Would you ever leave for a big road trip to a new destination without a paper map or your route charted on an app? Unlikely! You need to know some key details about your trip to make sure you can get to where you want to be. Being prepared can help you make informed decisions about your route.
So, why would you spend your money without a budget? The same logic applies to your finances — without knowing exactly where you are financially or where you want to be financially, you won’t get very far.
Setting a budget is one of the most strategic financial planning tips shared by financial advisors today. This spending plan is the roadmap to savings, helping you plot your financial journey towards success.
The contents of your budget are unique to your specific situation, expenses, and income. That said, you can follow popular budgetary methods to make the most effective plan for your finances. Check out this quick guide to three popular budgets.
1. The 50/30/20 Method
Perhaps the most well-known budget is the 50/30/20 Method. It breaks down your spending into three main categories, assigning each one a percentage of your take-home pay. (That’s your income minus taxes and other deductibles). This breakdown helps you set realistic limits to your spending, so you can focus on what really counts.
Let’s look at those categories below:
- Needs: The essentials take the lion’s share of your paycheck at 50%. This represents all your necessary spending, including housing costs, online loans and lines of credit debt, groceries, and insurance payments.
- Wants: Every budget should include some fun spending to liven up your day-to-day. According to this budgeting method, you should set aside 30% of your income for vacations, gadgets, entertainment, etc.
- Savings: The remaining 20% of your income should be squirreled away in emergency and retirement funds.
2. The Zero-Based Budget
Financial guru Dave Ramsey and his empire popularized the zero-based method as one of the best ways to pay down debt. This strategy aims to use up every dollar of your paycheck so that you have zero leftovers.
Now, this may sound like a careless way to spend your money, but it’s quite the opposite. Everybody has extra cash at the end of the month that sits around in their account. There, it’s liable to disappear as soon as you find the next sale. Ramsey and other zero-based budgeters recommend you assign this money to a constructive financial task before you spend it on something you don’t need.
Budgeting to zero doesn’t mean spending all your money just to get rid of it; it means strategically putting money towards debts and savings to ensure you don’t accidentally waste your cash.
3. The Reverse Budget
Typically, a budget puts the laser focus on your monthly expenses. That’s true of the first examples shared above. With luck, you have some leftover cash to play around with after you pay for your essentials.
The only problem is that this can easily trick you into spending too much without thinking about savings.
The reverse budget makes you pay into your savings first. It reorders your priorities so that you contribute to your emergency fund and investments before paying off bills and other necessary expenses. If you have anything left, you can spend it as you wish. This way, savings aren’t an afterthought you can easily overlook.
What Budget Will You Pick?
Choosing your budget method is a lot like choosing your route on a map app. While each one offers a different plan, they all have the same destination: financial security.