Budgeting is an important personal finance tip that often gets overlooked by many people who want to achieve financial discipline and confidence. Everyone needs a budget and it is detrimental to your financial success to think that only people who are “bad” with money need to budget. If you are spending money, you should budget. When you budget your money, you not only get to understand your finances better, but also gauge whether you are headed for a financial disaster or not. Budgeting is something we all need to incorporate into our financial lifestyle in order to achieve our financial goals. Unfortunately, there is no one-size-fits-all when it comes to how you want to budget your money. There are different budgeting techniques that one can use that suits their personal style, needs and preferences. This article will shed light on these budgeting techniques and the pros and cons of choosing these budgeting techniques to plan your finances.
Here are the top four budgeting techniques you can use today to budget:
1. Cash Envelope Method
This is perhaps the easiest budgeting method for anyone who is new to budgeting. It is quite simple and you only need your cash and envelopes for this budgeting system. To start budgeting with this system, the first step you need to do is to cash out all your income. All your salary earnings have to be in cash for this to be effective. Next, have your envelopes in order and name the expenses you wish to put in each envelope. For example, you can have one of your envelopes as “Rent or Eating Out.” All the money you wish to set aside as rent expense should go here. After you have labelled all your envelopes, you can start placing your cash in each of the envelopes. You are only allowed to spend money on each envelope for its specific use until you exhaust it. Do not use money in other envelopes if you don’t need to.
Advantages of the Cash Envelope Method
Here are the benefits of using the cash envelope method:
- It is quite simple to use this budgeting technique, as it does not require any level of expertise. You just have to practise high levels of financial discipline for this budgeting technique to work.
- You can easily track your spending with this budgeting technique.
- Enhances delayed gratification and financial responsibility, especially if you have to account for how money got used up in this one specific envelope.
Disadvantages of the Cash Envelope Method
Here are the problems and challenges of using the cash envelope method:
- It is not effective when you have to work with large sums of money.
- You can lose an envelope or have it stolen. This sets you back financially.
2. 50/30/20 budgeting rule
This is one of the most common budgeting systems that is preferred by people. It is a tried and tested approach that has proven to be effective to financially successful people. The 50/30/20 rule dictates that from your income, 50% goes towards your needs e.g food, clothing or rent, 30% goes towards your wants/personal desires, e.g a vacation or a lunch date and 20% goes to your savings. Your needs are those which you cannot survive without. Think of all these things that MUST be met in your life for survival and set 50% of your income for them. For any desires or pleasures you’d wish to spend your money on, the 30% will cater for that. If you want to save for a rainy day or set up an emergency fund, the 20% will take care of that. Provided you stick to the ratio and divvy up your expenses as needed, you do not have to be overly cautious with this budgeting technique.
Advantages of the 50/30/20 budgeting rule
- Just like the cash envelope method, it is a simple budgeting technique
- You do not have to be utterly meticulous about how you are spending your money, provided you stick to the ratio.
- You can easily account for your money at the end of every month.
- It encourages saving; for example, if you need to save for an emergency or towards a specific goal, the 20% rule will be your guiding principle.
- You get to evaluate and reduce your fixed costs, for example if you are paying more than 28% on rent, you will have to find a way to accommodate all this in the 50% of needs.
Disadvantages of the 50/30/20 budgeting rule
- This budgeting rule can be difficult for people who are struggling to distinguish between needs and wants. For example, if you have any subscriptions that you have been paying for, it can easily fall under the needs category and not wants. You have to be very intentional when you list your expenses.
- Spending 30% of your income on your personal desires can be too much, especially if you can easily do without those things.
- The 20% rule can be limiting to some, especially if you have major saving goals.
- This budgeting rule does not take into consideration the need to pay off your debts.
3. Zero-based budgeting
This budgeting technique dictates that all expenses must be accounted for and be zero at the end of every period. Your income and the expenses you incur must balance each other out and be equal to zero. Before you get your next salary, you need to create a list of your corresponding expenses and their costs. Once you have justified your expenses and your income for that period, then you can proceed and create a new budget for the next period, regardless of whether you anticipate a higher or lower budget from the previous one.
Advantages of zero-based budgeting
- You operate on a flexible budget because you can change things up the next period.
- You cannot easily misuse your money because you have to give an account of every single expense
- You can easily track your spending because you are consciously aware of where every one of your expenses goes.
Disadvantages of zero-based budgeting
- Since you have to create a new budget after every period, you have to put in a lot of time and resources to create an effective budgeting system. It is easier to use a budgeting template and modify it how you deem best.
- Worrying about small expenses can take a toll on you, especially if you do not remember where the petty cash went.
4. Pay-yourself-first method
As human beings, we work best on a reward system. The pay-yourself-first method emphasises this. This budgeting technique involves paying yourself first for savings and then doing whatever you want to do with the rest of your money. This is why this budgeting technique is also called a reverse budget. You prioritise your savings over expenses. If you are using this approach to budget your income, you first have to figure out how much money you want to pay yourself. What are your saving goals? Once you get paid, you need to immediately set money aside for this, after which you can spend the rest of your money how you want. You can set up automatic transfers for your savings, if you want to meet your financial goals faster. If you need to make any adjustments, you can do that how you see fit.
Advantages of the pay-yourself-first method
- This budgeting technique encourages saving, therefore you are more assured of achieving your financial goals. For example, you can easily save or investing towards getting your dream car or house.
- As you pay yourself first in savings, you prepare for your future by saving for retirement, saving for an emergency or a rainy day.
- Automating your savings will allow you not only grow your savings, but also exceed your savings limit. This is a good way of meeting your financial goals.
Disadvantages of the pay-yourself-first-method
- This budgeting principle does not prioritise debt repayment, therefore you may be saving a lot of money and still end up living life while heavily strapped in debt.
- You need to practise financial self-restraint and have high levels of financial discipline for this budgeting technique to work.
Budgeting is an essential financial habit that we all need to adopt. There are many surprising benefits that you can get when you budget your money. For starters, having a spending plan gives you control over your money. Money does not rule you. When you budget, you gain emotional security over your finances because you do not have to constantly worry about where your money goes. Getting rid of this kind of financial stress is beneficial for improved financial health. As you keep budgeting, you become more organised and put focus on things that really matter to you. It also becomes easier to talk about your finances more confidently. If you are new to budgeting, you can look at these four budgeting techniques and find out which one best suits your character or personality. Only then do you make a step towards attaining financial freedom and independence. So, which budgeting technique will you go for?