It’s a rare person who just loves a budget. I see why. The idea of setting strict boundaries on your money isn’t nearly as alluring as just spending what you want when you want. Budgeting may feel particularly painful for millennials who might already be strapped for cash and barely scraping by.
Even though I work as a personal finance expert and author, specializing in helping millennials get their financial lives together, budgeting is certainly not my favorite activity. But I recognize what a budget affords me: the ability to control my money instead of allowing my money to control me. Unfortunately, mindless spending is exactly what gets (and keeps) you in debt or unable to adequately save and invest for the future. It’s time to be the master of your money by using one (or more) of these effective budgeting styles.
1. Cash diet
Everyone should try a cash diet at least once. Nothing illustrates your true spending habits faster than only using cash. Before you immediately discount this by saying, “I always spend more money when I use cash versus credit cards,” consider these two points.
First, research* has shown that people continue to spend more money when they can swipe with plastic as opposed to handing over a crisp Andrew Jackson.
Second, you think you spend more money with cash because you’re seeing the money disappear out of your wallet faster. It’s a visual representation of your spending habits.
(Not to mention, your credit card company is trying to encourage you to spend more with sign-on offers, rotating bonus categories, points, and other little incentives.)
How the cash diet works
The easiest way to use the cash diet in your life is to first calculate your cash flow. Write down how much is coming in and subtract how much is going out, including money that goes into savings. Odds are that you probably get paid electronically and pay a lot of your bills online, so you obviously aren’t going to start paying your landlord with an envelope full of cash. What you can do, though, is start using cash in your day-to-day life.
Once you’ve run your cash flow and you know how much you have left to spend in the month on things such as groceries, transportation, and nonessentials, it’s time to use the cash. For the sake of simplicity, let’s say you have $800 a month after you save and pay your bills. That comes out to $200 a week you can spend—on things including food and gas or public transit.
What happens if you have to make an online purchase?
Go to the ATM and take out $200 at the start of each week. Put it in your wallet, use it to make all of your purchases. If you need to buy something online, make the purchase, take the difference out of the cash in your wallet, and put it in an envelope to use next week. For example, say you spend $20 buying dog food for your pup via Amazon. Take $20 out of your wallet and put it in an envelope to use next week. Then you only withdraw $180 next week.
Here’s a challenge for you: Take 1 month to do the cash diet to reset your impulse purchases and reframe how you think about your monthly expenditures.
2. Percentage budgeting
Once you’ve given the cash diet a fair shake, the percentage budget can keep your money in check while still allowing you to use plastic. Often referred to as 50/20/30 budgeting, percentage budgeting is based on the ideal allocations for your post-tax income.
The ideal percentage outline:
- 50%: Fixed expenses and life necessities (e.g., housing, debt, cell phone bill).
- 20%: Savings and investments.
- 30%: Flexible spending/lifestyle expenses (e.g., food, entertainment, vacation, pets).
It’s flexible—to a point
While these percentages are flexible, it’s important not to manipulate them so much that you’re saving and investing, say, 5%, while your fixed expenses are at 70%, and your lifestyle expenses are at 25%. Because high housing costs are often an issue for city dwellers, you may need to focus on reducing your spending in the flexible spending/lifestyle category before slashing the percentage you’re putting toward savings and investments. You should revisit your percentages as your salary increases and/or your debt decreases.
3. Zero-sum budget
Zero-sum is not for the novice budgeter. It requires discipline, research, and a healthy savings buffer. The goal of the zero-sum budget is twofold:
- You use last month’s income to pay for this month’s expenses.
- You assign every dollar a job.
Zero-sum is ideal for freelancers, contractors, and anyone with a variable income because the use of last month’s income to pay for this month’s expenses will prevent you from falling into the paycheck-to-paycheck lifestyle.
How to set up your zero-sum budget
The first part of creating your zero-sum budget is to track your expenses for a couple of months. This will give you a strong understanding of the categories for which you’ll need to assign all your dollars a job. It also helps you trim the fat in areas you may be overspending.
Once you’ve created your list of expenses (for example: rent, utilities, cell phone, groceries, student loan payment, transportation, car insurance, health insurance, and savings), you’ll assign a dollar amount to each category. Your goal is to “spend,” aka zero-out, how much you earn each month. Don’t get too excited—that doesn’t mean you’ll really be spending every last dollar. You need to include saving as a category as well—after all, you’re paying yourself.
Once you’ve saved enough to build a healthy emergency savings fund and can start working toward short-term goals, you can also focus on putting some of that money into nonretirement investments.
How should I be tracking my dollars?
Budgeting tools such as You Need A Budget (YNAB) popularized the zero-sum style and can be a tool to help you track your progress. There’s a fee, but it’s the go-to software for zero-sum budgeting. You can also use an Excel spreadsheet or Google Doc for a DIY approach. If you’re simply interested in seeing your cash flow without an emphasis on zero-sum budgeting, you can try mint.com.
Your sticking point for getting started
One common hitch in starting the zero-sum budget is getting to a place in which you have a month’s worth of expenses as a surplus so you’re using last month’s paycheck to cover this month. It may just be a slow process of putting aside a little extra every month until you’re ready, or you could consider dipping into a savings account (if it’s well-padded), and then just increase your savings goal until you’ve restored your savings.
Which one is best?
That’s easy: whichever one actually gets you on track when it comes to handling your money. Sure, this may be a bit of a cop-out answer, but everyone’s relationship with money is different. What works for your best friend, sibling, boyfriend, or mom isn’t necessarily what will keep you in the black. Plus, epically failing at one budgeting style does not give you a license to say, “Meh, budgeting doesn’t work for me.” It’s just time to pivot and try something else that does!
You need to control your cash flow in order to control your money. Without that control, you won’t be able to adequately position yourself to both save and invest to create wealth and make your money work for you.
*Psychology Today, July 11, 2016. Does It Matter Whether You Pay With Cash Or A Credit Card?
Erin Lowry’s opinions are not necessarily those of Vanguard.