What is Budgeting?
Budgeting is the simple act of deciding how you want to spend your money.
Whether you hold a part-time job earning minimum wage or you make six figures, your income is limited. Making a budget means 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. While most prioritize necessities like food and shelter, there’s nothing wrong with budgeting for indulgences such as trips, shopping, eating out, cars, 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.
The importance of budgeting
If you were asked how much you spend each month, how accurate would your guess be?
You might know some of the big ones. Your housing cost, for instance, might be at the top of the list. But what about some of the other spending categories? 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 nights out, new clothes, and that new bag you really want. However, without a budget, you might not 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 many different budgeting approaches, each with its 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. There are two overarching methods with different options :
- Income based budgeting methods
- Expense based budgeting methods
1. Income-based budgeting methods
The “Balanced Money Formula”
Also known as the 50/30/20 rule, this budgeting method divides your income according to three main categories: needs, wants, and savings.
According to this formula, 50% of your income should be earmarked for needs - essential expenses such as housing, utilities, groceries, transportation, and insurance.
The next 30% can be used for things you want - non-essential items like clothing, entertainment, eating out, and streaming subscriptions.
The remaining 20% should go to savings.
The advantage of the balanced money formula lies in its simplicity, needing no intricate balance sheets or tactics, just fundamental rules for spending. However, in order to be effective, meticulous spending tracking is key!
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, your budget outlines $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. Regardless of whether it is allocated 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 room for impulsive spending without forcing you to make tradeoffs and shuffling things around. Its limitation, however, is that it doesn’t work well for people who don’t have a predictable and stable 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, this method suggests dedicating 60% of your income to cover regular expenses - housing, car payments, utilities, groceries etc. - while the remainder is divided 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.
2. Expense-based budgeting methods
The balance sheet
This may be what you think of when you imagine what a budget looks like. It tallies all income and expenses, whether with a spreadsheet, or even pen and paper. 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 drawback is that you need to keep track of every dollar you spend. There are helpful apps you can use, but it still takes discipline to make sure everything’s accounted for. And if an unexpected expense comes up, it might not always fit in.
The envelope method
This method is making a comeback! You may have heard of this phenomenon on TikTok and is also known as "cash-stuffing". The envelope method is a simpler way of making sure money is there for all of your expenses. With this method, every expense has a corresponding envelope containing its budgeted cash. When an envelope is empty, its funds are fully depleted.
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 this 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 and allocate funds accordingly, addressing your top priorities first and continuing down the list. When you run out of money, the items left on the list aren’t important enough to worry about.
This method allows for customization and avoids strict limits. 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
Regardless of which budgeting method you choose, these tips can improve your budgeting success.
- Prioritize paying yourself first and saving. If you can afford it, put some money in savings before anything else, even a small portion of your earnings matters. Putting aside $25 every pay cheque can add up to thousands of dollars over the long term.
- Pay off outstanding debts before saving. 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.
- 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.
- Any budget is better than no budget. Any level of budgeting ensures you have money available for the things that are most important to you. Your money is a limited resource, so why not plan ahead for how you want to spend it.
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