3 Different Ways to Budget: What’s in Your Wallet?

Ah, budgeting.  For many people, the term “budget” is synonymous with “diet” – a term that is as important as it is uncomfortable.  But, just like dieting, the benefits that can be achieved by using this not-so-exciting tool should outweigh the initial discomfort.  Being mindful of where your money is going can make you stronger, happier, and in a better position to achieve your life goals (just like being mindful of what you put into your body can improve your health).

There are many ways to start setting up this good habit, and there are pros and cons to each method.  The important thing is to have the right amount of flexibility and consistency in your budget so that it fits you.  Like a diet, a budget should be appropriate for the person it’s designed to help.

Here are 3 popular budgeting techniques worth considering: 

Pay Yourself First
Well-known financial author David Bach says traditional budgets don’t work because they are too restrictive and go against human nature.  Rather than telling yourself that you “can’t” spend money on things you enjoy because you have to pay everyone else first, a better approach is to start by “paying yourself first.”  In his opinion, this feels less restrictive and more enjoyable than other types of budgeting, which means you’ll stick with it longer.

  1. First priority goes to “pay yourself first”: put money into your retirement accounts, investments, and savings.  At least 10-20% of your income should go here.
  2. Next are your life necessities like rent, utility, insurance, and debt payments.
  3. Lastly comes the category of lifestyle, like food and entertainment.

Bach suggests that this type of budget helps you to feel more in control, especially if you put the top priority payments on “auto pilot.”  In other words, set up automatic deductions from your paycheck into your retirement savings accounts and investments, if possible.  Use your bank’s online billpay to automate payments to your savings accounts.  This helps you to build a better financial future consistently, rather than letting life’s busyness get in the way of “I’ll do it someday…”

The 50 20 30 Rule
Touted by LearnVest, this one has gained popularity in recent years.  This “rule of thumb” simplifies budgeting by directing your monthly after-tax (take home) pay into 3 areas:

50% goes towards necessities (food, shelter/utilities, and minimum debt payments)
20% goes towards long term financial priorities (retirement, nestegg for a house, and/or any additional payments to debt)
30% goes towards desires (vacation, entertainment, pets, hobbies, and other non-necessities)

The definition of each of these categories allows for a small amount of “wiggle room” (ie, is your cell phone a “necessity” or a “desire”?  You decide.).  At the same time, the percentages aim at keeping your financial focus in the right areas (more goes towards necessities than desires).

A Variation on the 50 20 30 Rule
Millennial author Remit Sethi, author of “I Will Teach You to Be Rich,” breaks down the 50 20 30 rule a bit further and suggests that a “top-down budget” (where you write down what you should spend) is better than a “bottom-up budget” (where you write down what you did spend).  This is because a top-down budget lets you set goals to achieve, which is more motivating than restricting (echoing David Bach’s advice).  Here’s Sethi’s suggested budget breakdown:

50-60% to necessities including debt and insurance payments
10% to investments like 401k’s, IRA’s, and Roth
5-10% to savings for gifts, a future vacation, house nestegg, etc.
20-35% to “guilt free spending,” or your one splurge like eating out, clothing, movies, etc.

This is perhaps the most flexible budget, because it allows for varying ranges of spending, rather than strict percentages.  It also acknowledges human nature by creating a “splurge” bucket.  You’d think this would fly in the face of traditional, restrictive budgeting, but the opposite may be true: acknowledging this with its own category may just help to keep “splurges” in check.

The point of showing you three different ways to budget is to point out that, contrary to popular belief, there’s not ONE correct way to establish a budget for financial success. In fact, there are certainly more than these THREE ways to budget, but for the sake of simplicity, I wanted to highlight three of the most popular that I have come across in my practice.

I hope these approaches help you to be more successful in your budgeting going forward. Remember, no matter where you are in your financial life, there’s always room to grow and learn and improve your situation!

If you and your partner / spouse / child are arguing over how to budget, perhaps realizing that there is more than one way to do it can help you both reach a common ground and move forward successfully.

Good luck!