Of all the different types of budgeting out there, which method should you choose? Or, which one is the right one for me? If this sounds familiar, then continue reading! Today we discuss the four most common budgeting styles, explain how they work, and whether there really is a one size fits all budgeting method.
- Planning helps to maximize every dollar
- Makes you aware of impulsiveness
- Guilty-free buying
- Positive impact on relationships
- Easier to achieve both short & long-term goals
- Enable projecting how much to spend VS afford VS save
Traditional budgeting is a method of preparation of the budget in which last year’s budget is taken as the base. Current year’s budget is prepared by making changes to previous year’s budget by mainly adjusting the expenses based on the inflation rate, consumer demand, market situation, etc.
List down all your expenses as detailed as you like.
For example, you can divide your expenses into essentials (utilities, grocery, rent) and discretionary (facial, shopping, traveling).
Then, make separate categories for your expenses
In the case of utilities, for instance, you can have electricity and gas underneath this category. This way, you can see how much you spend, where you can cut down your expenditures and make potential adjustments.
After you’ve listed your expenses, then make three columns against each expense.
These are budgeted spend, actual spend, and their net difference (F/U). If favorable variance (F) means your actual expenses are lower than your budgeted expenses and if unfavorable variance (U) means vice versa. In other words, if it’s an (F), then it's your savings from your leftover balance. It’s as simple as that!
Easy to implement and allows you to compare how well you are doing each year with your spending.
It’s a very top-down style, which causes rigidity, such as not being a regular savings target.
Excessive reliance on past year budgets can be inaccurate with the continually changing market conditions and price inflations.
Zero-based budgeting (also known as the “zero-sum budgeting” or the “envelope” system) is a system in which every dollar has a job. That means you have to find a purpose for every dollar you receive in income and have zero dollars “leftover” in your budget at the end of the month.
The premise is simple: income – expenses = zero. If your monthly income is $3,000, then you want all of the line items in your budget to come to $3,000, leaving you with zero.
Unlike the traditional budget method, you don’t automatically carry over last month's budget because with this system, you make a new budget each month. Say you received $100 from your parents for your birthday. With zero-based budgeting, you need to assign that $100 to a category. You can create a new budget line for something like buying a music concert ticket for $50 and the remaining $50 goes to apparel shopping. Next month you won’t have that $100, so you eliminate that category and create a new category for your new budgeting month.
List down all your incomes such as work payrolls, small-business income, side hustles, royalty checks, and child support. - -
Rent, food, utilities, Internet, phones, streaming services, student loans, etc. — all of them go on the list.
Subtract Your Expenses From Your Income Each Month
Ideally, you want this to equal zero and if it doesn't, then bring in more money or eliminate some expenses (or both!).
Flexible and up to date information as it takes account of varying situations. For example, what if you got promoted? Everything changes too. You might want to spend more, invest in stocks/shares or simply allocate more money into your savings. Things like that are why you must create a new budget every month.
By giving every dollar a job to do, you drastically cut down on mindless spending. Suppose you earn $3000 per month, then you allocate $700 to savings, $200 to food, $800 to rent, $250 to utilities, $250 to entertainment, etc until you allocate all $3000. This way, you make yourself aware that you need to assign the money you earn!
You can take 100% freedom of your budget decisions. For example, if you need to change something, you can!
Time consuming because you have to continuously keep updating your transactions each month.
Difficult to keep track of fluctuations. For instance, if your income fluctuates quite a bit month to month, zero-based budgeting might be difficult. You might eliminate whole sections of your budget for low-income months, which can increase stress.
This budgeting method is similar to a traditional budget, except for one thing - you first set aside a certain amount for your savings out of your income. Then whatever’s left will be budgeting across your expenses. This budgeting method solves the problem of the traditional budget’s lack of a dedicated savings budget. And the good thing about the PYF is that it forces you to save for yourself first, before spending the rest.
Assess your spending.
For this to work out successfully, you’d need to be pretty realistic about your actual spending. Review your typical spending by pulling up your bank and credit card statements.
Determine how much to pay yourself
Pinpoint a realistic amount using the 50/30/20 approach. This method allocates 20% of your monthly income to savings and debt repayment, 50% to necessities and 30% to wants. With a $5,000 monthly income, for example, you’d reserve no more than $1000 for savings and debt repayment, $2,500 for needs and $1,500 for wants.
To learn more about this 50/30/20 rule including its pros and cons, listen to our podcast Ep 4 here.
Identify your saving goal
Make a list of your short-term and long-term savings’ goals. Saving for retirement and building an emergency fund should be your first priorities, followed by other goals, like travel, new appliances, or a house.
Adjust as needed
If you are still falling short on money despite your budgeting efforts, you may postpone new projects or spending on items that you do not need for that month.
This method prioritizes savings, but not at the expense of necessary expenses like housing, utilities and insurance.
Whatever your expenses, you’ll have a sum of money put aside for a rainy day.
Low maintenance compared with others, such as zero-based budgeting. It doesn’t require you to categorize every expense or keep a detailed record of your spending.
Focus on the big picture and reduce impulsive purchases.
If you have toxic debt — such as a high-interest credit card balance, prioritizing savings over other goals might not always be in your best financial interest.
Unlike PYF that prioritizes savings over any other goals, the bucket method, on the other hand, is to set aside money for different reasons. Perhaps you might want to have a bucket for saving, and another bucket for no-regrets spending – like for buying a house or a car?
Imagine the modern-day version of putting your cash into envelopes marked “blow”, “Mojo” and “Grow”.
To understand what I mean, let’s take a look at how you can use the three buckets of The Barefoot Investor approach’ to divide your income:
It’s for day-to-day expenses, the occasional splurge and some extra cash to fight financial fires,
It's to provide some ‘safety money’, and
to build long-term wealth (savings) and total security.
You see how the entire money management plan consists of dividing our income into three ‘buckets.
Account one: Daily Expenses - income split: 60%
Your everyday normal expenses such as rent, food, and regular bills are added into this account.
Account two: Splurge (or Fun Spending) - income split: 10%
This account mainly is to pay your huge bills or to get rid of your debts, and then the leftover money goes to Mojo.
Account three: Fire Extinguisher (or Debt Reducer) - income split: 20%
This account is for your weekly budget for fun purchases and social aka entertainment activities. For example hanging out with friends for bowling and dinner.
Account four: Smile (or Adventures) - income split: 10%
This account is for setting aside your money for long-term investment for buying a car, traveling, furniture or bigger ones like property investments.
Account five: Emergency funds
This account is where you hold your excess money that is left over from Blow as safety funds and save up reserves for the Grow bucket. It consists of one bank account, with a minimum of $2000 in it and you can have multiple of them. It acts as a replacement for your credit card in unexpected or emergency situations.
Account six: Investment
Now grow…With the money left from the above two stages, you can choose to invest the lump sum in whatever you want to invest in.
- You might just have savings.
- You might put it into shares
- You might put it into property
- You might put it into cryptocurrency.
- It helps you to control your money and improve the way your money flows from income to investments.
- Fast to implement due to the usage of automated fixed transfers to spread money across the accounts
- Time-consuming, especially if you are not familiar with this method, it takes time to classify your incomes and expenses into buckets plus the categories in each of them.
- Too much hard work is needed, first to calculate what you’re spending on like your bills and then to decide the amount that should go into each account until you get to the Grow bucket.
While all budgeting exists to help you control your spending, different budgeting methods work better for different people. Each budgeting method has its advantages and disadvantages depending upon your preferences. It is up to you to decide which one fits you best. You can always change methods if you find a certain type of budget is not working for you. Sometimes different life events, such as having kids or getting married, will require you to shift your budgeting method as well. Try several of them until you find the one that works best for you.
Otherwise, here are some questions you can use as a checklist to help yourself decide which budgeting method would suit your needs:
- Are you a detailed-oriented person?
- What is your main goal? To save, invest, pay off debts, or all of them?
- Are you good at managing your time?
- Are you good with using spreadsheets, excel, or you prefer conventional pen and paper?
- Are you good with managing your money or saving?
- Do you clear your credit card every month?
- How passionate are you about retiring early?
Rate yourself between 1(low) to 10 (high) for each question, then plus them all and do the average. For example, if you score a total of say 60, divide it by 7, giving you a rating of 8.57. This means if your score:
- Is between 1-3, then use TCB
- Is between 3-6, then use ZBB
- Is between 6-8, then use PYF
- Is between 8-10, then use BBM
This is a trial and error approach and incase if it still doesn’t work out then you can try using all methods to see which fits your finance lifestyle.
Thanks for reading this blog post, and if you think this blog post has helped clear all or most of your budgeting doubts away, then share it with someone to clear theirs. ;)
Disclaimer: The author is not a financial advisor and the information provided is general in nature and was prepared for information purposes only. This article should not be considered to constitute financial advice. Accordingly, reliance should not be placed on this article as the basis for making an investment, financial or other decision. This information does not take into account your investment objectives, particular needs or financial situation.