If you want to save money and pay down debt, you have to set a budget. No matter how little or how much you earn, a budget is necessary to meeting your financial goals.
There are a number of budgeting methods to try. Some require more work and organization. Others are more flexible. Some budget methods may emphasize saving money, while others are geared to those who need to look for areas to cut back.
Here are six of the most common budgeting methods (and how to determine which is the best fit for you).
1. The Line-Item Budget
This is the most common (and basic) budgeting method. It requires you to list out all of your expenses, both necessary and discretionary. This includes your:
The idea is to break everything out to see exactly where each dollar is going.
For some expenditures, you may need to estimate how much you will spend and adjust month to month. You can also start a line-item budget by reviewing how you spend money over previous months.
This method is best for those who need to get spending issues under control. It’s also viable option for people who like to plan and don’t mind categorizing each expense.
And what if you overestimate the monthly cost of a item for month? Simply reallocate that extra money to savings or debt repayment.
2. The 50/30/20 Budget
Also known as the Balanced Money Formula, this system divides your income into:
- Savings and debt.
You then allocate 50 percent of your income to necessities, 30 percent to wants and 20 percent to savings and debt.
This is an ideal method for people who are just getting started. It’s also great for those who want a simple budgeting process. The 50/30/30 method can help you:
- Pay down debt.
- Cover current costs.
- Save for future expenses.
However, this route may not be so cut-and-dry for doctors. Oftentimes their debt exceeds 20 percent given their combination of student loans and credit card debt. That means none of that 20 percent will go toward saving for future needs. In order to to make it work, you may need to spend less on either necessities or wants.
3. The 60% Solution
This is similar to the 50/30/20 method. It requires you to spend just 60 percent of your income on all necessities and household expenses. Unlike the 50/30/20 method, your debt payments are not its own separate category. You pay those obligations from your 60 percent of income.
The remaining 40 percent is allocated equally to:
- Retirement savings. This includes contributions to your 401(k), IRA, and other retirement vehicles.
- Long-term savings. This is an account for emergency needs and other long-term investments.
- Short-term savings. This is money you should be able to easily access. It can be used for vacations, irregular expenses and large purchases that don’t fit in your 60 percent budget.
- Fun money. Give yourself 10 percent of your income for fun and entertainment.
This method works for people who have the means and the willingness to save a greater portion of their income.
4. The Envelope System
This is an old-school, cash-based plan. It works by setting monthly spending limits on each spending category, such as:
Then, fill envelopes with enough cash to cover each expense. Once an envelope is empty, you cannot spend any more money on that particular category for the month.
Although brutally simple, this method is great for people who need to reign in their spending habits. It’s especially ideal for people who overspend on plastic. It forces you to use only the cash you have.
5. The Zero-Based Budget
This budget method requires some foresight. You need to project your income at the beginning of the month. Then make a plan for how you will spend every dollar. The goal is to have no money left to budget at the end of the month.
While that doesn’t sound like budgeting, part of the process is allocating dollars to your savings account to reach your goals.
This is an effective way to know exactly how you spend your money each month. Over time, you can find areas to cut back if needed.
You can use this method with the envelope system. If you choose not to, you will need to log each expense to make sure you’re on budget.
This style works well for meticulous planners who don’t mind spending extra time to manage their money.
6. The "Pay Yourself First" Budget
This style of budgeting starts by setting aside all of you savings at the beginning of the month. You can allocate money to different accounts based on your savings goals, such as:
- Emergency funds.
- Your children’s education.
- Your next car or vacation.
You can also allocate money upfront toward debt repayment.
Once you’ve designated your savings, you are free to spend the rest of earnings as you please. But whatever you do, do not dip into the money you are saving.
This method is ideal for those who want to prioritize their savings without spending time on traditional methods.
There is no "one-size-fits-all" approach to budgeting. Most people will need to try one more than one strategies to find the one that fits your needs and lifestyle. Some common, effective strategies include:
- The Line-Item Budget.
- The 50/30/20 Budget.
- The 60% Solution.
- The Envelope System.
- The Zero-Based Budget.
- The "Pay Yourself First" Budget
Regardless of which budgeting system you choose, the underlying goal is the same. To establish a plan for how you spend money today, so you can meet your financial goals tomorrow.