Budgeting is a necessity in the pursuit of meeting financial goals. Spending less than you earn is the key to financial success. In this article, I’ll discuss how to determine your specific needs, different budgeting strategies to consider, and steps to take to follow your budgeting strategy.
The first step to budgeting is understanding your income after taxes and other deductions. If you’re a W-2 employee, you can find this amount by looking at your net pay on your paystub. If your income varies monthly (business owner, sales professional), you’ll need to figure out your monthly expenses first. See my article titled “Budgeting Tactic for People with Variable Income Streams” for more information on this.
The second step to budgeting is understanding your spending habits and expenses. To understand your spending habits and expenses, you can start by tracking your expenses for a few months. I typically recommend putting them on a spreadsheet and categorizing them based on type of expense such as restaurants, groceries, mortgage, sports, etc. As you move through this exercise, you’ll want to categorize expenses into a few different buckets:
- Essential Expenses: Expenses that support your needs.
- Lifestyle expenses: Expenses that support your wants.
- Fixed Expenses: Expenses that stay the same each month.
- Variable Expenses: Expenses that can change from month to month, or expenses that don’t come up each month such as annual subscription.
- Savings: Amount set aside for cash reserve, retirement, and other goals.
Once you figure out how much you are spending and where, it’s time to choose a budgeting strategy that works best for you. I think of 4 common budgeting strategies that people can consider. We will discuss how each strategy works, who it’s for, and how it differs from other methods.
1) 50/30/20 method:
- Each month, you allocate your after-tax income into three buckets: 50% of income goes to needs (housing, groceries, debt payments, utilities). 30% of income goes to wants (eating out, vacations, gym memberships) . 20% of income goes to savings (retirement, cash reserve).
- This works best for those who are looking for a simple way to balance priorities.
- It differs from other budgeting strategies because it can be used on its own or as a starting point for other strategies.
2) Pay yourself first method:
- Decide how much of your income you want to save each month, pay yourself first by automatically routing a portion of your paycheck into proper savings/retirement accounts, then pay for essential expenses. After doing those three things, spend whatever is left over on discretionary spending items.
- This works best for those looking to prioritize certain savings goals and reduce spending on non-essential items.
- It differs from other strategies because it emphasizes savings rather than expenses.
3) Envelope system:
- Set limits for each spending category, fill "envelopes” with those set amounts, and use the money from each category to pay for monthly expenses. Once that money is gone, you can’t spend more money on that category for the month or you need to take money from another category for that month.
- This works best for those who are prone to overspending or impulse purchasing.
- It differs from other strategies because it draws attention to excessive spending on specifics items or categories.
4) Zero-based method:
- At the start of the month, allocate every dollar of income toward a specific purpose and various categories. Track and categorize each expense throughout the month. At the end of the month, subtract your expenditures from your income. The total should be zero.
- This works best for those looking to understand and control their spending habits.
- It differs from other strategies by providing a detailed view of where your money goes each month.
Once you’ve implemented a strategy, you need to make changes based on your spending habits and priorities. Life moves fast, things change, and your budgeting strategy will need to change accordingly. If you’re looking to reduce expenses, start with those that aren’t necessary such as subscriptions, restaurants, and vacations.
Lastly, review your plan regularly. Your income, spending, and priorities are likely to change over time. Make sure those changes are aligned with your budgeting strategy by reviewing your financial plan and adjusting accordingly. As outlined, there are multiple ways to go about implementing a budgeting strategy. Mistakes will happen and there will be months where your budget isn’t followed to a tee. THAT’S OKAY! It happens! Budgeting is not perfect and never will be but having a strategy is the foundation to meeting your financial goals.
Together, we can work to keep you on-track towards your financial goals.
Request a consultation with me to learn more.
Read more articles by Ryan Johnson