Have you ever run out of money before your next paycheck? Or are you never quite sure where your money goes each month? A budget may be the exact thing you need to fix your financial woes. With a budget, you can see the amount of money you have to spend and exactly where you’re spending it. It's essential for setting financial goals and making a plan to achieve them.
In many ways, the toughest part of making a budget is figuring out which budgeting method to use. The type of budget that’s best for you is the one you’ll stick with and continue to use. In this article, we’ll go over three popular budgeting methods and examine their benefits and drawbacks so you can choose the right one for you.
The goal of the 50/30/20 rule is to simplify your budgeting. Instead of having a long list of different spending categories, this method has only three:
Simplicity is the name of the game with the 50/30/20 budget. To start, calculate your total take-home pay after taxes. Then divide the amount of your take-home pay into three categories:
Needs: 50% of your take-home pay goes toward your needs. This includes all your necessities: your rent or mortgage, basic groceries, utilities, health care and health insurance costs, childcare costs, and transportation costs. The minimum payments on any debts you have also fall under this category.
Savings: 20% of your take-home pay goes into your savings. This includes emergency funds, retirement savings, outlier debts, and any debt repayments above the minimum.
Wants: The rest of your take-home pay, which should be around 30%, can go toward your wants. This includes things like cable, subscriptions, eating out, entertainment, sporting events, after-school activities for the kids, books, fashion, travel, and anything else that doesn't fit under needs or savings.
Here's an example of how the 50/30/20 budget can work. Say your take-home pay is $3,000 per month. $1,500 would go toward your needs (rent/mortgage, utilities, basic food, etc.), $600 would go into savings and debt repayment, and that leaves you with $900 for everything else.
Give yourself a reality check. If you haven’t spent much time thinking about how you spend your money or where your money goes each month, the 50/30/20 budget can really help. It's perfect for showing you if you’re spending too much in certain categories, or for helping you reassess your finances.
Boost your savings. The 50/30/20 budget automatically puts 20% of your take-home pay toward your savings or paying down debt. This method provides you with a concrete number so that you can be sure whether you’re saving enough or not.
Get out of debt. With this budget method, the minimum payments on your debts (credit card debt, student loans, car loans, etc.) should go under the 50% needs category. But depending on your financial situation, you might be able to also put some or all that 20% in your savings category toward additional debt payments. Devoting some or all of your 20% toward additional debt payments can help you pay down debt sooner. It can save you money in the long run and allow you to start working on other financial goals.
Have some fun! Some people avoid budgeting because they think that budgets are restrictive. With this budgeting method, that’s not the case. You get a full 30% of your take-home pay to use toward the things you want. Those things can include going out with friends and family, traveling, shopping, getting a monthly streaming subscription, and salon visits.
You don’t have to think about it too much. This method takes a big-picture approach, so you aren’t constantly keeping track of every little expense. Once you’ve calculated your needs and set your debt repayment and savings goals, you can sit back and relax, letting your money work for you. Just make sure you don’t go over budget in each category.
It can be difficult for some people. It’s not always possible for someone to stick with the 50/30/20 budget because of income or the cost of living in their area. If you live in an area with a high cost of living, you might find that you need to put more than 50% of your take-home pay toward necessities. A way to work around that might be to move to a more affordable area, but doing so might not be an option for you based on your job situation or your children’s schooling. Your income level can also make it challenging to only dedicate 50% of your take-home pay to necessities or to put 20% of your income toward savings. Depending on your circumstances, you might decide to change the formula to suit your needs. For example, you can put 60% toward necessities, 20% toward savings, and 20% toward wants.
It assumes a lot of disposable income. The 50/30/20 budget gives you the option of spending 30% of your income on non-necessities, which might appeal to people who feel confined by other budgeting methods. But for others, allocating 30% of take-home pay to wants can be too much. If you have a considerable amount of debt, or if you haven’t made any progress on your savings, spending 30% of what you bring home each month on fun things can get in the way of your financial goals or keep you in debt longer. It may seem wasteful or unrealistic to spend 30% of your income on things you want rather than dedicating that money toward savings or other goals.
It can be too flexible. For some people, too much flexibility can be challenging. The 50/30/20 method’s three categories are broad. If you feel lost on your financial journey, the 50/30/20 plan likely won’t give you enough guidance to set you on the right course or get you where you need to go.
Although digital tools, debit and credit cards, and online banking have streamlined and simplified finances for many people, some prefer the feel of cash. Physically handling money can make it feel more concrete and remind you that you’re spending your hard-earned income.
The envelope system traditionally relies on cash. To start, divvy up your income into categories and put the cash for each category into an envelope or set it aside. Once your envelope is empty, you’re done spending in that category for the month.
The envelope system works by giving you tangible spending limits in categories that you choose. To use the system, calculate your take-home pay and figure out what your expenses are. Then, you can pick the categories you use as part of the system and decide how much to allow yourself to spend in each category.
It's up to you what your envelopes or categories are and how much you put in them. You might have envelopes for things like groceries and gas, but you can also set aside money for coffee shops, pet food, or concerts. At the beginning of the month or whenever you get paid, put the designated amount of cash in each envelope. However much you put into them is your call, but that's all you can use for that month, and when it's empty, you're done.
Because using cash is becoming increasingly rare, you may want to digitize your envelope system and use it with your debit card or credit card rather than cash. If you’re a PSECU member, you can open multiple shares within your account and customize the names of these shares in online banking. Using our digital banking tools, you can easily move the money from your paycheck into the designated shares.
You can clearly define your spending targets. When you use the envelope system, you set spending limits. If you have $50 in your dining out envelope, once you’ve spent that $50, you’re likely to avoid going out to eat for the rest of the month. This method also helps you see exactly where you’re spending the most. You might realize that the $50 you’re spending on coffee each month could better serve you if it went somewhere else, such as in your savings account or toward paying down your loans.
Cash creates a spending limit. When you commit to paying with cash, you’re giving yourself a natural limit. With a card, you can easily spend more than you intended and not even notice it. With cash, you can only spend as much cash as you have with you (or in the envelope). The natural limit that cash puts in place can also keep you from making impulse purchases when you’re out shopping.
You have some flexibility. While you don’t want to move cash from one envelope to another to help you get through the month, the envelope system does give you some flexibility. If you’re having a lean month, you can decide not to budget for certain unnecessary expenses. You also have full say over the categories in your budget. If you need a category to pay for your kids’ ballet classes or painting supplies, you can create envelopes for them. And if there’s money left in the envelopes at the end of the month, it's up to you what to do with it. You can let it carry over to next month, put it in a different envelope, or put it into savings.
Cash isn’t always king. Although you can digitize the envelope budgeting method, it’s ultimately a cash-based budget method. There are certain drawbacks to cash. It’s not as secure as other methods of payment, so if someone steals your cash, it can be very difficult to get it back. Not every company accepts cash payments either, so paying your bills with cash usually takes longer than paying by card or check. If you pay an electric bill with cash, you’ll most likely have to go to the utility office and wait in line.
It can get complicated. It’s up to you how simple or complicated you make your envelope system. But if you create envelopes for very detailed categories, things can get very complex very quickly. And if the system becomes too involved, you might lose track of some money or want to give up using the method altogether.
You can lose track of spending. When you pay for items with a card, it’s easy to track them. You can simply log into your account to review your transactions or look at your statement to see where your money went. But it’s a different story with cash. It’s easy for $5 here or $10 there to go missing, especially if you don’t collect receipts for every transaction. You might find yourself wondering how you spent all the money in a particular envelope at the end of the month.
With the zero-sum budget method, every penny you earn has a purpose. This method asks you to spend down your monthly income until you reach zero. So if you take home $3,500 per month, you should have $0 left by the end of the month.
But aside from giving every dollar you earn a specific role, the zero-sum method differs from other methods in a few ways. For one, the method expects you to be one month ahead. Rather than living paycheck to paycheck, you live on last month’s income when you use zero-sum budgeting. This can work particularly well for people who have irregular incomes, such as freelancers or small business owners.
With the zero-sum method, you decide ahead of time what every cent you earn is going to do. If you earn $3,500 each month and your monthly expenses total $3,000, figure out what to do with the extra $500. You can put it toward savings or debt repayment, or you might decide to use it for a larger purchase.
A key feature of zero-sum budgeting is that you plan your spending based on money that’s in the bank. It can take a while to adopt this budgeting method since you might need to save up enough to stop living paycheck-to-paycheck. You also need time to track your expenses and make decisions about altering your spending.
One feature that zero-sum budgeting has in common with the envelope method is that you assign categories to your spending and choose amounts for each category. How many categories you have in your budget is up to you, and you base it on your needs. But unlike the envelope method, the zero-sum method doesn’t expect you to make all your purchases in cash.
Stop living paycheck to paycheck. Since you’re spending last month’s earnings with the zero-sum budget method, you can break the cycle of living paycheck to paycheck. It’s also easier to build up a small financial cushion because you’re one month ahead on all your paycheck spending.
It keeps you from overspending. Like the envelope system, the zero-sum method can help you if you find yourself always spending too much. If you set limits for each category, you can train yourself to stop spending once you reach the limit. Depending on your lifestyle and goals, you might find that combining the zero-sum method and the envelope method provides you with a budget that helps you reign in your spending.
It puts you on track financially. As you prepare to use the zero-sum method, track your income and expenses for several months. Doing so lets you see where your money goes and can help you adjust to better reach your goals. The idea of assigning every dollar or cent a job can also help you get and stay on track financially. If you have money left over at the end of each month, you can add it to your savings, put it into a retirement account, or use it to pay off debt.
You need a month's worth of savings to get started. Spending last month’s money this month can be a big issue for many people, especially those who live paycheck to paycheck. One possibility is to use money in your emergency fund to get you started on your first month. The income you earn from your paychecks during the first month will go toward the next month’s budget and replenishing your emergency fund. If the idea of dipping into your savings makes you nervous, another possibility is to focus on saving up an additional month of income before you jump into using this method.
You might miss some expenses. This is true especially if you have irregular expenses such as insurance that’s due quarterly or vet bills every so often. One way to account for those irregular expenses is to divide them up and treat them as monthly expenses. A $200 insurance payment due quarterly can become a $50 monthly payment. Set the $50 aside each month until the bill is due.
The budgeting method that works best for you depends on your goals, your lifestyle, and your income. You might want to experiment with a few different methods, weighing the pros and cons of each one before you settle on a budgeting method you like best.
At PSECU, we want to help you get the most out of your money. For more tips on money management, visit our blog.