Not All Budgeting Is Equal

Various budgeting methods exist, each tailored to different financial goals, income levels, and personal preferences. I’ve gone through all the various approaches, and categorized them into three major approaches:

·  Ratio-Based Budgeting,

·  Goal-Oriented and Personalized Budgeting, and

·  Flexible and Adaptive Budgeting.

These categories simplify the understanding of different budgeting strategies, allowing individuals to identify which approach best aligns with their financial situation and objectives.

How Do I know Which Approach To Use?

When deciding which of the three top-level budgeting approaches is right for you, consider asking yourself the following questions:

1. How Do I Prefer to Allocate My Income?: If you like the idea of having a structured, percentage-based allocation for your income that categorizes expenses into clear segments (like needs, wants, and savings), then Ratio-Based Budgeting might be suitable for you. This approach is ideal if you seek a straightforward, organized method to distribute your income across various financial needs.

2. What Are My Primary Financial Goals or Values?: If your budgeting is driven by specific financial goals (like aggressively saving for retirement, paying off debt, or funding a large purchase) or if you want your spending to align closely with your personal values, then Goal-Oriented and Personalized Budgeting could be the best fit. This approach allows for more personalization and flexibility to focus on what matters most to you financially.

3. How Predictable is My Income and How Flexible Do I Need My Budget to Be?: If your income varies from month to month, such as in the case of freelance work, or if you prefer a budgeting system that can adapt to changing financial situations and doesn't require strict adherence to set categories, then Flexible and Adaptive Budgeting might be the most appropriate. This approach is beneficial for those who need a budget that can easily adjust to fluctuations in income and expenses.

Once you’ve answered these three questions, you can explore the many ways to apply one of these three major approaches:

1. Ratio-Based Budgeting: This approach involves dividing income into specific percentages for different categories. Below, the first number represents what you will save, the second your needs, and the third your wants. Examples include:

-  10% savings, 90% needs/wants (10-90 Rule): This rule is really for those of you who are saving *nothing*! Here, if you are doing nothing then you have to start somewhere, and saving just 10% of your earnings per paycheck is better than nothing.

-  20% savings, 80% needs/wants (80/20 Budget): This simple framework advocates saving 20% of your income off the top, leaving 80% for everything else, without needing to categorize expenses further.

-  20% savings, 50% needs, 30% wants (50-30-20 Rule): This rule simplifies budgeting by splitting income into three categories: needs, wants, and savings. It's designed for balanced financial management, ensuring essential living costs and financial goals are met while still allowing for enjoyment. Your needs are things like your utility bills, your wants are things like a major purchase you are saving for, and your savings are well, your savings 😊

-  30% savings, 20% needs, 50% wants (30/20/50 Rule): If you are in debt and have lower monthly expenses, then you need to prioritize debt repayment. With 50% of income, you will pay down debt, then use 20% for needs and 30% for savings. This approach focuses on debt reduction.

-  40% savings, 30% needs, 30% wants (Balanced Money Formula - 40/30/30): Offers a more equal distribution, with 40% of income allocated to savings, 30% to needs, and 30% to wants. This is good if you know what you want and need, you want to save, but you are indecisive.

-  50% Savings / 50% everything else (50/50 rule): This is like saying to yourself “I’m going to live off of one paycheck a month instead of two.” Think of it like this: If you can live off of one paycheck, then every other paycheck you save is like you’ve paid yourself an entire month in the future. This approach is great for those of you who hate to be super meticulous with your numbers, but know that you can survive off of one paycheck.

-  60% savings / 40% everything else: You get the idea 😉

-  70% savings/debt, 20% needs, 10% wants (70/20/10 Rule): For aggressive savers or those focusing on rapid debt repayment, this plan suggests allocating 70% of income towards these goals, with minimal discretionary spending. You have to be a frugal person in order to do this and it takes lots of mental prep and discipline.

-  90% savings, 10% needs/wants (90/10 Rule): An extremely aggressive saving approach where 90% of income is directed towards savings and investments, leaving only 10% for all living expenses. Now this may seem extreme, but if you are consistently investing your savings into income generating assets (like business or a DRIP program), then it may be difficult at first, but you will eventually have replaced your income from your job and have lots of latitude to make life decisions (leave your job, start a business, vacation, study, etc.).

2. Goal-Oriented and Personalized Budgeting: These methods focus on personal financial goals or values, allowing more flexibility and customization. They include:

-  Reverse Budgeting: Known as "pay yourself first," this method prioritizes savings by setting aside a fixed portion of income for financial goals (like emergency funds, retirement, or specific purchases) before other expenses. After allocating for savings, the remainder covers fixed and variable costs like housing, utilities, and personal spending. This approach ensures key financial goals are met first, promoting disciplined spending and long-term financial health. It requires understanding one's income and expenses to balance savings and spending effectively and offers flexibility to adjust savings based on changing financial situations.

-  Priority-Based Budget: This method aligns spending with personal values and priorities, starting with a thorough assessment of expenses. You categorize costs based on their importance, ensuring that essential and meaningful expenses, such as housing, savings, or personal growth, are addressed first. This is ideal for those seeking to align their financial habits closely with their personal priorities and requires a good understanding of one's financial situation.

3. Flexible and Adaptive Budgeting: These budgeting styles adapt to changing financial circumstances or provide more flexibility in managing finances. They include:

-  Zero-Based Budgeting: This approach assigns every dollar of income to expenses, savings, or investments, aiming for no unassigned money by month's end. Every check you get, you should know exactly where your money is going and not have “play money” left over. This is ideal for building discipline because it enhances your accountability and helps you identify and cut unnecessary expenses.

-  Variable Percentage Budget: Suited for individuals with fluctuating income, like freelancers and contractors, this method adjusts monthly. You allocate income percentages to various categories, which vary based on monthly earnings and expenses. To manage inconsistent income you have to allowing adjustments in spending and saving in line with income changes. What this means is that if you generally want to save 20% monthly, but some months you only make enough to save 10%, then you save 10%, then increase your savings in months where you make more. Start with savings goals, then keep a running tab on all others.

-  Envelope System with Ratios: A practical, cash-based budgeting technique, this system involves dividing cash into envelopes for different spending categories based on set ratios. Once an envelope is empty, no further spending is allowed in that category until the next budget period. Effective for curbing overspending, it's especially useful for those who struggle with credit or debit card spending. This is great for people that use lots of cash or are trapped in 1994.

-  Income Slicing: This method involves dedicating each paycheck to specific expenses, such as one paycheck for rent and utilities and another for groceries and savings. Beneficial for those with multiple paychecks, it provides a straightforward way to distribute income across various expenses and financial goals, ensuring efficient use of each paycheck.

Conclusion

Each approach above has its merits. Based on your individual goals, income stability, and personal preference for flexibility, you should choose a budgeting method. Although this was a lot of information, I’m sure you can find something that works for you in the many different approaches above. Some of you will stick to one approach, others will mix and match for a hybrid approach. Effective budgeting is key to managing our assets and liabilities, guiding us in both measuring and improving our financial health.

Wa Salam,
Joe