Everyone has a budget. Most people just don’t know what their budget is. Finding the budgeting system that works best for you is the first step. Some people needlessly struggle while trying to implement another person’s budget system. So let’s talk about the three different ways to budget so you can identify the parts of each system that work for you. Then you can create your own blended system.
Every Dollar Has a Job - The Envelope System
Currently being championed by You Need A Budget (YNAB), this style of budgeting has been around for a very long time. Years ago, you would withdraw your paychecks in cash, and put money into labeled envelopes. Then when it came time to pay rent, you went to the Rent envelope and there was the money, already set aside. Or when you went out to eat, you’d grab your Dining Out envelope, and hope that it wasn’t already empty. If it was, you could choose to take money out of another envelope, but by doing so, you knew that the next time you reached for that other envelope it wouldn’t have enough money, which provided the natural encouragement to stick to the plan. YNAB, and similar systems, follow this same methodology but have made the system available online so you can use debit cards (or with some work, credit cards) for your spending.
Setting up this kind of budget takes time and trial and error. Since most people don’t track spending, it’s unreasonable to expect that they would be able to guess in the first month of budgeting how much money to put into each envelope. So for the first few months, you should be adjusting the funding of your envelopes based on the reality of your spending. This requires a lot of work and a lot of diligence, particularly if you are using software rather than cash envelopes (which have their own challenges). Credit card companies and retailers both know that using a little piece of plastic to buy things disconnects us from the reality of the amount being spent, especially since you get that doo-dad that you really want right now, but don’t have to pay for it for another month, where it will be commingled with lots of other doo-dads.
In order to avoid overspending in a category, you have to know before you decide to spend how much you have available, then pay attention to the price when making your purchase. Luckily YNAB and others have mobile apps, so you can quickly check your dining out budget before deciding between that sit-down restaurant or the quick-service meal.
Every month you’ll then need to review how you did, and eventually only make minor adjustments. The largest adjustment after the first few months will be accounting for once-in-a-while expenses that were forgotten upfront. For instance, if you celebrate Christmas by giving away gifts, you will want that to be part of your monthly budget rather than getting to December and having to take money away from other spending categories to be able to afford the gifts that you want to buy, or worse yet, paying on credit and then paying interest for a few months as you pay off the debt.
The Good - for those that can make it work, this style of budget is the best, bar-none. It gives you maximum control over your money and maximum insight into your habits.
The Bad - this style of budgeting can be a TON of work depending on how much detail you go into. Was that spending at Target all from the clothes envelope? What about the soda you bought there, or the games, or the crafting supplies? So not only will you need to assign each transaction to an envelope, but many times you will need to split transactions between multiple envelopes.
The Ugly - YNAB is not free, nor are most of the similar technology solutions for this style of budgeting. Now I firmly believe that, if this style works for you, the fee is 100% worth it, but no one needs yet another subscription they’re not actually using. And going full-on cash is not easy in today’s world.
The Richest Man in Babylon - Pay Yourself First
The opposite end of the spectrum is where most people find themselves, but without the structure that I’ll suggest here. The idea from the classic book The Richest Man in Babylon by George Clason is to spend no more than 70% of your income (take home that is), put 20% toward paying off your debts, and save the other 10%. Or rather, save at least 10% of your income FIRST, then pay off your debts with the next 20% and finally make sure you can live off what’s remaining. Saving first is the key to making this style of budgeting work. Instead of focusing on exactly what you are spending on, the focus is solely on how much you can save, and how quickly you can pay down your debts. Once your debts are gone, you should continue living off 70% of your take home and start saving that additional 20%.
Now there’s still some trial and error for people starting this style of budgeting. I would encourage you, that if you want to try this style, start by opening a high-interest savings account (Ally, Marcus, etc.), then try to put 5% of your take-home pay into the new account. If you need the money during the month, you can always pull it back into your checking account. If you had to pull some of the money back, lower your savings by 1% the next month, but if you didn’t, then increase it by 1%. Hopefully you also have a retirement account through work that you’re saving into. If not you may want to start with a higher percentage. The goal here isn’t to determine what the savings is for yet, but to find that spot where you’re saving more than you thought possible, but not really feeling like you’ve given up much in your lifestyle.
The fastest way to tank a new budget is to cut too deep, have no fun and then give up because honestly, it’s better to live with fun and the stress of mismanaged finances than it is to live without fun and a full savings account. The trick is to find the balance between the two because it is FAR more enjoyable to have some fun and a mostly full bank account. Especially the next time your A/C gives out or your car breaks down.
The Good - this style of budgeting allows for a lot of freedom. There’s no judgment by you or anyone else about how much you spend on coffee, as long as you’re also hitting your savings target.
The Bad - it’s difficult to know what to cut if you don’t know what you’re spending on. Some people will struggle to make room in their budget for saving because their level of spending feels like the bare minimum already. It’s particularly difficult if you have friends who are in a different income class than you. Try to remember that if they are really your friends, then they like you, not your money or your possessions.
The Ugly - it’s very easy to slide from Pay Yourself First to Treat Yourself First. While it may not seem like it, this style of budgeting still requires a lot of self-discipline. But if you can maintain it then you can be enjoying life now while also saving for your future.
Not many people fit entirely into one budget camp or the other. There are some things that you should plan ahead for, like vacations or large holiday spending. While, even if you were to plan out every dollar, you should probably start with setting a savings target first, and remember to leave yourself some freedom with maybe something like a “Slush” envelope. The most important part of the budgeting process is to start.