This article was originally published on Arrest Your Debt and has been republished here with permission.
A budget method sets out how an individual, company, or organization plans to spend money over a period of time. Budgeting methods vary by needs, but a failure to budget is a quick path to long-lasting debt problems.
The process constitutes a critical part of your financial plan. Yet, nearly one in every three respondents of a 2019 survey admitted to not preparing a budget. Though not a majority, the proportion of those who live without a budget is sizable. It also speaks to some concerning statistics regarding overall financial awareness, even among those with well-paying jobs or income sources.
Here Are a Few Shocking Financial Statistics:
Nearly 80% of individuals facing financial problems earned at least $40,000 per year or otherwise were not living below the poverty line.
Approximately 47% of those with annual salaries of $50,000 or higher report living from paycheck to paycheck. And, around 9% of those who struggle to meet monthly expenses earned at least $100,000 per year.
The Budgeting Methods–Your Definitive Guide for All Types of Budgets
The Traditional Budget: Income Less Expenses (Basic Budgeting Method)
The traditional way is a budgeting technique rooted in the business and corporate world. For those of you with the time, orientation to details, and analytics, a traditional budget method can serve your personal financial management.
Unlike most systems, the traditional budget system calls upon you to use a prior period's (either year or month) income and expense figures in planning the next month or year. You subtract the expenses from your take-home income, or dollars you place in the checking account or a savings account from which you can withdraw easily.
Choose Your Budgeting Style
You'll find an Excel application, Google Sheets, printable budget template, or budgeting app program beneficial to use traditional budgeting. You list your take-home pay and other income you received in the period. If you're basing the budget on a year, find your W-2 form and subtract the taxes withheld for the state, federal, FICA (Medicare), and Social Security from the gross income. You might consider the Social Security gross salary and wages. As an easier approach, use your final pay stub for the calendar year or total the paystubs in the particular previous month.
Create on your Excel spreadsheet a list of expenditures you commonly spend on each month. You might have debt payments such as mortgage, car, student loan debt, and credit cards. Other categories of expenses include transportation, food, clothing, utilities, entertainment, television, and other media and insurance.
Track Your Expenses
Your ability to track expenses by type is important to the usefulness of the traditional budgeting technique. Check with your bank for options to get spending reports. Several apps also accomplish this goal. On a daily or regular basis, you might wish to record and label your Excel spreadsheet expenses.
With this type of budget, you can easily see what you brought in with the traditional way, what you spent, and what you have left. This approach prompts you to examine where you may need or wish to trim spending–especially if you're running at or close to deficits each month or lack the funds to save or accomplish other financial goals. For example, you might see opportunities to lower food expenses by:
Using store-label or generic brand groceries rather than national name brands
Cooking more and eating out less
Opting for water instead of sodas at the restaurant
With eating out in particular, a family of four might lower the restaurant bill by at least eight dollars by not ordering sodas. At many restaurants, sodas run north of $2.00.
Change Your Shopping Habits
Certain shopping habits might promote less driving and, thus, lower gas bills. Consider online ordering, especially if you can avoid shipping and handling charges. Take inventory of your grocery stock and plan meals so that you reduce the number of times you need a grocery store run. Grocery store trips to buy one or two items for a meal takes gas. If you need to supply something in your home, consider going while you are already out of the home, perhaps after work or while performing another errand.
Zero-Based Budgeting Method: AKA Zero-Sum Budget
The zero-based budgeting technique promotes discipline and careful tracking of your spending. In this approach, you give every single dollar that you bring home a task. Since you account for every dollar of income, you should not have any money left over in your budget at the end of the month.
Here, you don't simply rely upon expense categories. Using a general budget category, such as food, might guide your zero-based budget. However, you would identify specific categories for food spending with this method and then allocate money to it.
Below is an example of a zero-based budgeting system for a particular month:
Total Monthly Income: $3,000.00
Rent – $700.00
Electrical – $100.00
Water – $50.00
Cable and Internet – $175.00
Wireless/Cell Phone – $200.00
Grocery Shopping – $400.00
Dine out – $75.00
Car Payment – $200.00
Gasoline – $200.00
Car Insurance – $150.00
My Credit Card 1 – $75.00
My Credit Card 2 – $100.00
Doctor's Visit – $25.00
Church Offering – $100.00
Deposit to Savings Account – $450.00
(=)Total Expenses $3,000.00
You have all of your $3,000 in take-home pay allocated to various expenses and items in this example.
The zero-based method might not involve as much detail and time as you think. Remember that you have many fixed expenses such as mortgage or rent, student loan payments, car payments, wireless phone bills, and cable bills. You can plug in certain one-time or normally non-recurring expenditures in your zero-based budgeting, such as an insurance premium, a medical appointment copay, scheduled oil change, and oil change.
With this budgeting strategy, you have to examine priorities in light of mandatory expenses that do not arise monthly. The one-time mandatory or essential items may take funds from discretionary ones for that month. In other words, you may have to forgo some restaurant trips or vacation to pay insurance.
Proportional Budgeting Systems
In a proportional budget, you devote a certain amount of your income each month to specific categories. Unlike the zero-based method, you focus less on specific items. Instead, general areas of expenses guide the budgeting process.
The 50/30/20 Budget Method
Many proportional approaches allocate fifty-cents of every single dollar to the mandatory expenses. You use 20% of your after-tax income for items such as retirement or educational savings, a fund to handle car or home repairs, a sudden job loss, and other emergencies. In other words, the 50/20/30 method calls for you to treat 20% of your take-home pay as generally untouchable except for emergencies and paying extra on your debts. The remaining 30% goes to your wants.
Suppose you have a monthly after-tax income of $3,000. In the 50/20/30 budget, you distribute your money as follows:
(50%) Essentials: $1,500
(20%) Savings, Retirement, Emergency-Fund: $600
(30%) Discretionary: $900
The 50/20/30 method carries the advantage of making you think about savings and emergency funds. When you budget for especially emergencies, you more likely than not will resist the temptation to incur credit card debt for repairs, meet unexpected expenses, or handle a drop of income.
However, this approach calls for you to make perhaps unrealistic assumptions about your financial condition. If you have a low income, the pitfall of the 50/30/20 method of budgeting lies in the fact that your essential expenses likely climb above the 50% called for in this technique. That means you likely must reduce much of your discretionary spending, and your ability to build a nest-egg for emergencies or other future goals is limited. Those with greater means might yield to the temptation to overspend on luxuries.
The 60/40 Budgeting Style
The one-time MSN Money Editor-in-Chief Richard Jenkins developed another proportional budget. In the 60/40 approach, you spend 60% of your net income on committed expenses. This categorization of spending includes mandatory expenses and non-essentials to which you commit.
By treating them as committed, your discretionary items in effect become somewhat "mandatory." Of course, if you see some of the committed expenses busting the budget, you can eliminate them or find lower-cost alternatives.
With the remaining 40%, you allocate savings and money that might not have any utility beyond "fun." You distribute these funds in 10% increments among perhaps three 401(k) or retirement plans, including a tax-free one. In developing his budgeting plan, Jenkins expressed a strong preference for saving well above the recommended 5%of income.
With enough income and an ability to shave expenses from your committed expenses, you might reach significant savings goals and future spending power in a small number of years.
Proportional Budgets for Would-Be Homeowners
Banks and other mortgage lenders use a variety of percentage or proportional budgeting in loan underwriting. If you're planning to buy a home, your monthly debt payments should not exceed 43% of gross (pretax) monthly income. In calculating this debt-to-income ratio, you include car loans, student loans, credit card debt, and the anticipated monthly mortgage payment in debt. If, for instance, you have a monthly gross income of $6,000, your debt payments should stay at or below $2,580 per month.
Also, consider the cost of maintaining your home. Some financial or home experts suggest budgeting one percent of your home's price for maintenance, as we discussed above. Other advisors include maintenance costs with mortgage payments to recommend that your housing costs do not exceed one-fourth of your income.
Reverse Budgeting: AKA Pay Yourself First Budget
A budgeting technique, such as a proportional budget, stresses the value of saving money. Reverse budgeting takes that a step further by making saving the top priority. Most budgets have you start with mandatory expenses such as debt payments, food, and utilities. When you put the budget in reverse, you first decide how much to save and then treat the remainder of your income as available for expenditures.
With its focus upon savings, reverse budgeting users should have in mind short-term and even long-term savings goals. If you're planning to buy a home or car or save a certain amount for college or retirement, start the process with an estimation of the cost of the particular benchmark. You may also use online savings calendars or consult with financial advisors to determine how much a savings account or investment fund will have based upon how much you contribute monthly.
Envelope Budget AKA Cash Envelope Method
Many budgeting techniques focus on determining how much to spend on particular categories depending on your financial goals. With the cash envelope system, you're mentally forcing yourself into a planned spending limit.
Specifically, you label envelopes according to spending categories. Your take-home play goes into particular envelopes based on what you have budgeted for the categories in its purest form. To that end, you might use some of the methods we've discussed, especially a proportional budget method, to decide how to allocate the money.
As you want or need to pay for something, you take money out of the envelope for that category and pay for the items with cash. A trip to the gas station means you draw from the transportation or gas envelope. When you buy groceries, take the envelope labeled food or groceries. Once you have emptied the envelope, you no longer spend on that category. With discipline and commitment, you resist the urge to borrow from another category.
The Advantages of Budgeting Will Change Your Financial Life
The budgeting method that works best for you is a personal preference and depends on your financial situation, financial goal, goals, and ability to be detail-oriented. Whatever you use to create your budget, the exercise of budgeting should enhance your financial literacy, help you find approaches to debt repayment and other financial goals, and afford you discipline and structure in your spending habits.
A successful budget involves total buy-in and a belief that you can achieve financial independence and finally fix your debt payoff problems. Choose one of these simple budgeting methods to take control of your financial future and reduce your overall money stress.