6 Types of Budgets and How to Choose
In hindsight, it makes sense that at the height of the COVID-19 pandemic Americans hoarded more money than ever. In fact, the U.S. Bureau of Economic Analysis (BEA) reported that...
In hindsight, it makes sense that at the height of the COVID-19 pandemic Americans hoarded more money than ever. In fact, the U.S. Bureau of Economic Analysis (BEA) reported that the personal savings rate hit a historic 33% in April 2020. That does check out between shutdowns and stimulus checks.
However, that trend was unlikely to continue. BEA actually notes thatpersonal income decreased by $216.2 billion (1.0 percent) in September 2021. Again, that makes sense as businesses have reopened and there has been a decrease in government spending.
While understandable, this is still should raise concerns. After all, Bankrate found that only 41% of Americans would be able to cover a $1,000 car repair or emergency room visit. Additionally, if hit with an unexpected bill, 37% of people would have to borrow this money in some capacity.
Furthermore, 59% of adults in the U.S. are living paycheck to paycheck. And, via a CreditDonkey survey, 29.2 percent of respondents say they aren’t saving any of their income.
How can we resolve these frightening statistics? The most obvious answer might be through a budget.
To be honest, a budget won’t magically relieve all of your financial stress. However, a budgeting system can guide you in understanding and evaluating your relationship with money. Mainly, this is by determining your available money and it can be used wisely.
But, did you know that there is more than one type of budget available?
While all budget systems have a similar concept, they have their own unique tactics that can help you reach specific financial goals.
1. Line-item budget.
Line-item budgets are most commonly associated with a typical budget or budgeting process.
“You know the kind, in Excel or some other spreadsheet that lists out each expense by category,” Brian Walsh, a certified financial planner for the personal finance company SoFi, tells Real Simple.
To get started, you’ll list each of your expenses. Or, even better, categories of expenses. This will be for a specific timeframe, like a month. “Line-item budgets function by grouping related costs together,” adds Mia Taylor.
From there, you’ll want to identify a target spending amount for each line item or category in your budget. “Ideally, you will do this based on reviewing your prior spending in such categories,” explains Taylor. If you’re developing a new line-item budget, a good place to start would be by reviewing your last three months’ worth of spending and assigning each transaction a category.
While you can use this type of budget for your personal finances, it’s usually used by businesses in order to conduct a year-to-year analysis or comparison of spending in expense categories. This method also makes it easier to track both income and expenses.
“Because a line-item budget is detailed, this could be a great option if you require more control over spending or are a detail-oriented person,” explains Walsh. The level of detail involved, however, can be a downside for some due to the need to set up and maintain it.
2. The 50/30/20 budget.
Popularized by Senator Elizabeth Warren the 50/30/20 budget rule is so straightforward that it’s perfect for budgeting beginners. But, it’s also appealing to anyone who wants to not only cover their current costs but also chip away at debt and save for their future.
Here’s how it works, just divide your income into the following categories;
- 50% goes to necessities
- 30% to wants
- 20% to savings and debt repayment
What I also like about this type of budget? It’s flexible enough that you can use other variations to better suit your needs and goals.
- For a stripped-down version try the 80/20 rule. Here 80% of your income goes to essentials and luxuries, while the remaining 20% is set aside for savings.
- Are you an ambitious saver? The 60/30/10 rule might be a better option. With this type 60% of your take-home pay goes towards savings, investing, or paying off debt. You’ll spend 30% on your needs and the remaining 10% on discretionary spending.
- If you attempting to save for your retirementand your child’s education try the 50/15/5 rule. Withthis model you would allocate 50% of your income to essential expenses, 15% to retirement savings, and 5% to an emergency fund. What about the 30% that remains? You can use that to beef up your retirement, your child’s tuition, or go on vacation.
- There’s also the 30-30-30-10 budget. Here 30% of your monthly income will be evenly split across housing, necessities, and financial goals? The remaining 10% will budget for vices like entertainment, dining out, and vacations.
3. The envelope system.
Do prefer physically handling your money. Or, do you need to curb wasteful spending? If you said yes to either, then the envelope system might be right up your ally.
But, how exactly does it work?
“Once the month (or pay period, if you refill your envelopes biweekly) begins, look at your categories in your budget,” explains William Lipovsky in a previous Due article. “Food, clothes, gas for the car… I’m sure you have a few more. For each and every category, the envelope system dictates that you pull out an envelope of your choosing (decorated ones look pretty, but longer security envelopes work just fine) and write one category name on each envelope.”
Next, you take the actual cash you need to cover these expenses. And then, you “divide it up into your envelopes based on your budget.”
“The theory is, if you only have $200 in your food budget for the month, you will only use that $200. Not a penny more,” says Will. “The truth is, this takes major dedication. Even if you only buy the essentials you need to last through the month, you can still run the risk of going over budget if you aren’t careful,” which requires accurate calculating.
You can, however, move money from one envelope to another. Let’s say that you spent $175 at the store. You could take that extra $25 and place it into the “gas” envelope if the bill was higher than expected.
4. Pay yourself first.
Also known as reverse budgeting, this is a savings strategy where you save a portion of your income towards goals, like retirement, before spending money on food, utilities, or discretionary items. The amount you set aside is usually predetermined and is automatically redirected into the appropriate savings account(s).
People enjoy this method if they want to bolster their savings without having to crunch every number each month.
5. The zero-based budget.
Want to make the most of every dollar you earn? You might want to create a zero-based budget.
“Zero-based budgeting is a way of budgeting where your income minus your expenses equals zero,” clarifies Ramsey Solutions. In a zero-based budget, you must ensure that your income matches your expenses each month. That way you’re giving every dollar that’s coming in a job to do.
That doesn’t mean that your bank account is empty. It simply means that your income minus your expenses equal zero, they explain.
Let’s say you make $3,000 each month. All your spending, saving, giving, and investing should total $3,000. “That way you knowexactly where every one of your hard-earned dollars is going,” they add. After all, if you do not know exactly where your money is going, you could face a financial disaster.
6. Hybrid budget.
Do you like parts of each budget listed above, but not the entire kit and caboodle? That’s perfectly acceptable, says Evan Gorenflo, a financial advice expert with the banking, saving, and investment app Albert. Why? Because you can take the elements that you do like and combine there with others to create your own personalized hybrid budget,
“For example, you could start with a 50/20/30 plan, where the goal is to save 20 percent of your income,” says Gorenflo. But, you could also establish a detailed category of spending and use cash envelopes for these different types of spending.
“Ultimately, the most important thing to remember is that creating a budget is a very personal thing,” states Taylor. “There is no one right way for everyone to budget. Identify an approach that works for you, your goals, and your personality type.”
How to choose the right budget.
When it comes to budgeting, how do you decide what type is best for you? Well, just like when car shopping, you can try the system out first. If it’s not to your liking, you can take another system out for a test drive.
Generally speaking, though, here are three ways to help you narrow down your decision;
- Conduct a financial self-assessment to find out where you are and what your goals are. For example, if you want to pay off your debt, then you’ll want a system that lets you identify where you can decrease spending so that you can throw those savings at your debt.
- Prior to getting on board with a budgeting system, consider how much time it will take for you to manage it. Some budgeting systems are more rigid than others. As an example, Excel spreadsheets and zero-based budgets require frequent and detailed tracking of expenses, while the pay yourself approach is more hands-off.
- Compare your manual and digital options. Do you want to be more hands-off or let technology do most of the work? If the app or program allows you to automate savings or access your information on the go, personal finance software can be handy. But, it might not be useful if there’s a steep learning curve or it doesn’t automatically input and categorize your purchases.
As a final point of advice, some experts state that there’s no need to follow a specific budgeting system. The catch? You know what your income, debts, goals, and general spending are. If so, then tracking every penny could be excessive if you’re living within your means and know that you’re able to meet your financial goals.