Budgeting Styles Explained | How to Create a Budget

So the six most common budgeting styles are the percentage based budget (such as the 50/30/20 budget, the 6 jars budgeting method, and the 60% solution), the hard copy budget (such as the cash-only budget), the comprehensive budget (such as a line item or zero-based budget), the automatic budget (or no-budget budget), the value based budget, and the reverse budget.

1. Budgeted Budget

The percentage-based budget is a popular budgeting method.

A percentage-based budget can take many forms.

T. Harv Eker’s 6 Jars budgeting method, Jim Rohn’s 70/10/10/10 budget, Richard Jenkins’ 60 percent solution, and the 50/30/20 budget based on Elizabeth Warren’s book All Your Worth are all popular examples of this budgeting style.

On the most basic level, their goals are all the same. They are intended to assist you in allocating specific percentages of your money toward meeting all of your financial obligations and goals. Of course, the percentages differ; for example, in the 50/30/20 budget, you simply divide your income into the three budgeted categories.

50 percent of your income goes toward necessities, 30 percent goes toward wants, and 20 percent goes toward financial goals.

In the 70/10/10/10 budget, 70% goes toward your needs, 10% goes toward active capital such as a savings account, another 10% goes toward passive capital such as a 401K or IRA, and the remaining 10% goes to charity.

Despite these distinctions, the fundamental goals remain the same.

The primary advantage of these budgets is their ease of use.

You already know how much money goes toward each category in your budget for every dollar you make.

And, as long as you aren’t in dire financial straits and the percentages are applied correctly to meet your objectives, any of these percentage-based budgets can work out very well.

The issues arise when the percentages are not applied correctly for your goals or when you are in financial distress.

Let’s take a look at an example to see how this could go wrong:

Assume John is 55 years old, has no retirement savings, earns $36,000 per year, owns and pays for a home, and has the following debts: $5,000 on a credit card at 15% interest, $10,000 on a car loan at 5% interest, and $20,000 on a student loan at 4% interest.

The minimum monthly payments for the credit card are $100, $186.43 for the car loan, and $202.49 for the student loan. These minimum payments total nearly $500 per month, or roughly one-sixth of John’s total income.

If John followed the 50/30/20 budget (and assuming he didn’t change the numbers to fit his situation), he would allocate $1,500 per month to necessities, $900 to wants, and $600 to financial goals.

The $1,500 a month for necessities is certainly doable, especially since his home is paid for, and the $900 a month for wants is not half bad either. The concern for John’s case, in particular, is the $600 a month for financial goals.

With nearly $500 of that amount going toward debt repayment, he doesn’t have much left over for investments, which is a potentially concerning issue given that he is 55 years old and has no retirement savings.

John would need to have saved approximately $450,000 to cover his needs alone in retirement.

If he invested the remaining $100 a month from his financial goals after paying his minimum debt payments and earned an average return of 8%, he would be financially independent in about 43 years, when he turns 98, which is probably not the time frame he is hoping for.

If he sold everything and put the full $600 a month toward investing, he’d be financially independent in 22 years and 5 months when he’s 77, which is… better but probably still not in the time frame he’s hoping for.

However, if he reduced his necessities (say, to $1,200 per month instead of $1,500) and put half of his wants into investments while still putting the full $600 per month into investments, he would be financially independent in just 15 years when he turns 70.

And this is assuming, of course, that he receives no social security benefits. If he does, his “out of pocket” costs in retirement will be lower, making it easier for him to become financially independent by the time he wants to make that transition.

However, depending on the other factors in his finances, he may want to consider paying off those debts and adjusting some of those figures between now and retirement so that he can support himself when he retires.

2. Budget in hard copy.

The envelope or cash-only budget is the most popular variation of this budget.

The primary goal of this budget, and its greatest strength, is to ensure that you never spend more than you earn and that you have control over your spending, especially in areas of the budget that are frequently budget-breaking.

After all, if you’re truly following a “cash-only” budget, you simply can’t spend money that isn’t there, and as a result, you’ll have a much more difficult time falling into debt.

Simply label a bunch of envelopes with the names of various things you spend money on, such as groceries, restaurants and eating out, entertainment, gas, clothing, and so on, to create a budget.

Determine how much you want to spend in each of those categories and write it down on the envelope. When you get paid, fill the envelopes with the appropriate amounts.

A couple of things to keep in mind here: if you get paid twice a month, you may only be able to put half of the amount you wrote on the envelope in there, which is fine; and most people who use this budget don’t have envelopes for things like mortgage payments, insurance premiums, or cell phone bills because those expenses are usually more stable and predictable, but you can have envelopes for them if you want.

And, while it’s fine to adjust your budget amounts for each envelope as you go along because, again, you’re not going to get it perfect right away, the key is to make sure you don’t start taking money out of the food envelope to buy that nice pair of jeans you saw because you’ll run out of food money.

Or you’ll have to bring money from another envelope into the food envelope, and then you’ll run out of money in that category, and it’ll be an endless cycle in which you’re not actually controlling your spending and are probably starting to rack up debt.

This somewhat defeats the purpose of using this budgeting method. As far as I can tell, that is the only major disadvantage of this budgeting method.

If having cash in those envelopes tempts you to overspend and then beat yourself up about it, you might want to try another budgeting style… like the automatic budget.

3. Budget without a budget.

The goal of this budgeting style is to automatically make as many of your financial decisions as possible for you, giving you the fewest opportunities to be your own worst enemy and break your budget.

This is accomplished by establishing automatic payments for items such as your mortgage, rent, cell phone bill, savings and retirement contributions, and anything else that can be automated.

Remember that if you never see the money, it’s much more difficult to spend it on things it wasn’t meant to be spent on.

The nice thing about this budgeting method is that once it’s properly set up, you know that any money left over is yours to spend on whatever you want, guilt-free.

In some ways, this budgeting style is similar to the Hard Copy budget on steroids because it takes the biggest disadvantage of that budgeting style and makes it much less likely to occur.

That is not to say that this budgeting method is without flaws. If you intend to use it in the long run, make sure you have well-defined financial targets to aim for. This is primarily due to the fact that this budgeting style is more hands-off in nature than most others.

It’s very easy to set things up and have everything going well at first, and 10 years fly by without any major problems until you realise that your longer-term goals will be difficult to achieve if you don’t start putting enough money towards them from the start.

4. The zero-sum budget

which is a budget that attempts to make your monthly income minus your monthly expenses equal zero.

Its purpose is to put every dollar to work before the month begins so that there are no surprises or unknowns that you can’t handle.

A comprehensive budget is so named because of the amount of detail that goes into it when it’s properly set up.

Everything from your mortgage payments to your emergency fund, Christmas gifts, and car payments should be tracked.

And you’re not finished until you’ve assigned each dollar a task.

The most obvious advantage of this budget is that there are no unpleasant surprises, and you know exactly where all of your money is going.

This makes it easier to determine where you can cut costs, as well as a variety of other things.

There’s a reason why I recommend that everyone at the very least try this budget.

When done correctly, it can provide you with numerous benefits for a long time to come, even if you eventually switch to a different budgeting style.

The most significant disadvantage of this budget is most likely the level of detail involved in its creation.

It can be a daunting task the first time you sit down to do it, but there are many apps and spreadsheet templates available to help make that first go easier for you, and if you’re doing the budget electronically, it’s fairly simple to add and remove line items as you go.

5. Use reversal budgeting.

Reverse budgeting takes a savings-first approach, forcing you to figure out how much money you need to save each month to cover your future financial goals, and then you can spend the rest of your money guilt-free.

This budget obviously has many similarities to some of the other budgeting styles; the main difference is its emphasis on paying yourself first.

The strongest pro to this is that, in comparison to other budgeting styles, you’re less likely to find yourself in a situation where you don’t have enough money to cover your long term future because the first, and most important, thing you figure out with this budget every month is how much you need to save in order to cover your future financial goals and commitments (assuming, of course, you don’t just set this budget and forget it, which does happen sometimes).

The disadvantage of using this budgeting method is that you may find yourself living on a shoestring budget after your savings have been made, especially in the beginning.

This usually occurs when your savings goals are very lofty and must be met in a short period of time, or when you simply aren’t making much money.

Fortunately, what this can do for you is focus your attention on ways to improve your offensive strategy in order to earn more money and improve your standard of living.

So, depending on how you look at it, this may or may not be a major disadvantage in the long run.

6. Budgeting based on values.

It’s set up similarly to a zero-sum budget, with the primary goal of directing the majority of your spending toward things that you actually care about.

As a result, if done correctly, it is very good at helping you to cut unnecessary costs while also increasing your enjoyment of the money that you do spend, as well as having potentially positive effects on your general mood and happiness outside of times when you’re actively spending money or working on your budget.

Now, while you’ll likely waste less money with this budget, at least in comparison to less detailed budgets like percentage-based budgets, that doesn’t always mean you’ll technically spend less each month (though you might if you place a high value on saving and investing for your future), you’ll likely just be spending more on the things you actually care about.

This is because using this budget forces you to examine all of your expenses and determine whether they are worth spending money on in the first place. If they are, you may continue to spend the funds.

You can also take this a step further and see if you can spend less on that thing without sacrificing your enjoyment of it, which is highly recommended because, once again, we don’t want to waste money if only because it means we have less time to do the things we want to do, but you’re still spending the money.

Another advantage of this budgeting style is that it is extremely adaptable, allowing you to take ideas from other budgeting styles and incorporate them into this budget without sacrificing the level of detail and knowledge that you can gain from more comprehensive budgets such as the zero-sum budget.

As I see it, there are three major potential cons to this style of budgeting: the longer time commitment required to set up the budget in the first month you use it, the potential for initial discouragement when you look at your initial financial situation, and the possibility of not having your future fully secured if you don’t put enough money towards it right now, similar to the automatic budget.

One thing I should mention about these disadvantages is that, like the other budgeting styles I’ve mentioned, they all have workarounds.

The time commitment can be avoided by using a template that has already been created for you and that you only need to modify a few minutes to fit your needs.

The issue of the future being properly funded and secured can be solved by educating yourself on how much you’re likely to need when that time comes and working backward to figure out how much needs to be saved in order to meet that goal (essentially taking the main idea from the reverse budget and using it as part of your budget here), and the potential (and I emphasise potential) initial discouragement that you may experience if you discover that you don’t have enough money.

Whether that is by paying down debts (if you have them) so that more of your money stays in your pocket rather than someone else’s every month, or by getting a part-time job, investing, or starting a side hustle to earn some extra income whether actively, passively, or both, and finding ways to get what you want out of the things you want to have, do, and be in a more cost-effective way, or even all of the above.

Remember, there are always alternatives.

So don’t let that initial setback deter you from achieving your own definition of financial success.