What's the best way to budget? Here are the 3 major types of budgets you can use to save money.
So, you've finally decided to create a budget. But where do you start? The key is to find a budgeting method that actually works for you. Some people love to break out spreadsheets and figure out exactly where every dollar is going — while others would rather have a root canal than tackle that task.
The good news is, there are different kinds of budgets. So you can find one that is right for your personality, allowing you to be smart about spending with minimal frustration. These three basic options are the most common budgeting choices, so you can pick the one that suits your needs and behavior.
1. The classic "zero-based" budget
A zero-based budget is what you probably think of when you plan to make a budget. This type of budget involves establishing different specific spending (and saving!) categories and allocating a certain amount of money for each category. The budget should account for every dollar you have coming in — so "income minus outgo equals zero," as Dave Ramsey explains.
To make a zero-based budget, start by figuring out your total income. Next, list all the different things you're going to do with that money over the month, including spending and saving.
Total expenditures should equal total income, so give every dollar a specific job to do. If your income exceeds your expenses, bump up your savings. If your expenses exceed your income, start cutting costs or look for a side hustle to bring in more income.
Here's a sample. if you bring $2,700 into your home each month (after taxes).
To create this type of budget, track your expenses for around 30 days, so you can see what your current spending is in each category. Yes, you can adjust this up and down as needed — seeing where you're overspending is part of the point of budgeting — but you need to have a realistic idea of how you're using your money so you don't create a budget you can't actually live by.
Once you've made your budget, set up automatic transfers to retirement savings and other accounts and then keep your spending in each category within the established limits.
2. The extra-disciplined "envelope" budget
The envelope budget is a twist on the zero-based budget. With this system, you still allocate a set amount of money for discretionary spending: spending on things like groceries, clothes, entertainment and other variable expenses.
The difference is, with the envelope system, you actually put your designated cash into a physical envelope — and spend only the money inside. It's a smart move if you often overspend and need a big dose of discipline.
So: If you've allocated $400 to groceries, $250 for entertainment and $50 for clothing, write yourself a check for $700 each month. Physically take $400 and put it into an envelope labeled groceries, $250 into an envelope labeled entertainment and $50 into an envelope labeled clothing.
When you go to the grocery store, take money out of your groceries envelope. When you go to a movie, grab from your entertainment envelope. When the envelope is empty, you're done spending on that category for the month.
This system might force you to learn the hard way that you need to spend less on beers if you're going to be able to afford dinner — but because you're dealing all in cash, you won't run into problems like the dreaded overdraft fee. Still, if you don't like the idea of carrying cash, you can also use apps like Mvelopes or Goodbudget, which behave like a virtual proxy to the envelope.
3. The easy "percentage-based" budget
If living by a detailed budget sounds like a nightmare to you, consider a percentage-based budget as an alternative. There are two really basic options if you go this route. One option is the 80/20 budget. With this budget, you put 20% of your income automatically into savings and live on everything else.
The other option is the 50/30/20 rule. This budget allocates 50% of your income to essentials like housing costs, utilities and commuting expenses. Twenty percent of your income goes to savings, and the remaining 30 percent is for discretionary expenses like cable TV, entertainment costs and gym membership.
There are downsides to these options. You could be significantly overspending on certain categories of expenses. You might be tempted to tap into your savings. And, allocating only 20% to all savings may be insufficient when some experts suggest millennials need to save 22% just for retirement.
Plus, if you opt for the 50/30/20 budget, you have to decide what is a discretionary expense versus an essential.
To make this type of budget work best, set up an automatic transfer of funds to a retirement account and other savings account. You could transfer 15% of your income to a retirement account and 5% to other savings, starting with fully funding an emergency fund and then saving for other goals like a down payment on a home or an awesome summer vacation.
While you might not be using your money as wisely as you could with other budgeting methods, percentage-based budgeting is far better than having no budget at all. If you feel less constrained in your spending, you may be more likely to stick to this plan even if you find other budgets don't work for you.
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