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What’s the Best Way to Budget?

Studies show that Americans spend approximately $1.2 trillion every year on goods and services they don’t need.

picture of a magnifying glass over a chart labeled budget, what's the best way to budget

This makes sense, as U.S. shopping malls outnumber schools two to one. When we overspend on unessential items, there never seems to be enough left for the important things like retirement savings or dental insurance. Most financial experts agree that creating a budget and sticking to it is the best way to manage your money, but if you’ve never budgeted before it can be difficult to know where to start. Consider these different approaches to find a budgeting method that suits your needs.

Group Expenses Into Categories

The idea of grouping expenses into categories is nearly as old as budgeting itself. However, this approach remains popular because it really works. Assign a limit for each spending category, track your expenses, and then stop spending in each category when you reach your limit.

The downside of this approach is that monitoring a lot of categories can be confusing. However, it can be really effective if you focus on the areas in which you usually overspend.

For example, you might tend to eat out a lot so you decide to allocate $200 for this category. Once you start nearing $200, you’ll know not to order the lobster. Once you hit $200, you might host a potluck dinner instead of eating out with friends at a restaurant.

Use Envelopes and Cash

The idea of putting cash into envelopes is a variation on the categories idea, which may work well for visual people or for those reluctant to do math. With this budgeting approach, you label envelopes with categories and allocate a dollar amount to each. Every payday, you withdraw the money and divide it between the envelopes. Then you simply use cash from the appropriate envelope to spend within each category.

Besides being easy to understand, the envelopes approach is also really flexible. Once the envelope is empty, you don’t necessarily need to stop spending from that category, but you do have to sacrifice money from another envelope. Is it worth spending a little less on groceries this month to buy a new top while it’s on sale?

Work With a 50/20/30 Ratio

The categories approach works well for those areas in which you tend to overspend, but keeping track of too many categories can be a headache. A much simpler approach uses just three categories split using a 50/20/30 ratio. The largest share of your take-home pay will typically go to fixed costs. These are the ones that don’t vary significantly from month to month, like your rent or mortgage payments, utility bills, car payments, and subscriptions to magazines or streaming services. Your fixed costs shouldn’t total any more than 50 percent of your take-home pay. If they do, consider canceling non-essential spending such as your membership to that gym you only visit on occasion.

With roughly half your pay left, you’ll have enough to put at least 20 percent toward your financial goals. Perhaps you want to pay down your credit card debt, build an emergency fund or nest egg for your retirement, or save for the down payment on a house. Make it a priority to put a set amount aside each month so you keep moving toward those goals.

Finally, you’ll have roughly 30 percent of your take-home pay for flexible spending. Flexible spending is spending on things with amounts that vary month-to-month. This category is made up of essentials, like groceries, and non-essentials, like concert tickets. If you’re spending a lot on one area in this category, adjust your spending on other flexible items accordingly. If you’re hosting a dinner party, your grocery bill is likely to rise, so you might miss a few cocktail nights.

Track Your Spending With a Budget App

We typically spend the most money when we’re on the go, so it makes sense to upgrade from old-fashioned spreadsheets and use a budget app instead. Popular budget apps like Mint, You Need a Budget, and GoodBudget allow you to enter expenses as you make them and label them according to their category, so you can see whether it’s your love of fast food or fashion that’s putting you in a financial hole. Watching those expenses add up can be a great deterrent to spending.

Apps automatically deduct your expenses from your income so you can avoid spending more than you can afford without doing complicated math. The budgets created on these apps can usually be shared with multiple users, so they’re ideal for couples and families attempting to rein in their spending.

Automate Priority Expenses

If you automate your priority payments to coincide with your paydays, you never need worry about not having the money to afford the things you really want. From dental insurance payments to charity donations, almost everything can be automated these days. You can even set up your online banking account to automatically deposit an amount into a high-interest savings account every month.

Once you’ve made your priority payments, you’ll know exactly how much you have left to play with. Remember to monitor your bank account between paydays to ensure you don’t overdraw your account; that sort of mistake can be costly.

Limit Your Withdrawals

Automatic tellers and credit cards make it all too easy to get the funds we need to indulge ourselves. Then before we know it, we’ve drained our bank accounts and maxed out the cards — with almost nothing to show for it. You can quit this bad habit by only using cash for luxury items and limiting yourself to just one withdrawal a week.

Decide how much you can afford to spend on luxuries, withdraw the money, and stop spending on those non-essential items once it runs out. You’ll soon work out which items are worth the splurge and which ones you can do without. You don’t need to spend all the money you withdraw each week either. If you’re lusting after the latest tech toy, save your cash and only buy it once you know you can afford it.

Budgeting can be tricky at first, and it can take some trial and error to find the strategy that works for you. However, it’s worth persevering for the peace of mind that comes from knowing you can afford life’s important expenses.

Featured Image via Flickr by GotCredit

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Brought to you by The Guardian Life Insurance Company of America (Guardian), New York, NY. Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, investment or medical advice.

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