Budgeting is a proven way to strengthen your financial footing. However, upon setting out to create a budget, it’s not uncommon for some people to find their efforts stalled as they encounter a confusing array of sites all offering competing methods of budgeting. Just Google “How to create a personal budget” and you’ll find 56 million results.
Depending on your financial circumstances and your personal preferences, your budgeting method can be simple or sophisticated. There is no one-size-fits-all budget that works for everyone.
Keep this in mind as you read about the budgeting methods below. Which method are you most likely to be able to stick with and consistently follow the rules? The answer to that question is probably the one that’s going to deliver you the best results.
1. Envelope Budget
If you just aren’t into charts, graphs and number crunching, the envelope budget was tailor made for you. This dead simple budget style can be set up with actual envelopes or digitally on your computer. With either approach, you create a list of your household expenses and determine how much money to allocate to each expense.
Your first designations are for essential items such as food and shelter. Some of these essential expenses (like mortgage or rent) are fixed, while others (such as groceries) are somewhat flexible. After you have delegated funds for essential items, the remaining funds are allocated to the nonessential items. If you have more categories than funds available, you’ll have to start making some tough decisions – either cut back funds from one or more of your other categories or eliminate the categories that have no funds available.
There is also no “borrowing” allowed, or moving money from one envelope to cover shortfalls in another – with the possible exception of food. When funds from one envelope are depleted, you simply stop spending in that category until the next time you allocate funds from your income. If you are chronically short in one or more categories, you must rethink your budget.
Besides its simplicity, the envelope method represents an excellent form of forced discipline. After you develop a workable set of categories, the envelope method is self-sustaining. On the other hand, the envelope method is probably not realistic for complex financial circumstances.
2. Bucket Budgeting
In some aspects, the bucket budget represents a similar version of the envelope method. For bucket budgeting, you divide all your incoming paychecks and income among three separate accounts. Account one is a checking account from which all your fixed expensive are to paid. Add up all your basic monthly living expenses — your rent/mortgage, food, utilities, etc. — and put this amount into account one every month.
Account two is a savings account into which you deposit a set percentage of every paycheck. The money in this account is for your retirement, kids’ college, and purchasing a home. No tapping this account for routine purchases, luxury items or bills, understood? If you’re following this method correctly, this account should rarely see a withdrawal.
After the deposits to accounts one and two have been fulfilled, any remaining funds go into account three, which is second checking account. But unlike the first checking account, this one is for the fun stuff – vacations, nights out on the town, new gadgets and toys, etc.
Like the envelope system, the bucket list system pretty much runs itself once you’ve set it up. But like the envelope system, it can also be rigid. Changes in your financial circumstances often require will require budget revisions.
3. Incremental Budget Method
With an incremental based budget, you use your prior spending patterns as a basis to guide future spending. Your initial allocation of funds follows the actual level of spending for whatever period you are covering: week, month, quarter or year. Additions are made to various categories based on anticipated increases (such as inflation).
Incremental budgets are easily adjusted to account for inflation, known unusual expenses and other variations in your financial situation. On the other hand, making a blanket acceptance of the status quo as a basis for budgeting doesn’t do much to eliminate wasteful spending. And if your problem is too much month for your money to cover, an incremental budget is of no assistance at all.
4. Zero-Based Budget
Unlike an incremental budget, a zero-based budget makes no assumptions about spending levels. Every item in your budget begins with a zero allocation which remains at zero unless a justification can be made for providing funds for that item. Each item is assessed for its cost and purpose, along with whether alternatives exist for accomplishing the same goal – or the costs of not funding that item at all.
Of course, certain items such as housing and food are nearly automatically assumed to be worthwhile. But under a zero-based budget indulgences such as big screen TVs are difficult to justify, especially when funds are tight. As a result, zero-based budgets are great for imposing tough discipline.
On the other hand, zero-based budgets don’t really take intangible factors – such as quality of life into account. You may not “need” to spend money on a vacation but denying yourself down time can be detrimental to your mental health. Zero budgets can also be very difficult to set up. Finally, it can be very difficult to adjust zero-based budgets to changes that occur between budget planning periods.
5. Elimination Budget
With an elimination budget, you start with your present budget and eliminate categories of spending, such as your cable TV subscription, your annual vacation or other major expenses until your spending is reduced to a level below your income. That’s it. Following an elimination budget can be painful but if you are faced with drastic circumstances, drastic means may be necessary to deal with them. On the other hand, the deprivation of an elimination budget may make it difficult to stick with long term.
6. Penalty Budget
If your parents had something like a “swear jar” when you were growing up, you already understand the basic principle behind a penalty budget. Under a penalty budget system, you set up spending goals. Whenever you fail to meet your spending goals, a previously specified amount is deducted from your bank account into a “do not touch” account.
A penalty budget can provide the motivation you need to stick to a spending plan. On the other hand, if you suffer several penalties during a short period, you may be left with insufficient funds to cover basic expenses.
7. Survival Budget
You’ve lost your job and you have few or no prospects. Under such circumstances, you must tighten your belt. A survival budget is designed to cover the bare minimum of expenses: food, shelter and perhaps transportation. If your circumstances are truly desperate, your survival budget may require you to move to a less expensive home or give up your car and rely on public transportation. Survival budgets are only meant to cover the most desperate financial circumstances.
8. Budgets and Savings
Many financial experts give the same advice: pay yourself first. Setting aside funds for savings is an essential aspect of successful budgeting. You may want to establish several savings accounts: an emergency fund to cover expenses for six months or more, an annual vacation or holiday spending fund and funds to cover educational expenses for your kids and retirement expenses for yourself.
9. Establishing Your Budget
Once you’ve chosen a budget style, you still need to establish your actual budget. A smart way to approach your budget is to plan an annual budget to account for items such as vacations, special events or holidays, and a weekly or monthly budget to deal with everyday spending. With continued discipline, you may very well find that you are no longer living paycheck to paycheck.
That’s the reward for prudent budgeting.