Once you have identified your average monthly income and categorized your expenses into discretionary or non-discretionary expenses, it’s time to start coming up with guidelines or strategies for your budget. We’re going to look at several different strategies that can be used to better manage your budget more efficiently and meet your financial goals.
50/30/20 Rule
The 50/30/20 rule is a basic strategy that says 50% of your budget should be allocated towards essentials or non-discretionary expenses such as your housing, food, utilities, etc. 30% of your budget should be allocated towards wants or discretionary expenses like entertainment, vacations, dining out, etc.. 20% of your budget should be allocated towards savings such as for emergency funds, investments, retirement, or even paying extra on debt.
Looking within this strategy, in the 50% essentials category, housing probably makes up the biggest chunk of these expenses. I think it’s important to make sure you are not using too much of your income to go towards housing because it could put unnecessary stress on you financially in the future when unexpected costs do arise. A good percentage to keep your housing costs under would be 30% of your net income. This includes the mortgage/rent payment, the utilities, the insurance, and the taxes. If you can keep your housing under this amount then you should have a good start to maintaining a healthy budget. You still have 20% of the 50% to go towards things like groceries, vehicles costs, other insurance, clothes, etc.
One thing about the 50/30/20 budget I’m not exactly keen on is the 30% allocated towards wants or discretionary spending. While it is good to be able to spend money on things you like, 30% seems a bit over the top in my opinion. It could also serve as a buffer in case your non-discretionary expenses run a little over, you could always cut back on your wants to make sure you maintain your overall budget.
The 20% savings portion of this guideline is a really good number to focus on. You should make sure you have an emergency fund first and foremost. Each month you should be saving up to 20% of your budget until you get to an emergency fund that makes up 3-6 months of non-discretionary expenses for a 2 income household and 6-12 months for a 1 income household. You should have this set up on automatic draft each month going into a high yield savings account or money market fund that is liquid and still earns some interest for you while it is setting in the account. Once you have your emergency fund established, then you can start focusing on using that 20% in savings each month to go towards your retirement plan and/or paydown high interest debt or debt you want paid down sooner. Ideally, you should be saving up to 20% for retirement if possible. If I could make one minor tweak in the 50/30/20 rule, it would be that it should be 50/25/25. 20% is a great target for saving for retirement, but 25% can really put you in great shape for your retirement goals in the long run. If you can make it work, this would be optimal for your future self.
Envelope Budget
The envelope strategy is fairly simple and it focuses more on using cash. You categorize your monthly expenses that are variable or don’t have a fixed amount each month and you allocate a dollar amount towards those expenses. Once you know how much each month you can spend on each category, you actually will take envelopes labeled for each of those expenses and put actual cash in them. When the expenses arise, you have to physically take the cash out of those envelopes and pay for them. This is a great strategy for those that have trouble with debit or credit cards. You can choose to keep paying your fixed non-discretionary expenses via credit card, automatic bank draft, or online. You can also choose to make those payments in cash if you wish. The key to this method is usings the envelopes for variable expenses like groceries, utilities, fuel, dining out, or entertainment. Its more effective on these types of expenses because these expenses can change each month. The envelope method keeps you from over spending on each of the different categories in your budget that you have an envelope to use.
Zero Budget
This strategy focuses on making sure your budget at the end of the month is at zero. That sounds odd to have a zero at the end of the month, because it makes it sound like you have no money left. What this strategy is really trying to accomplish is to make sure all of your income is accounted for each month. You should have zero money left because any surplus you may have should go towards your emergency fund, retirement savings, paying down debt, or something else of your choosing.
Essentially this is what the 50/30/20 guideline should accomplish, however this strategy has more flexibility in what you allocate your money towards. For those that are fairly disciplined, this works well for them. You can choose to pay extra each month on a debt until its paid off or you can choose to invest extra maybe during a market downturn so you can take advantage of the lower prices. Maybe you want to go on a trip one month and you can use all of your extra money to pay for the trip.
These are some of the most popular strategies that are used for budgeting. It’s good to keep in mind that each of these strategies may not work perfectly for everyone. You may have to try a few different strategies to see which ones work best for your situation. It may be that you might like to use a combination of these strategies or maybe you try these and come up with your own budgeting strategy. What’s important is that you find a way to help you manage your monthly budget to accomplish your goals financially. Hopefully, these strategies can help you get started on the right path to put your future self and family in a better position.