I am a huge proponent of the 50/30/20 approach to budgeting (see below). This is a great place to start the budgeting process if this is your first attempt at budgeting and have no other baseline to follow. The budgeting style I am covering in this post are for those had started tracking their spending and have identified their spending targets for essential and/or non-essential categories.
I’ve encouraged you all to use April as a budget detox month and stressed the importance of tracking spending as a starting point to building a budget. With the month quickly coming to an end, I wanted to share how you can plug the figures you collected from tracking into a brand new budget.
Being the math nerd that I am, the beauty in budgeting is that there are multiple ways to approach this equation. At it’s core, your budget is an algebra problem with constants and variables lending itself to solve for an unknown variable. In most households, the income component of a budget is fixed as is the essential/fixed spending which leaves non-essential expenses and savings as potential variables to solve/budget for.
Income = Essential Spending + Non-Essential Spending + Savings
For the purposes of this post, I am going to walk you through the various ways to approach your budget to solve for a variable using the data collected from your month of budget detoxing. In addition to walking you through the budget equation, I’ll also point out which approach to building a budget makes the most sense given stage of life and point to which approach is my favorite.
The Leftover Method – Solving for Savings
This first approach to budgeting, what I call the leftover method, is the most common approach to budgeting. In this approach, people will start by plugging in their fixed spending and discretionary spending and solve for what’s leftover that can be earmarked as savings. While yes, this is a type of budgeting, I find it flawed as it emphasizes spending rather than savings. The savings aspect of the budget becomes the after thought rather than the focus of the exercise.
$5,000 = $2,500 + $1,750 + Savings
Savings = $750/mo.
This approach might sound familiar to you. I find that majority of clients I meet with for the first time come in with this approach to budgeting because there is no financial plan to inform their savings goal. While its not a bad budget, if you can stick to each area of spending, it’s not an optimized budget because spending dictates savings.
The Pay Yourself First Method – Solving for Non-Essential Spending
The second approach to budgeting is approaching the equation with a set savings goal and solving for non-essential spending. I like to call this the “pay yourself first approach” because the focus is on savings with the remaining dollars going towards non-discretionary spending. For this approach to really compliment your financial goals, the first place to start is by creating a financial plan to encompass all your financial goals. The exercise of creating a financial plan will point to how much you should be saving, and where, to meet all your financial goals.
This intentional approach to budgeting is my favorite and how I personally create my budgets and how I work with clients on budgeting. With this approach, the non-essential spending becomes the “need to balance” amount setting limits around how much money can be spent on categories like travel, dining out and entertainment.
$5,000 = $2,500 + non-essentials + $1,000
Non-Essential = $1,500
While this approach might sound restrictive, its quite the opposite and becomes a really freeing exercise. When taking this approach to budgeting, you might find that the savings required to meet your financial goals aren’t as overwhelming as initially thought. In this scenario, you can walk away having more dollars to put towards non-essential spending than originally thought and the freedom to know that you can spend at that level and not feel guilty or fearful of not having enough funds for a future retirement.
The Rightsizing Method – Solving for Essential Spending
I know I originally said that essential spending is a constant, and many cases it is, but consider for a moment a time in your life when fixed expenses were up in the air. Think specifically, moving into a new apartment, getting a new roommate or buying a new home. It’s in these moment’s that the fixed expenses component of your budget goes from being a known to variable to solve for within the context of your household budget. This is an exercise that my husband and I recently completed before making an offer on our new home.
With this budgeting approach, it is crucial to have a strong understanding of how much money you need to save to meet your future financial goals, like sending children to college or retirement, and have a strong sense of your non-essential spending and your ability to control those expenses.
$5,000 = Essential Spending + $1,250 +$1,000
Essential Spending = $2,750
Working off the example above, if you were to commit to $2,750 in essential-expenses each month but have a month in which this area of spending is actually higher fall higher, it would be at the sacrifice of your ability to save. If this continues to occur, you could potentially erode all your savings ability which is not a good financial place to find yourself. All this to say, be responsible when committing to a new set of essential expenses as they will create a domino effect on your other areas of spending if you are unable to budget effectively.
With April almost in our rear-view window, you should have a strong sense on at least one area of your budget and can use these Excel templates to solve for the other areas of your budget. If the savings component of your budget is still fuzzy, consider sitting down with a financial planner or advisor to walk through your financial goals to create a financial plan. Any questions, feel free to reach out!