Many people think of budgeting the same way they think of dieting: the only way to do it is to cut everything fun out of your life. Instead, think of creating a budget as an exercise in examining your priorities and then using money as a tool to help you reach your goals. The people who have the best success sticking to their budget recognize that a budget you can stick to is one in which you allow yourself to spend money on the things you enjoy. There are many ways to monitor your spending so focus on finding a process that works well for you.
This type of budgeting requires you to take your after-tax income and split it into percentages. One common proportion is 50/30/20: 50% for needs, such as housing, groceries, and utilities; 30% for wants, such as movie tickets or eating out; and 20% for savings and/or paying down high-interest debt.
This approach requires you to look at all of your spending and decide whether it is a need or a want. If you are currently outspending your income, you may have to cut back on both wants and needs in order to set aside 20% for savings and paying down credit cards, student loans, or personal loans.
The “pay-yourself-first” approach prioritizes savings above everything else. You only have to decide how much to set aside in savings each pay period and then you have the rest of the money to spend on both needs and wants. This approach can be used to save for retirement, a special vacation, a down payment, or to build up your emergency fund. It works well if your savings account is at a separate institution than your spending account so that there is less temptation to dip into savings.
This approach can also be used to pay down high-interest debt before building up savings. You simply decide how much to put towards debt each pay period. This type of budgeting works well for people who are highly motivated by seeing their debt shrink or their savings grow and are not inclined to feel deprived by reducing spending.
Envelope budgeting, as the name implies, uses envelopes as a key part of the strategy. You withdraw cash from your bank account each period and divide your spending into categories like groceries, gas, entertainment, etc. You create your own categories and can get as specific or as general as possible.
Using actual cash in a physical envelope works because you see the number of bills shrinking as you go through the month and this may help you identify when you are running low and therefore make it feel easier to understand when it is time to spend less.
You are allowed to move money from one envelope to another as needed while limiting your overall spending to only what you have. When the money is gone, it’s gone. Some billers, like utilities or cellphone providers, will not accept cash so you must leave cash in your bank account for these expenses.
This type of budgeting approach is the digital version of envelope budgeting. You account for every dollar of your income and categorize your spending as you go. Using an app like Pennies or Mint can help you track what is left in your “envelopes” as the month goes on. Like envelope budgeting, you can move money from one category to another as needed.
Whatever your preferred budgeting strategy, checking in on it regularly is key. Some people find that having to write down every expense each time they spend money is best, so a combination of zero-based or envelope budgeting with a digital or physical ledger works for them. Other people find that opening multiple bank accounts and using the proportional budgeting approach works well for them. As their “wants” bank account balance decreases, they may find they consider each purchase and cut down naturally.
If you have questions about the best budgeting style for you, call your American Money Management advisor today.