With so many different budgeting methods it can be overwhelming to figure out which one is the best for you.
If you are searching for budgeting methods then you landed on the right page to educate yourself.
There are many different types of budgets. For instance, whether it is home or office management, you need the proper techniques to manage finances.
It is an essential thing that plays a vital role in how you manage your money.
Did you know that a 1/3rd of the individuals do not have a budget? If you are shocked by that number then join the club. When I first saw that stat I was so surprised. But chances are most people don't have a budget because they haven't found the right budget for them.
What is a budget and how do you find the right budgeting system?
“Budgeting is like the breathing plan for the money. It helps in planning that you don't spend too much or too little.”
Budgeting involves creating a budget. And creating a budget can be as simple or complicated as you want it to be.
It involves keeping record of your money including what you earn, what you owe and how much you have left over.
Every person has some specific goals in mind regarding personal finances and goals that they want to achieve. This is why it is crucial to have accurate information before making any decision.
When it comes to budgeting you may have seem some these terms floating around.
Don't let those terms scare you off. They are just a fancy way of saying how much do you need to pay your bills. If words like that make you run the opposite direction then stay away from budget systems that are complicated. You don't need a seven tab excel sheet. A simple budget planner can be all you need.
Some people like to plan for a set time, e.g., one year or six months. Also keep this in mind when deciding on what type of budget would work for you. There are budgets that are best for those that want to budget by paycheck and otheres for those that like to plan out their whole year.
The importance of having a budget
We mentioned earlier that a 1/3rd of individuals don't plan their financial matters. It is an alarming situation that can later have an impact on other factors.
We all know that financial stability is of utmost importance. However, we can achieve this if we follow the right budgeting methods for our lives.
In case you're wondering here are some reasons why you should have a budget.
- If you don’t follow a budgeting system, then you can end up in heaps of debt. Budgeting is the best way to keep yourself financially stable and away from bad spending habits.
- Having a solid budgeting system can help you avoid a low credit score. The accumulation of debt can easily increase your monthly financial obligations. As a result, all of these monthly payments bring pressure on your credit card. Keep in mind that payment history contributes 35% to your credit score. Budgeting can help you to avoid this.
- Having a budget will help you keep track of what you need to pay and will keep you from missing a deadline and getting charged with late fees.
- Finally having a budget will help; you to start on track with your savings goals. Whether you're saving for retirement or saving up for a dream vacation having a budget will help you to reach your goals faster.
According to survey reports in 2017, every ten Americans saved less than $500 for emergencies. On the other hand, 7/10 Americans saved less than $1000 in saving accounts. There are more than 42% of Americans who don't save for after retirement period. Think about these stats and then think about how many of those people don't have a budget and if they did how those numbers might change.
What are the famous budgeting methods?
Now it is time to dive into the different budgeting methods. Understanding the different budgeting methods will help you to choose the budget that is best for you.
Everyone else's needs are different. And if you apply other people's plans, you will spend too much or too little. Or better yet you will just give up.
So, before making the plan, take a moment to review each of the different budgeting methods available.
Used mostly in business incremental budgeting sound exactly like what it is. Though it may go by different names is the the most common type of budgeting method and most followed.
In incremental Budgeting, you adjust the existing budget by setting the different ratios. And ratios are adjusted accordingly based on your income.
For example, if you earned 10% more or less than the last year, you can make the new budget according to that ratio.
This budget is straightforward to calculate.
You can adjust the budget according to your needs very quickly. It is effortless to make adjustments in this budget type. And you can easily calculate the budget as your income changes.
If your income fluctuates every month, then you can calculate based on average earning. For instance, if you are into freelancing, then your payment will not remain the same. So, in this situation, you can calculate average income.
Pros and cons of Incremental Budgeting:
|It is effortless to calculate and implement||The budgeting system remains the same and lacks innovation.|
|It ensures the continuity of the funding for all spending of the household.||It encourages overspending in the hope that you can manage it next year.|
|You don't need a separate massive system to maintain activities.||It remains the same over the years.|
|It works as a signal that you can raise your living standard.|
|You can immediately see the changing impact.|
|Best for people who have fix funding|
One of the pros of this type of budgeting method is it is easy to plan. But it comes with some limitations. As a result, it can put you in a non-innovative mindset.
Some people my find the budgeting limits restrictive and hard to follow. So while it is a good place to start it might not be the best fit for everyone.
Zero-based budgeting method:
With zero-based budgeting the goal is to allocate all your income so you are left with a balance of zero.
This leaves you little wiggle room. And while it can get a great way to budget for some the lack of flexibility can be restrictive.
The easiest way to do a zero-based budget is to start with listing what you have. One side is your income. The other side is your bills and expenses including savings.
Then you start allocating the funds appropriately. If you have money left over then you work to figure out where to put that money. So for example maybe it is paying off debt, paying off student loans or topping off your emergency fund.
Either way every dollar should be accounted for.
Pros and cons of zero-based budgeting method:
|Zero-based budgeting methods are accurate.||It requires taking a start from scratch; that's why it is time-consuming.|
|These methods provide efficient results.||No room for flexibility|
|It helps you to keep track of all your money|
|It fills in the gaps that might otherwise pop up for traditional budgets.|
A zero-based budget can be time consuming and limiting however it is a great way to make sure that you're accounting for every dollar and putting your money to work.
It doesn't leave much room for flexibility however this can help with savings goals and it gives you an opportunity to really learn how much you need for certain expenses.
Traditional budgeting methods:
The traditional budget is what most of have probably done before.
In this type of budget, you take a look at your expenses and income for the past year or past three months and create a budget based on those figures.
You're pretty much preparing an new plan based on previous behavior and spending.
For example, start with fixed costs such as your mortgage and then work your way down to your variable costs using the average of the past three months or year as a guide.
This is the budgeting method that most people are familiar with but it has it flaws.
First it doesn't really encourage you to find ways to cut back. It is more of a “well this is how much stuff costs so we gotta make it work” kind of style of budgeting.
It can also be overwhelming to tweak. There is no guidance on how to cut back in certain areas or find money for savings when your money is tied up on expenses.
While this type of budgeting method works it can be very limiting especially for those that are trying to look for creative ways to make their money work better for them.
Pros and cons of the traditional budget:
|Easy to implement, and saves time.||You're relying on the history of your expenses and as a result, this type of budget tends to be very fixed.|
|Expenses and incomes are stable.||Less motivation to make changes because you know it will remain almost the same|
|Easily implementable due to simplicity|
This budgeting system is similar to the incremental approach in the sense that is it is very limited. However, it is easy to create and implement. That's why people usually go for a traditional style of budgeting.
Pay yourself first budgeting system:
The name is exactly what it sounds like. In this budgeting method you pay yourself first.
Basically what this means is that you will set aside a specific percentage of your income to put towards a savings goal for example. The remaining will then be used for expenses.
So for example let's say you earn $1000. You may set aside 25% or $250 in a savings account. The remaining amount of $750 will go towards living expensesi.
With this method some people choose to further break down that 25% and allocate to items like personal expenses, travel, and leisure or other savings goals they may have.
This is agreat method for those that are variable savings goals or want a little flexibility. By have some money to play with it allows you to have room for the things you want to do without having to dip into the money that is allocated to fixed expenses.
Pros and cons of “Pay yourself first”:
|It encourages savings so it's great if you want to save money||It isn't suitable for people who already prioritize savings.|
|Glorify savings||It will help if you have a tracking technique for expenses.|
|Best for individuals who are looking for flexibility in spending.||If you allocate too much to paying yourself you may fall short with budgeting your expenses.|
|Easy to follow|
If you like to spend and can't imagine have every dollar tied up on boring living expenses, then a pay yourself first budget is a great budget for you.
It does take a certain level of discipline to maintain.
Envelope budgeting methods:
The envelope budgeting system promotes the habit of controlling expenses systemically.
In this type, you allocate a specific amount for different budgeting categories.
For example, you can make separate envelopes for categories like travel, personal loans, shopping, etc., and assign a set amount in each category.
The main goal of this budget is to put limits on how much your spending money in each category.
If your envelope is empty, then it means you have met your limits.
Most people follow the envelope system by using cash but you can also do it by setting up specific checking account for each category and automating it.
Pros and cons of Envelope budget system:
|Best to set limits on spending||This budget doesn't always promote savings|
|Having cash on hand forces you to think twice about spending.||If you run out of money, then you have to go to the bank every time.|
|Easy to follow and understand|
|People spend less when they have cash.|
If you tend to be an overspender, then this type of budget could work for you.
But there is a bit of a learning curve. It requires you to be more conscious of your spending because once the money runs out you're done.
It also is focused on spending and expenses so it would have to be adjusted for those that have savings goals.
50/30/20 budgeting methods:
The 50/30/20 budget is one of the more popular budgeting methods. And there is a reason why. It is quite simple and leaves room for flexibility.
The way the budget works is that you split the income between a set and pre-decided ratio. It looks something like this.
- 50%: Needs
- 30%: Wants
- 20%: Savings/debt repayment
It is among the best types of budgets and it provides a good baseline for other budgeting methods. It's a great way to get started with budgeting while giving you an opportunity for flexibility.
Here is an example of some of the ways you can allocate your budget line items:
|Needs 50%||Wants 30%||Savings/debts/repayments 20%|
|Housing||Monthly subscriptions||Emergency fund|
|Childcare or other vital expenses|
As you can see this bugeting method helps you to get organized while still giving you the opportunity to have flexibility and still live and enjoy life.
Pros and Cons of 50/30/20:
|Easy to plan and use||Could be limiting for those with tight budgets that need to set aside more than 50% towards their needs.|
|Provides a great starting point||Doesn't track spending.|
|You will spend money according to a set structure.||There is very little guidance with this system which might make it difficult for those that would like more structure.|
The 50/30/20 budgeting method is a suitable type for those first getting started.
Because there is little guidance it might not be best for those that need more structure. But it is a great starting point and something to use as a foundation when first getting started.
The 80/20 budgeting method:
Also known as Pareto Principle the 80/20 budgeting method is similar to the 50/30/20. However in this model 80% is dedicated to expenses and 20% is dedicated to savings.
It can be similar to the Pay Yourself First budgeting method where you set aside an amount for savings or expenses that is outside of your necessities.
What is great about this method is that it allows you to devote a set chunk of money towards your savings goals. And is great for those that have saving goals and want to create a system where they are prioritizing saving.
Pros and cons of 80/20 budget:
|Great for those with goals such as getting out of debt.||Might be a bit difficult to adjust to if you're on a tight budget.|
|Teaches you how to live within your means.||Doesn't provide a lot of guidance as to how you should divvy up your spending.|
|Your spending is limited.|
|Easy to follow and plan|
As mentioned above this is very similar to the Pay yourself first model.
If you want to try something significantly different then this is a great budget method to try. This is great for those that are embracing living with intention.
With a value-based budget you do the following:
- You identify and prioritize the things that are most important to you
- Based on this list you will allocate your income based on the things that you value the most.
For instance, if travel is important to you, then you can allocate more towards that. However if paying off your debt is a high priority then you will allocate accordingly.
This budgeting method allows you the flexibility to prioritize the things that are important and decide on what you don't need to so you can spend your money with intention.
Pros and cons of Value-based budgeting methods:
|Great is you're a spender and never can keep track of where your money is going.||Requires constant engagement|
|You can spend on the items that make you happy.||Less tracking of spending|
|It helps to categorize things based on the value that they are providing you.||Sometimes you may end up spending more than the limit.|
|You can make adjustments as per your needs.|
Sometimes it is hard to prioritize and pick and choose what is really important. But by following a budgething method like this it forces you to really assess what is most important and adjust your budget accordingly.
Which budgeting method is the best? The Final verdict
We talked about many methods, and each one is different from the other. But you can see there is some overlap in some of the above ways. When it comes to choosing the right way, then you should consider the following factors:
- Personal preference
- Current financial situation e.g., personal loans
- And spending habits
These three points are the pillars that will help you to choose the best budgeting method to meet your needs.
You also have an option to mix and match and create your own budget that works for you. The main goal is to choose a plan that will help you stay on budget and reach your financial goals.