend up to 20% on whatever you please.
Or maybe you’re not a point in life where saving 30% or 20% of your income is feasible. Things such as medical expenses, child care, mortgage and/or car payments may be part of your “needs,” pushing you over 50%. Or you have debt to pay off. You can easily adjust this method to be 70/20/10 or whatever percentages work best for you.
If you want to take the simplest budgeting route possible, the 80/20 budget is best for you. It divides your income into two segments: 80% for life expenses (needs and wants) and 20% for saving.
Expenses: $3,200 (80%)
Savings: $800 (20%)
All you need to do is add up receipts, credit card statements, etc. and make sure your expenses are no more than 80% of your income. Save the rest.
It’s simple, it’s quick, and it ensures you’re still saving money – without the granular spending limits. The drawback to this method is the lack of structure. If you’re consistently overspending, it may be hard to determine where exactly to cut back without a more detail-oriented analysis of your expenses.
Keeping a budget doesn’t have to be overly complicated or time-consuming.
No matter which budgeting technique you choose, the important part is to follow through with tracking your spending and making sure you’re achieving your savings goals. Whether you’re detail-oriented and prefer the zero-based technique or you want something simple like the 80/20 method, make sure your method matches your time and preferences.
At the end of the day, the goal is to maximize every dollar you earn – so any budget is better than no budget.
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