Budgeting is at the heart of achieving financial freedom and it is crucial to understand the different types of budgets that are available to get your started.
3 Types of Budgets
1. Traditional Budget
This is the most common type of budget that everyone knows and understand. Under this method you just list income and expenses and monitor your spend, curtailing spending as needed. If you opt for traditional budgeting method then you will probably recycle your budget from the previous month and make adjustments as you go along.
Benefits:
- Easy to implement, just list income and expenses
- Includes details of expenses making it easier to cut down on spending, if need
- Once a budget is set, you can use the same budget every month
Disadvantages:
- Reactive method of managing finances rather than proactively managing your finances. You make adjustments after the fact.
- Easy to miss key expenses if copying the same budget every month
- Not geared towards financial goals.
2. 50/30/20 Rule
Under this method you would spend:
- 50% of income would be spent on needs
- Needs are expenses you cannot avoid, such as rent/mortgage, groceries, bills, etc.
- 30% of income would be spent on wants; and
- Wants are expenses that are avoidable, such as entertainment, shopping, vacations, etc.
- 20% of income would be spent on savings
- Savings are not an expense but rather funds for specific goals such as retirement, vacation, education, etc.
Benefits:
- Splits the budget into easy to understand categories that may be easier to manage.
- Allows for personal spend where you can allocate 30% of your income to spend on things you want.
- Encourages saving by requiring 20% of income to be saved, which can help towards longer-term goals.
Disadvantages:
- This method assumes 50/30/20 rules applies to applies to all. Every individual has specific needs and plans that may not fit with this split.
- Allocating 30% of income towards wants may be too high. This places importance on spending rather than financial responsibility.
- In majority of cases, individuals may need to allocate more than 50% of their income on needs. Those struggling financially may not be earning high enough income to warrant only 50% of their income going towards needs.
3. Zero-based budgeting
The idea behind this method is that the bottom line of your budget nets to zero. Take all your income and allocate it so that there is nothing left at the end of the month. Savings would form part of the budget, so basically you allocate whatever is left over to savings to net the budget to zero.
Benefits:
- Encourages saving by forcing allocation of left-over income to savings
- This is where budgets meet goals. You are can build your financial goals in your budgets forcing spending adjustments to achieve zero balance budget.
- Enables identification of expenses that may not be optimal for your financial well-being. If the budget is going over due to excessive expenses, this method allows your to identify and cut down those expenses.
Disadvantages:
- This method can be time consuming. Trying to produce a net zero budget can take effort, especially if you are new to budgeting.
- If you don’t have fixed income then you are constantly trying to make adjustments just to achieve net zero budget.
- If you are already struggling to make ends meet then this method will make it harder to balance the budget.
I feel these three methods are most common and widely used. Of course, their are other types of budgets and you may already be following a method not mentioned here. Follow a budgeting method that works for you. The main take away here is that use a type of budget that works for you. Each individual has a unique situation and will require a budgeting approach that is most suited to their needs.