Some of the best budgeting methods include proportional budgeting, zero-based budgeting, and reverse budgeting.
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 time. Budgeting for beginners can be an extensive process, but a failure to budget is a quick path to long-lasting debt problems.
Multiple budgeting methods address different needs—some people might only need to set a budget for a specific purchase, while others might be looking for long-term financial strategies. Here, we’ll explore several different budgeting methods and valuable personal finance resources to help you address future financial questions.
The traditional way to budget is rooted in the business and corporate world. Those who are willing to invest the time can use this method to handle their personal finances.
With this method, you study the income and expense figures from a previous month or year to help you plan out an upcoming period. You subtract the expenses from your take-home income, the funds in your checking account, or cash in your savings account. With this method, you’ll also need to account for inflation and any significant changes to your income.
Check with your bank for options to get spending reports, and use banking apps to help streamline this process. You can then update your expenses daily or weekly for the most accurate results.
This type of accounting helps you understand what you’ve brought in, what you’ve spent, and what you have left each period. You can then decide where you may need to trim spending—especially if you find that your funds are running low each month. For example, you might see opportunities to lower food expenses by:
Switching up your shopping habits based on sales and price hikes is an excellent way to save money. Some common habits to target include:
In this approach, you give a task to every dollar you bring home. 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. However, you would identify specific categories for food spending and then set funds aside for that distinct purpose.
Below is an example of a zero-based budgeting system for a particular month:
Total Monthly Income: $3,000.00
(-) Expenses:
(=) $0 leftover after paying all expenses
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, car payments, and phone or cable bills. If one-time expenses crop up that are high priority, you can briefly pull funds from non-essential items.
In a proportional budget, you devote a certain amount of your monthly income to specific categories. Unlike the zero-based method, you focus less on specific items. Instead, general areas of expenses guide the budgeting process.
The 50/20/30 method calls for you to reserve 50% of your funds for fixed expenses (i.e. rent & car notes), 20% for emergencies, long-term savings goals, and paying extra on your debts. The remaining 30% can then go 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:
The 50/30/20 helps you keep long-term savings in mind, but it might not be effective if your income is low and inflation is high. When the cost of living increases, it’s easy for the essential budget to exceed 50% of your monthly income.
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.
You then dedicate savings and money that might not have any utility beyond “fun” to the remaining 40%. Ideally, you can distribute these funds in 10% increments across three 401(k) or retirement plans, including a tax-free account. In developing his budgeting plan, Jenkins expressed a strong preference for saving well above the recommended 5% of income.
With enough income and the ability to shave expenses from your committed expenses, you might reach significant savings goals and future spending power in a few years.
If you plan 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. For example, your debt payments should stay at or below $2,580 per month on a monthly gross income of $6,000.
Also, consider the cost of maintaining your home. Some financial or home experts suggest budgeting 1% of your home’s price for maintenance. Other advisors include maintenance costs with mortgage payments and suggest that your housing costs do not exceed one-fourth of your income.
Reverse budgeting makes 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 set funds aside for your other expenses.
Reverse budgets should include a mixture of short-term and 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 by estimating the cost of the particular benchmark.
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 pay goes into particular envelopes based on your budget for each category. 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. 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.
Calendar budgeting encourages you to base your spending on your paydays and your monthly due dates. For example, if you get paid on the first and the fifteenth of each month, you would mark down those days on your budget along with the amount you expect to receive.
Next, you can mark down each fixed payment that will be due during your payment periods. If you receive $1,500 on the first and you have an $80 smartphone payment due on the 10th, you’ll want to jot down $1,500-$80 on your budget. Knowing how to read your paycheck stub is vital to effectively using this method.
Value proposition budgeting, also called “priority-based budgeting,” prompts people to measure the importance of every item they spend money on. The more integral an expense is, the more it’s justifiable if a large percentage of your budget is spent on it.
Businesses and entrepreneurs might favor this method, as it illustrates which expenses are worth their weight in revenue and which you can trim down. Using this method before applying for small business loans can also help you stay within your limit.
A lot of questions can surface when you’re building out a budget. Here are some of the most common questions we’ve encountered.
Budgeting isn’t a one-size-fits-all process, so there isn’t one model that beats the rest. It helps to learn about as many different budgeting strategies as possible to help you construct a plan that suits your specific needs.
The following information will highlight some of the most prominent budgeting methods people use. However, incorporating ideas and budgeting categories from multiple different methods is also a fantastic strategy.
Excel spreadsheets, Google Sheets, a printable monthly budget template, or a budgeting app can all help you account for your income and expenses. Start by listing your take-home pay and other income you received in a given period. If you’re basing the budget on a year, find your W-2 form and subtract all of the taxes withheld from the gross income. As an easier approach, use your final pay stub for the calendar year or total the paystubs in the particular previous month.
Next, list your common expenses for 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.
The budgeting method that works best for you is a personal preference and depends on your financial situation, goals, and ability to be detail-oriented. Whatever you use to create your budget, 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.
Check out Credit.com’s guide for managing debt if you need help recovering from a financial setback. When you’ve got the funds, our investing guide can help you learn more ways to strategically increase your income.
The post 5 Best Budgeting Methods for Short and Long-Term Goals appeared first on Credit.com.
