What is Budgeting?

by Jordan Lavin July 3, 2018 / No Comments

Budgeting is the simple act of deciding how you want to spend your money.

Whether you have a minimum wage part-time job or you make six figures working on Bay Street, your income is limited. When you make a budget, you’re deciding how your income should be used.

A budget doesn’t have to be about saving money or cutting expenses; your budget can include anything you want. Most people make basic needs like food and shelter their top priority, but there’s nothing wrong with budgeting for cars, trips, shopping and anything else that makes you happy. In fact, budgeting is the best way to ensure you can have those things that are valuable to you personally.

Why budget?

If you were asked how much you spend each month, how close do you think you would get to the actual number?

You might know some of the big ones. You probably know to the dollar how much you pay for your home. But what about some of the other categories you regularly spend money on? Do you know how much you spend each month on groceries? Restaurants? Transportation?

If you’re not keeping track of what you’re spending, it can be difficult to stay within your means. You can easily use your credit card to pay for a few nights out, some new clothes, and that new bag you really want. But without having some kind of budget, you might now know whether you can pay off your credit card bill until it’s too late.

Having a budget helps you keep track of your spending so you can spend your money on the things that are most important to you.

How to make a budget

There are several different methods of making a budget, each with their own advantages and disadvantages. There is no one “right” way to budget. Money is a very personal subject, and different people will succeed with different approaches.

Income-based budgeting methods

The “Balanced Money Formula”

Also known as the 50/30/20 rule, this budgeting method is a rough guideline that divides your income according to three main categories: needs, wants and savings.

According to the balanced money formula, 50% of your income should be earmarked for needs. These are things you actually need to live and get through your day, like your home, utilities, groceries, transportation and insurance.

The next 30% can be used for things you don’t necessarily need, but which you still want. This category includes things like clothing, entertainment, restaurants, and Netflix.

The last 20% should go to savings.

The advantage of the balanced money formula is that it makes make budgeting really simple. You don’t need a complicated balance sheet or any tricks, just some basic rules about how you spend your money. You’ll need to track your spending closely to make this method work, however.

Zero-sum budgeting

The zero-sum budgeting method requires you to allocate every single dollar you earn. If you take home $2,500 per month, you have to plan $2,500 in spending.

That doesn’t mean you should spend every dollar you earn, however. It just means that you will have a plan for where every dollar is going to go. Whether it’s to housing, transportation, bills, savings or shopping, all of your income is spoken for.

The advantage of a zero-sum budget is that it helps you stay on track no matter what. Once the budget is made, there’s no leeway to add in an impulse purchase without shuffling things around.

The disadvantage of this method is that it doesn’t work well for people who don’t have a predictable income. If you work irregular hours or earn commission, this method may not work for you.

The 60% Solution

Similar to the balanced money formula, the 60% solution suggests using 60% of your income to cover all of your regular expenses (housing, car payments, utilities, groceries etc.), and dividing the rest among irregular expenses (shopping, entertainment) and savings. Some advocates of the 60% solution also recommend including taxes in this portion.

The primary benefit of the 60% solution is its simplicity. Just take 40% of your money and set it aside in savings and fun. Whatever’s left over is what you have for the month.

Expense-based budgeting methods

The balance sheet

This may be what you think of when you imagine what a budget looks like. You can make your balance sheet with a spreadsheet or even pen and paper, and it simply adds up all of your money in, and all of your money out. You can choose to spend as much or as little as you like, carry forward leftover money, or use it to pay off debt or for saving.

The benefit of making a balance sheet is the level of detail it allows. You can plan ahead for every expense you can think of, and shuffle things around as you need.

The disadvantage is that to stick to a balance sheet budget, you need to keep track of every dollar you spend. There are helpful apps you can use, but it still takes some discipline to make sure everything’s accounted for. And if an unexpected expense comes up, it might not always fit in.

The envelope method

The envelope method is a simpler way of making sure money is there for all of your expenses. In this method, you literally create an envelope for every expense (rent, car payment, bills, groceries, restaurants, etc.) and insert the amount of cash you’re budgeting for that category. When the grocery envelope’s out of cash, you’re out of grocery money.

The advantage of the envelope method is that it makes it really easy to see where all of your money is going. Studies show that the physical act of buying items with cash is more painful than credit or debit because the outlay is tangible and immediate.

You can also use a different budgeting method, but use the envelope method to stick to it. For example, if your budget includes $200 for restaurants monthly, you might make a single envelope to be used on those expenses.

The disadvantage of the envelope method is that it requires cash up front, which is a luxury many people don’t have.

The priority method

Think about the things that are important to you when it comes to money. Maybe your priority is to have a nice home. Maybe your priority is a hobby, or travel or new toys for your children.

With the priority method, you choose what’s important to you and rank them in order. Set aside money for the most important things first, and then keep going down the list. When you run out of money, the items left on the list aren’t important enough to worry about.

The priority method doesn’t insist on any limits or self-denial. If you want to have a big house that costs 75% of your income, that’s allowed. If it’s important to have a nice retirement, put savings at the top of your list. If it’s more important to go on a great vacation every year than to buy a new car, that’s a valid choice. You get to choose where your money goes.

Be warned that you may need to make some difficult choices, and if you’re not careful you may find that things you thought were unimportant actually matter a great deal.

Budgeting Tips

Whichever budgeting method you choose, these tips may help you be successful in achieving your goals.

  1. Pay yourself first.

If you can afford it, put some money in savings before anything else. It doesn’t have to be a large amount. Even $25 every paycheque can add up to thousands of dollars over the long term.

  1. It’s better to pay off debt than to save.

Before you start saving, make sure you’ve paid off all of your consumer debt (e.g. credit cards and unsecured lines of credit). Every dollar you use to pay down debt will save you more money than it could earn if it were saved or invested. Mortgages and car loans typically have very low interest rates and are the exception to this rule.

  1. Consider upcoming expenses.

Major expenses can have a major effect on your budget but planning ahead can help make them more manageable. If you know you’re going to need a new car, new furniture or even a new phone, you can help fit these items into your budget by spreading the cost out over a few months.

  1. Any budget is better than no budget.

Any kind of budget you make, even if it’s very simple, can help make sure you have money available for the things that are most important to you. Your money is a limited resource. Planning ahead for how you want to spend it.