Now more than ever, it's important to know where your money is going each month. If you're just starting this journey, you may have many questions about the different types of budgets out there.
What's the difference between a 50/30/20 budget and a reverse budget? What kind of person should invest in the 60% Solution? And how does the envelope system work, exactly?
It's true that there are numerous ways to manage your finances - and that different methods suit different people - but with careful planning and consistent improvement, you can make your budget work for you. Here are seven popular types of budgets and what makes them unique:
In a zero-based budget, you start from scratch every year. Instead of building on previous budgets, you assess your current situation and decide which expenses will be worth keeping and which ones should go.
Using this current financial situation, you allocate all your income to expenses, your savings and debt repayments if you have any. The goal is to have your income minus your expenditure (which includes savings and debt repayment) equals to zero every month.
This type of budgeting is helpful if you tend to let your expenses creep up over time by spending more than necessary on things like food or entertainment. You can also use zero-based budgeting to track expenses that vary significantly from year to the next, like vacations or holiday shopping.
However, you may find it challenging to let go of certain items once they've been added to your budget; in this case, it might be best to build on an existing one rather than starting from scratch each year.
If you have an irregular income, this budgeting method can get a little complicated for you.
The 50/30/20 rule is one of the most popular budgeting methods because it's easy to set up and maintain. In this type of budgeting, 50% of your income goes toward necessities such as housing, utilities, and transportation.
30% of your income goes toward wants such as fancy clothing, personal care items (such as makeup), and entertainment costs such as going out to eat or going to movies with friends.
Finally, 20% of income should be set aside for savings - and this can include retirement savings and emergency funds for things like car repairs or medical bills.
If you are not very good at expense tracking, you may find this otherwise simple budgeting method to be a little restrictive.
Read Also: 8 Ways to Track Your Spending
The reverse budget is a budgeting technique that focuses on savings. Instead of starting your month with how much you can spend, you first figure out how much money you want to set aside for savings and then use the rest to meet your expenses.
The idea behind this method is simple: if you save first, there will be more left over at the end of each month. Even if you lose your job or take an unexpected sick leave, you’ll still live off your savings until you get back on your feet.
The reverse budget works by setting aside a portion of your income for savings (like an emergency fund) before spending any part of it elsewhere. The formula varies depending on where you get started. However, most people save 10%-20% or higher of each paycheck before using any remaining income for living expenses
The debt avalanche method is a budget strategy that allows you to pay off your debts in order of their interest rate, from highest to lowest. This is specifically useful for someone with more than one debt and wants to get out of debt quickly and in the most cost-efficient way possible.
The debt with the highest cost is paid off sooner than the one with the lowest balance and interest which means you get to save on the higher interest you would have needed to pay if you kept that debt for longer.
You do this, while paying the minimum payable amount for your low-interest, low balance debt. This is to ensure you do not go into default.
Once one debt with the highest balance and interest is eliminated, you can apply that money toward paying off the second debt in the queue until all of your balances are gone!
When setting up this method for yourself (along with any other budgeting strategy), it's important to consider how much money you want to put toward each payment.
You'll need enough money coming into your account every month to cover these payments and still have enough to cover your expenses and put into your savings. Debt is not an excuse to postpone saving, although some may opt to clear debt as fast as possible before resuming saving.
So make sure they're realistic numbers based on what kind of income schedule you have before adding them into your budget!
The debt snowball method is similar to the debt avalanche method, except that it prioritises paying off debts from the smallest to the largest as opposed to based on the interest rate.
While this may seem odd, especially since most people would rather pay off their highest interest rate debt first, doing so can help you maintain the motivation of becoming debt free by employing the "tackle the easy jobs first" approach.
Rather than taking the biggest amount you owe head on, eliminating the smaller amounts at a time and moving towards the large ones encourages you to keep going as you see the balances go away.
For every smaller debt you eliminate, you carry those repayments you would have been making to repay the larger amount which eventually means you will be making bigger repayments on the larger debt.
The debt snowball method works by ranking your outstanding debts from the smallest amount owed to the largest amount owed and then paying them off one at a time, while paying the minimum amounts for the rest.
While by using this method you may end up paying more in interest than by using the avalanche method, you are likely to stay encouraged to reach your goal using this method than the latter which requires much more discipline.
The 60% solution is also known as the 60/40 budgeting method. This is a good choice, especially if you’re just starting with budgeting.
It's also recommended if you are trying to get your finances under control and don't have any credit card debt or other financial obligations that need to be paid off right away.
This type of budgeting splits your income two ways;
Just like the 50/30/20 budgeting method, you can also adjust the percentages on the 60/40 budget to suit your income and financial goals.
One unique factor in this method is there is no requirement to track your expenses as long as they do not exceed the percentage you have chosen to keep them at i.e. 60% in this case.
It is sometimes referred to as the budgeting method of choice when everything else has failed.
The envelope method is a budgeting strategy that's all about splitting up your money into different envelopes. You use each envelope to designate where the money in it should go.
It is important to note that this method is designed for people who primarily spend in cash. It ensures that one only spends the money in the envelope designated for that specific expenditure.
For example, if you have Kshs 10,000 to spend this month, you'd divide it up evenly into three separate envelopes labelled "groceries," "transport'' and "entertainment."
So each time you use cash from one of these envelopes, that amount will be applied only toward purchasing what's listed on its label (and nothing else).
An advantage of the envelope method is that it's simple and easy to follow - you just need some empty envelopes! Many people find this method more effective than other types because fewer steps are involved; no complicated formulas or spreadsheets are involved here!
This method also makes sure spending stays under control by forcing you to make conscious choices about how your money should be spent. It minimises the likelihood of overspending as compared to the pitfalls associated with using cards or mobile money. This can prevent impulse buys from happening.
If you want to adopt this method but do not exactly want to use envelopes or are not in favor of keeping all your money for the month in the house as cash, it is possible to create virtual envelopes.
Some banking apps will allow you to create virtual accounts that you can deposit money to and give them names according to the purpose that money is meant to serve. These virtual account labels can still have the same effects the envelope labels have on you every time you draw from them.
The same is applicable to cards where if you find it more convenient to have all your expenses paid by card, you can get several zero-fees prepaid cards that you load every beginning of the month with the amount you intend to spend on a particular expense type.
For example, if you have loaded Ksh3,300 to your ‘entertainment’ card, once you swipe the last Ksh300 at the bar, you are not allowed to buy one more drink that month.
Whatever budgeting method you choose, it's important to stay consistent and cut back on unnecessary expenses. It can be tempting to think that when your income increases, so should your spending. But the truth is that if you're not careful with money now, it won't matter how much more you earn later - you'll still end up broke.
You can make any budget work if you're willing to put in the effort needed to succeed at meeting your financial goals. The key is finding something that makes sense for your life situation and sticking with it long enough to become habit-forming.
If your main goal is to pay off debt, the debt-snowball or debt-avalanche methods might be more effective. If you are more focused on saving money for specific goals in your future, the 50/30/20 Budget or Reverse Budget might be more useful to you.
Whatever method works best for you and whatever goal your budgeting is trying to achieve, it's important that it works with your life and keeps track of both necessary expenses and unnecessary ones so that they can be cut back on whenever possible - that will help ensure that your budget leads you to financial success and stability!