Budgets are like diets. You don’t want to go on a diet and you’re certainly not going enjoy it. But, well, you’ve eaten more than you should for a while now and it’s time to get it back under control.
Like diets, you need to find a way of budgeting that suits you. If you don’t, you won’t stick to it.
Budgeting requires making some financial decisions about what you spend your hard-earned money on. You consider your priorities and put some boundaries in place on your spending.
Budgeting teaches you to control your money – and not let it control you!
And everyone needs to budget. Have you got debt to pay? You need to budget. Saving for a new car? You need to budget. Want to retire at 50? Yep. Even lottery winners need to budget, otherwise it all gets spent…
By sticking to a budget and controlling your spending now, you are opening yourself up to a future of wealth and the freedom to do all the things you’ve always wanted to do.
“The budget really is the backbone of financial success.”
There are several ways to budget
Just like dieting, there isn’t a one route fits all when it comes to budgeting. What works for me might not work for you. It depends largely on you and how you like to manage your money. If you need tight boundaries and to count every penny you spend, that’s ok. Do that. If budgeting bores you and you need more flexibility, go for it.
The important thing is that there is some sort of plan in place to manage your money and you stick to it.
Here are some of most popular options for you try on, to see what fits.
The Cash Envelope way
The Cash Envelope way involves you taking all the cash out of your bank account each month or week – once all your fixed expenses have been paid – and dividing it into different expenses pots, or buckets. Usually there is one envelope per expense, with the expense name written on the front along with the allocated amount.
You can only spend what is in each envelope and only for that specific expense.
If you have money left over at the end of the week or month in any of the envelopes, you can put it into your savings account, overpay on a debt or treat yourself.
Expenses categories can include groceries, clothes shopping, entertainment, fuel for the car etc. Whatever expenses you usually spend your money on.
Cash envelopes are great if you are someone who needs to see your money and likes to use cash. We actually spend around 15% less on items when we pay for them with cash, which is down to the psychology of us physically handing something over, in exchange for something else.
The Cash Envelope way is a strict budgeting approach and whilst some people love this method, for me it doesn’t work. Life gets in the way and no month is the same. I can’t tell you on the 1st of the month if I’m going to meet friends in a restaurant for dinner or if I’ll cook for everyone at mine, in 3 weeks’ time. Which would mean moving money from my grocery envelope to my eating out envelope. It’s too restrictive!
50/30/20 percentage budgeting
This approach uses percentages to allocate your spending. The 50/20/30 rule was popularised by US Senator Elizabeth Warren in her book All Your Worth: The Ultimate Lifetime Money Plan.
The rule is to take your after-tax income and allocate 50% of it towards your needs. The other half is split between 20% savings and debt repayments and 30% for ‘wants’ or everything else.
Here’s how it’s done:
50% on needs – These are the things you absolutely must pay for each month, such as your mortgage or rent, utility bills, insurance, car payments, groceries and any minimum payments on debts. The non-negotiables, the fixed bills that keep a roof over your head, get you to work and food on the table.
30% on wants – This is any spending that isn’t classed as a need. This is the Sky bill, the gym membership, dinners out, new shoes etc. Everything in here is optional and it’s up to you how and where you spend it. Cut the Sky bill to enjoy eating out once a week? It’s up to you – as long as it all fits inside the 30%.
20% on savings – Savings and investments get 20% of your net income. This could be payments into your pension, an ISA, an emergency fund or other cash savings. Debt payments that are above the minimum payments are included here too – for example, if you want to pay off a credit card balance above the minimum payment (the min payment is a need) or to overpay your mortgage.
This way of budgeting gives you 3 main buckets and all spending fits inside one of them. It’s simpler and much less restrictive than the Cash Envelope Method.
If you want to keep things simple, or hate living in a spreadsheet, reverse budgeting might be for you. It focuses on prioritising either savings or paying down debt, by paying yourself first.
Normal budgeting involves you working out your individual expenses, taking them away from your net income and anything that is left over, is popped into savings.
The biggest problem with that, is that we often over-spend. It’s really easy to do. Even with a budget sheet that is tracked daily, life happens, and unexpected expenses crop up.
Have you ever planned to save 10% or 20% of your income, but the end of the month comes around and you have nothing left? Yep.
So reverse budgeting removes that savings obstacle.
“With reverse budgeting you focus on saving, so you can’t spend what you don’t have.”
Here’s how to go about it:
- Work out what you’re saving for
These are your savings goals, so sit down and really think about what you’re aiming for. Increasing your pension contributions? Building an emergency fund? Clearing a student loan? All of the above?
Next, work out your desired time frame for getting there. 3, 4 or 5 years is a good place to start. Whilst 3-5 years is short-term – and I would encourage you to think mid to long-term as well – it’s hard to envisage this far into the future and life has a habit of changing. It’s more important to make reverse budgeting a habit and hitting short-term goals will inspire you to continue long-term.
Add up your savings goals and divide by 36, 48 or 60 (the months in you goal time-frame) to get a monthly figure. This is what you’ll need to save each month to hit your goals.
2. Assess your current cash flow
Whether you use the 50/30/20 rule or another method, you know what your current incoming and outgoings are. How does your monthly savings figure, above, sit with your current cash flow? Do you have enough to save what you need to save, to hit your goals?
It might be that you can’t, in which case you can look at cutting your expenses, earning more money or start saving a smaller amount and escalating it over time.
This is super important! Open a savings account, or several savings accounts – one per goal – AWAY from your main bank account. Choose one with the highest interest rate you can find. Then set up one or multiple payments from your main account into these accounts, for the day you get paid.
That’s it! The rest of the money in your account is free to spend as you wish. You are now saving towards your goals without the option to dip into and spend your savings pot.
Reverse budgeting is a great option if you want a more hands-off budgeting approach. It’s even simpler than the 50/30/20 approach.
So, there we are. Only you will know which of the above methods will work for you – the same diet doesn’t suit everyone.
As long as you are eating less than you burn, that is, spending less than you earn, you’re on your way to financial success.