To continue our support of Financial Literacy month, let’s talk about a subject near and dear to my heart and causes dread in a lot of people…. budgeting
When most people hear the word, “budget”, the Charlie Brown phrase of “AAGGHhhhh!” comes to mind. Don’t worry, this does not have to happen to you.
If you’ve struggled with the dreaded “B” word, welcome to the club. Very few people get it right the 1st time. I didn’t. The reason for struggling could be that you haven’t found a method that works for you.
If struggling to figure out how to start creating a budget and not sure where to begin, then this week’s article is for you!
We’ll go through 3 common budgeting strategies that can be applied today no matter your current money management skills. While some are well-known, others are newer yet very effective. Let’s get started.
50/30/20 Rule
New to managing your finances? Struggling to setup a budget? Try implementing the 50/30/20 rule.
The 50/30/20 rule is a basic, straightforward monthly budgeting method that tells you exactly how much to put towards your living expenses, savings goals, and fun money.
To be clear, the 50/30/20 rule isn’t really a rule but more of a guideline for setting up budgeting. It gives a simple, clear, big-picture view of your monthly budget. It can help you avoid overspending and keep your goals on track without having to painstakingly record every single transaction.
The 50/30/20 rule came from U.S. Senator Elizabeth Warren’s (and her daughter Amelia Warren Tyagi) 2005 book, “All Your Worth: The Ultimate Lifetime Money Plan.” In the book, they referenced over 20 years of research to conclude that a complicated budget is not needed to get finances on track. All that is needed is to balance your money across a person’s needs, wants, and savings goals.
This is where the 50/30/20 rule comes in.
The basic rule of thumb is to divide your monthly after-tax income into 3 basic categories: 50% for needs, 30% for wants, and 20% for savings goals.
50/30/20 Rule builds a basic and uncomplicated structure into spending habits. Keeping things simple enables good financial habits to be developed and adhered to over a long period of time. This is because knowing exactly how much to spend on each category makes it easier to keep your spending in check.
Here’s what a budget that adheres to the 50/30/20 rules may look like:
50% Of Monthly Money for Needs
Needs are essential expenses that cannot be avoided no matter what and difficult to live without.
Needs may include:
- Mortgage / Rent
- Utility Bills
- Transportation
- Groceries
- Insurance
- Minimum Loan Repayments (i.e., auto, credit cards, personal loans, etc.)
- Medical Bills
Other things that people think they really need and are essential (i.e., streaming services, eating out, gym memberships, etc.) technically are not part of this category. That’s because while your physical fitness is important (and some may say essential) for overall health, you don’t need a $50/month gym membership to make it happen. Instead buy a $40 pair of gym shoes and go for a run.
A good rule of thumb is if there is a less expensive option available (i.e., cook yourself ilo eating out), it is a want.
30% Of Monthly Money for Wants
This section is also known as discretionary, personal, or non-essential spending. These are the things that you could technically live without. Wants are the nice things or little upgrades you spend money on that make life more fun and enjoyable.
Wants may include:
- Eating out
- Streaming Services
- Ultra-High-Speed Internet
- Gym Memberships
- Vacations
- Concerts
20% of Monthly Money for Savings
This is what you save every month. It includes personal savings account, retirement, college for your kids, and even accelerated debt repayment. Extra debt payments may not seem like part of savings, but it is. Reason is the minimum debt payment is under “needs” because without making these payments your credit score suffers. Accelerated debt payments is part of savings because the money is being chosen to be spent on debt repayment instead of accruing in a savings account. “Savings” really means growing your net worth and there are 2 ways to do it: increase savings or reduce debt.
Saving this much of your income may sound like a lot but it really isn’t. For example, let’s assume you have a take home pay of $5,000 / month. This means that $1,000 a month goes towards your 401K, IRA’s, personal savings accounts, accelerated debt repayment, and 529 plans for kids.
Here is a monthly snapshot of what that could look like:
- $250 – Roth 401K (5% of monthly after-tax salary)
- $250 – Personal Savings (5% of monthly after-tax salary)
- $250 – Roth IRA (5% of monthly after-tax salary)
- $250 – extra credit card payment (5% of monthly after-tax salary)
See what I mean? It doesn’t take much to get to 20% savings.
If just starting out and unsure how to start budgeting, you can’t go wrong using the 50/30/20 Rule.
Want to learn more about this budgeting strategy? Click here to learn more.
Zero-Based Budget
A zero-based budget is where you assign all your income to specific budgeting categories until there is no money left over. It’s sometimes referred to as the zero-sum method because income minus expenses always equals zero when you’re finished.
For instance, if your paycheck is $4,000 a month, divvy up all $4,000 among your expenses, savings, and debt repayments until you’re left with $0.
This way, every single dollar has a job and a purpose. Nothing is left over for wondering how to spend it.
What happens if your budget doesn’t equal zero? Then adjustments need to be made. For example, if after setting the budget and paying all expenses there is money left over, good for you! You can use this money to pay down debt or increase your savings rate.
On the other hand, if you end up short on cash to pay off your expenses, you’ll need to adjust spending habits to make up for the cash shortfall or pick up a side hustle to earn more money.
To implement this budget, take a few steps to ensure you get off on the right foot:
- Know Your Income – Total your paycheck and all other sources of income (i.e., side hustles, alimony, child support, dividends, etc.) to find out how much money you have to work with.
- Track Expenses – Knowing what you spend creates a framework that can be used going forward. Don’t just track for 1 month but do it for several months so you know all about those expenses that infrequently pop up that could wreck a budget if not tracked.
- Categorize Your Expenses – Identify all your priorities including needs, wants, debt repayment, emergency fund, and other goals. Want a vacation? Create a “vacation” category. Want a new car? Create a “new car” category. Just ensure that this year’s priorities are accounted for.
The pros of this type of budget are that it keeps you aware of how much money flows in and flows out. You know where every dollar is spent and where every dollar is going to. In other words, you have a sense of control over your money.
A zero-based budget is also customizable. You decide where the money is going and for what purposes. You own it. If you don’t like where the money is going, you can change it. Beautiful! 😊
On the downside, the cons of a zero-base budget are that it can initially eat up quite a bit of time to set up. To hold yourself accountable, you’ll have to monitor spending closely and consistently.
Another downside is if you don’t track expenses close enough when setting up, variable expenses can send the budget in a downward spiral. While the budget is customizable, it is also dependent on how much upfront work is put into setup.
Lastly, a zero-based budget may not be right for you if you have a variable or irregular income stream (i.e., salary is based on 100% commissions). If you don’t know how much money is going to be coming in, make sure to have at least a month’s average salary (preferably more) saved up as a buffer for life’s expenses.
Envelope Method
The envelope method is a simple, systemic way of budgeting money to pay bills. This method helps you set aside what you need for bills and can be done either with physical envelopes or personal finance software.
Here’s how it works. The envelope method divides your income up into different spending categories such as groceries, utilities, savings, vacations, daycare, mortgage, etc. Once it is decided how much to spend on each category, you’ll take that amount in cold, hard cash and literally place it into an envelope.
Next when it’s time to pay for the expenses, you only spend what’s in the envelope. That’s it. The goal of this method is to prevent overspending by limiting the available cash to spend.
Even if you no longer use cash to pay bills, the principle still works and can be applied using financial software.
The strength of the envelope budgeting method is that it forces you to stay in touch with both your spending habits and your money because once the envelope is empty, there is no more to spend on that category. You don’t borrow from other envelopes or borrow ahead on a future paycheck. You simply spend what you have until the next paycheck comes and the process starts again.
Here are a few steps for getting started.
- Establish Categories and Spending Limits – The total amount for the spending categories must not exceed your monthly income. To set the categories, figure out where your money is going and create an envelope for each category. To set the spending limits, research what you have spent on each category and take an average. If you fall short of spending, save it for the following month.
- Label Each Envelope – Physically write the category name on each envelope and the budgeted spending amount. I prefer to write the monthly spending amount of each envelope instead of pay period. People pay bills monthly so use that as your basis.
- Separate Funds Into Each Envelope – Suppose you have a paycheck of $1,000, cash the paycheck and divide the money in the following categories:
- Rent – $500
- Food – $200
- Gas / Utilities – $150
- Vacation – $75
- Personal Care – $25
- Savings – $50
- Spend From The Envelopes – When you go shopping, take the money from each envelope to spend. If you spend all the cash from one of your envelopes, do not pull cash from other envelopes. Only spend what is there and that is it. Any money left over at the end of each month, either keep it or carry it forward to next month.
While this method is great for those who need help curbing spending but don’t want to track every purchase, the biggest downside of the envelope system is that most people do not use cash anymore. People carry less cash than ever before and may find it awkward to carry cash envelopes around with them.
Where To Go From Here?
We’ve covered a few strategies for getting started on managing a budget. It may seem overwhelming at first but don’t let that stop you.
Budgeting can be hard at first because you’re not used to it. Like anything else, the more you stick with it, the better you’ll get.
Also, don’t be afraid to create your own strategy or combine several of these strategies to suit your needs. We did and it works for us.
Remember, the important thing is to just do it. It’s better to try, fail, and learn from your mistakes than to not try at all.
Live The Life You Love, Want, And Deserve……