You've tried to budget before.
It didn’t work.
You still have no control of your money. You feel frustrated and overwhelmed every time you try to get the finances in order.
I've been there too. Our family has been there too.
Most people who are serious about their money have been there. The vast majority of us aren't born with money skills. We don't learn much about it in school either.
We have to figure it out on our own.
Or with the help of other people who already figured it out.
It's not confusing enough to use a budget, but today I'm here to tell you about different kinds of budget systems. Only to confuse you more.
If you want to read this article later, you can download it in PDF and read it whenever you wish: Download it here.
Not joking about the different kinds of budgets, that's real. I'm doing it to show that there are options. The reason you have failed a budget before could be because the system wasn't good for you.
I will go through four, or five... alright, four and a half different budget systems today. There are more kinds of systems out there, but these are the big ones that I know of. If I missed any, please educate me.
The explanation of each system can be a bit long. For your convenience, I have a section about who it could work for and a conclusion at the end. So if you're short on time, skip to the end and see if it could be a fit for you.
This is the kind of budget most of us think about when we hear the word budget. It also has a much fancier name, which is line-item budget.
In this budget, the idea is to first split your budget into income and expenses. Under each of these main categories, you will fill up with subcategories.
For most people income would be the salary you bring in each month. But you could also have income from, for instance, rent If you’re renting out a room in your house or something. As an example, the income category might have the following items:
Even if categories like things you sell might not occur monthly you should list it. This way you account for all the money and avoid having "free money" in the budget.
Under the expenses category, you will list all the things that cost you money during any given month. Subcategories here are things that cost the same each month, as well as costs that vary. The easy categories to budget are the ones that are the same, like rent and subscriptions to services.
The costs that can vary or be different each month can be groceries and transportation. Your job is to get a value that covers the expenses without being too excessive. If you don't know how much you use for groceries in a month, check your history. Take three months (or more) and sum up how much you used each month. Add the totals up and divide by the number of months.
This average value should give you an idea of how much you need in the category. Do the same for all categories that vary like this.
In the expense category you could have subcategories like:
Within each of these subcategories, you will list the different types of expense. For instance:
Fuel under Transportation
Mortgage or Rent under House and Home
Cable or Netflix under Fun and Leisure
You get the idea. How you categorize is up to your preference.
Almost anyone. It's not a very complex budget to set up and you can get started as soon as you get the values in your income and expenses.
A word of warning, this budget will take time in the beginning. But once you get used to it, you will have a budget that gives you great control of your money. This budget works well for most people, even if you never used a budget before.
When I studied business economy we created budgets of this kind. The line-item budget in personal finances reminds of the ones used in business. Most often business budgets need a lot more tracking than personal budgets. If you use this kind of budget you will be doing a lot of categorizing and tracking of your money.
I like to compare the budgeted money in the categories of the line-item budget to the envelope system. I could be wrong in this comparison. But it works in my brain.
An envelope budget is exactly what it sounds like. You use actual envelopes to control the money. When you get your income, you withdraw it from the bank and put it into envelopes. Each of the envelopes is for different categories of expenses. You put as much money as you can spend for each month in the different categories.
The idea of this system is simplicity and visibility. It might be the budgeting system that takes the least amount of math and calculations. That is after you've figured out how much you need in each envelope.
As you most likely figured out, the point of this system is that you can only spend what's in each envelope. In each category that is.
When it comes to categorizing the money, it's easier than the line-item budget. You only need the main categories, without each of the expense lines here. For instance, you only have one envelope for transportation. If you use the money in there for fuel or the fare for a bus, doesn't matter. It still comes from that same envelope.
No. You can't borrow money from another envelope if one runs out. That's cheating the system and no one likes a cheat. Don't do it. You're only cheating yourself in the end.
Joking aside. If you have no money left in the food envelope, but lots in the transportation one, use it. This will be more common when you start out. Make sure you adjust the envelopes for the coming month though if you set it up wrong.
This system is easy to handle for most people. It's great for people who have issues with the abstract thinking of numbers in a bank account. If you can relate better to the money you have in your hand than in your bank statement, this might be for you.
The idea is that all the expenses go in physical envelopes. But in the digital world today, that might not make sense. If you pay for things online you might want to leave some money in your bank account. Keep in mind why you do, though. It's not money you can use as you wish, they are there for a reason.
To consider is that it might be risky to keep all your money in cash also. Do it in a smart and safe way. Don't bring all the envelopes out when you go shopping. Take what you need and leave the rest at home.
The proportional budget doesn’t use fixed amounts of money in categories. This makes it quite different from the systems mentioned earlier.
This sounds simpler than the other budgets, doesn't it? It can be. Let's see how this works then. In short, you divide your income into three different categories. Oh, ok, so there are categories here too. But not in the same way.
The categories in a proportional budget are, for instance, Needs, Wants, and Savings. These are sometimes called other things too, but we'll use these names here.
Needs are what it sounds like. Things you need to survive, in a basic way to think about it. To determine what a need actually is, let's turn to Maslow's hierarchy of needs. For the sake of argument, we’ll look at the basic needs - food, water, warmth, rest, security, and safety.
To sum this up we have somewhere to live, a shelter. That would cover Maslow’s rest, warmth, security, and safety. Then we have food and water. Ok, so your home with is under need.
Keep in mind that internet connection, Netflix, a phone with a contract for that, aren’t needs. Those are wants.
Savings doesn't need an explanation. It’s what you save.
One way to divide the money with this system that is quite usual is 50/30/20. Let me explain. The numbers are a percentage for each category in order. That would mean, Needs: 50%, Wants: 30%, Savings: 20%.
Looking at it like this, it seems easier. 50% of your income cover the things you need. 30% cover the things you want, and you save 20% of your income each month.
Adjust the values to what fits your life best. You might have low Needs, high Wants, and want to add more to Savings. Then the numbers could be 33/33/34. Or you have low Needs and Wants compared to what you want to save. This could be if you have a high income compared to expenses. In that case, it could look like 20/20/60.
You get the idea. The numbers aren't set in stone. You change them as you need.
This system is for people who doesn’t want to categorize a lot. It’s for people who want a more free system. It’s for people who want a system that is easy to adapt to changes in life or changes in lifestyle.
Proportional budgets are flexible. You can change then how you see fit. Changing them means changing the percentages. You don't have to change a spreadsheet for the coming months. It’s easy and fast.
The thing you need to figure out before you decide on using a proportional budget is what is a Need and what is Want. As I write above, Go very basic. Check out Maslow’s hierarchy of needs a bit more to get a better understanding.
The idea of a zero-sum budget is that you assign all your money to a task. Let’s look at what that means.
Say you have an income of $3000 each month and you have fixed expenses of $1500. On top of that, you have groceries, medical, and electricity that add another $750. That leaves you another $750 that doesn’t go anywhere if you haven’t planned for them to do so.
All budgets are about planning. But with a zero-sum budget, the plan behind gets more obvious. That's also the idea. In the above example, you only cover the expenses you need to. Let's add another layer to this financial cake.
Most people in personal finance argue that you should have an emergency fund. A stash of liquid money that you can access in case of emergency. Out of the $750 you have floating around, you decide that $250 of those goes to an emergency fund every month.
First, you build up an emergency fund of at least 6 months expenses. After that, the money can go to retirement saving instead.
You might have a life before you took a stand for your finances by creating a budget. In this previous life, you had a credit card and you used it to spend. It landed you a credit card debt of $10 000. The smallest payment you need to make is $350 per month.
You want to get rid of the debt as soon as possible. You decide that the remaining $500 goes to paying off the credit card debt until that's done.
There, all the income assigned to a task. To spice things up, a lot of people who use a zero-sum budget also lives off the previous month’s income. This takes a little while to set up, but it's great once you get it working.
This gives you an extra buffer to your finances, on top of your emergency fund.
In my experience, a zero-sum budget can combine well with a line-item budget. This is the way we budget in our family. The money which is not used for expense goes into savings.
Anyone. In particular, people who are comfortable with line-item budgets and wants more.
You can make your zero-sum budget complicated if you wish. Especially if you are going to use it together with living of last month's income. Zero-sum budgets need you to track the money you spend, so you know how much you have left. You also need to know your income and make a plan in advance.
It's not much more complicated than the line-item budget. Apart from the fact that you need to remember to assign all the money you make.
This might not qualify as a budgeting method in itself. Even so, it's often referred to as a budget system. I include it to explain it and avoid confusion. I've also seen people confuse the proportional budget with this.
The name tells a lot. When you get your salary or other income, you set aside a specific amount into a savings account. The idea is that you can't touch the money you set aside. Ever! Or at least not for day to day expenses. It's savings.
Anyone who wants to pay themselves first. This is a good strategy if you have problems saving money in other ways.
As stated, this is not a budget. It's more of a general rule in personal finances, though. Pay yourself first is a way to build wealth.
We can for the sake of argument say that this is a budgeting method. Combine it with a line-item budget to get a complete budget, though. To make this work you set the line-item budget up without the money you set aside. This way you only get to work with the money you have after savings.
If you have tried using a budget before, my guess is that it was a line-item budget, right?
You hated it. Right again?
It's not for everyone.
To use a budget is all about having a system in place where you can follow your money. A system that you have a plan with. Goals. If you do, the system you use becomes less important.
You need a system you feel comfortable with. One that works for you.
That’s what we did in our family. Found something that worked for us.
We started with a simple line-item budget many years ago. Today we're using a zero-sum system that lives inside a line-item system. We also pay ourselves first - and last.
Use the budget systems to get you started. Find your own way as you go. But take control of your money.
No one else will do that for you.
If none of the systems above appeal to you, use a budgeting or tracking application on your phone. But do something to get on top of your money.
You owe it to your future self.
What system do you think would work best for you? Have you tried any of the systems and can share your experience?
Leave us a comment below and let us know!