Choosing and Using the Right Type of Budget

  • Budget! Budget! Budget!

That seems to be the only thing parents and other adults have to say to their younger adult counterparts about money. Clearly, everyone knows budgeting is important, but what the word means to a young adult can vary greatly from what it means to a GenXer or a Boomer.

types of budgets
  • What is a budget and how can you create one that works for you?

A budget is a personal or household spending plan for a specified period of time, usually the upcoming month. Successful budgets must address the individual’s goals, match his or her personality, and fit within the household’s financial circumstances.

Creating a budget “because you are supposed to” or creating one that is too complex or too simple for your personal preferences will lead to epic failure. Not only will such budgets fail, they become exercises in frustration that will discourage you from responsibly planning your finances in the future.

What Budgeting Means

Before you can identify and create the best budget for you, you must first define the word and the process.

The term “budget” carries multiple negative connotations, from being restrictive to being cheap or stingy, to sucking the fun out of life.

One of the most common usages of “living by a budget” simply refers to an awareness of your spending.

Others consider budgeting as something you do to spend less than necessary, such as enjoying Valentine’s Day even when on a budget, going on a budget vacation, or trying to eat more at home on a budget rather than regularly dining out.

For older generations, a budget is a piece of paper that orders the date and amount of every future expense over the coming month or more.

Since the beginning of the millennium, personal finance experts and counselors have been moving toward a new term, away from using the word, “budget”, altogether in favor of “spending plans”.

Besides dumping the negativity associated with budgets, spending plans acknowledge the necessity of spending money and the importance of your choice in that spending.

What Budgets Look Like

As a spending plan, your budget can be as simple as scribbling bill dates and amounts on the back of an envelope or as complex and expensive as buying a piece of software that costs hundreds of dollars a month. Most Gen Z, and even Millennials with teens, can get away with a paper version or an electronic spreadsheet.

You can find plenty of free budget downloads and even online calculators like the three described below.

  • The Traditional Budget

The traditional budget asks you to follow just three simple steps:

  • Add up all your expected income for the month
  • Add up all your expected spending for the month
  • Subtract your expected spending from your expected income

If the figure resulting from step three is negative, you will need to increase your earnings, cut your spending, or do a combination of both. The alternatives include debt, default, late fees, and trashed credit.

The advantages of the traditional budget involve your need to detail and categorize all your expected expenses. Consequently, you will better understand where every penny of your money should be going each month. Theoretically, you should also have a better understanding of the expense categories where you spend more than others, such as dining out, car payment, or clothing and shoes.

The disadvantages of the traditional budget include discouraging many people from planning their spending at all because of the complexity and demands on your time and energy to create and adopt.

Additionally, since the traditional budget involves monthly calculations only, it does not identify any days or weeks during the month when your expenses might outpace income temporarily, leading to overdrafts and rejected payments. This can be especially common in the days leading up to a payday.

  • The Refrigerator Budget

The refrigerator budget addresses this last problem of the traditional budget. Rather than calculate your budget based only on your monthly income and expenses, the refrigerator budget projects how much money you will earn, spend and actually have on any given day throughout the month.

Here are the basic steps:

  • Write or type numbers down the left-hand side of your page or document from 1 through 31 (28 for February, 30 for April, June, September and November).
  • On each number line of the month, describe any expected income or expenses.
  • Add expected income to the balance column on the right-hand side of the page.
  • Subtract expected expense and purchase amounts from the balance column for each line.

The balance at the end of each line should show you how much money you can expect to have in your account (or your wallet or wherever you keep your money) every day of the month. Many households will use this form and extend it out for the entire year, calculating their account balance for every one of the next 365 days.

These projected figures, identifying any monthly “hotspots” where your balance might be expected to approach or go below zero, constitute the greatest advantage of the refrigerator budget. If you foresee a potential negative balance, you can often push some planned expenses further back in the month till after the next payday, thus preventing the negative balance.

The major disadvantage of the refrigerator budget must be its intense need for calculating and recalculating your balances each time you adjust, remove or add an expense. For this reason, creating or using a spreadsheet will be essential.

  • The Money Pie Budget

If you are looking for simplicity when it comes to budgeting, look no further than the Money Pie budget. The Money Pie is a derivation of the 50-30-20 budget (pay bills and live on 50% of your income, enjoy 30% of your income, and save 20%).

Money Pie

The 50-30-20 budget does not take into account generosity, does not differentiate between short-term savings and long-term investments, and does not encourage you to grow your income earning potential. The Money Pie does all of these.

Here are the steps, in their recommended order:

  • Identify your monthly take home pay (add or estimate your paychecks AFTER deductions).
  • Give 10% through acts of generosity.
  • Spend 50% of your paycheck to live on (rent/mortgage, utilities, transportation, cell phone, groceries, clothing).
  • Transfer 10% into savings accounts for emergencies, vacations, Christmas and birthday gifts, car replacement, and other short-term goals.
  • Invest 10% in your retirement, a future home down-payment, college education, and other long-term (10+ years) goals.
  • Use 10% to improve your earning potential by starting a business, getting an education, or acquiring certification.
  • Use the final 10% to have fun without guilt.

Obviously, the Money Pie advantage is its simplicity and how quickly you can figure it out. This budget is ideal for individuals and households facing new situations, such as a new apartment, a new job, a move to another state, heading off to college, graduating from college, etc. It quickly shows you how much you might consider putting toward various important expenses.

It also includes the two key household expenses that I believe are crucial for financial peace of mind: generosity and fun money.

The Money Pie’s main disadvantage also involves its simplicity. It does not provide means for tracking your regular or unexpected expenses. You will need to use a separate expense tracking sheet for such purposes.

Additionally, if your local housing market (rents and mortgages), your cost of groceries, or the gasoline prices in your area are significantly higher than the national average, you will likely need to adjust the suggested percentages. Try not to adjust them so much that you completely eliminate any of the pieces of the pie. They are all critical for short- and long-term stability, security and satisfaction.

Regardless of how those around you use the word “budget”, you now have three budgeting tools to choose from. Make sure to tie whichever one you use to your financial goals. Doing so makes your budget meaningful and, thus, motivational.

Helping you get what you want out of life. Now that’s a good definition for a budget.

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