How to budget: A pain-free guide to building a budget that works

How to budget: A pain-free guide to building a budget that works

“A budget is telling your money where to go instead of wondering where it went.” — John C. Maxwell

I've had more one-on-one money coaching meetings during the past year than my previous twelve years writing about money combined. I used to claim that I'd never do money coaching. Apparently, I was wrong.

As I meet with folks, certain common themes stand out.

For one, most folks have no idea how much they're actually earning and spending. Their finances are like a black box. They get paid, put the money in the bank, then spend it until it's gone. Almost nobody actively tracks what they earn and spend. “Do I have money in my checking account? I can buy something!”

Because people don't track what they spend, it's tough for them to plan what they spend. Frequently, I suggest that the people I meet with make a budget. Because budgets have been demonized for so long, there's a lot of resistance to this idea. That's too bad. Budgets don't have to be a bother. When used correctly, they're an excellent way to take control of your money.

If you pick a budget that fits the way you live, it can help you meet your goals more quickly. The key? Don’t think of a budget as a constraint. Real Life is a constraint; a budget helps you break free so that you can spend on what’s important to you, on the things that bring you joy.

Why Budgets Fail

A lot of people get frustrated with budgeting because it never seems to work. They never reach their spending targets. Or emergencies break the budget. Or it seems like so much work for so little reward. I hear you. I've been there. But if you follow a few rules (or maybe “guidelines”, if you prefer), budgeting can be less stressful and more useful.

Based on my own experience — and based on comments of GRS readers like you — I believe there are a handful of reasons most budgets fail. You may encounter trouble with your budget if:

  • It's too complicated. People have a tendency to make budgets more complex than they need to be. A simple budget is usually more useful.
  • It doesn't reflect your values. A budget should help you achieve your goals, so make it personal. If you try to use somebody else's budget, you're going to have a tough time.
  • It doesn't reflect reality. When you build a budget, base it on your actual income and behavior — not on some imaginary ideal you.
  • It seems like a chore. Don't let your system bog you down. Your goal is to have a budget that works, so keep looking until you find one that works for you.

To summarize: To minimize the risk of failure, a budget should be simple and easy to use while reflecting both current realities and your future goals.

That's all rather esoteric, though. What does a simple, easy budget look like? There are a lot of approaches that work. While some people do manage to make detailed budgets work, I've found that “budget frameworks” are more effective for me and the people I coach.

Today, we're going to take a deep dive into the world of budgeting. Based on my thirteen years of reading and writing about money, here are my thoughts on how to budget effectively.

How to Build a Budget

A lot of times when a person decides to get their financial house in order, the struggle to figure out how to build a budget that works. It's common to build an elaborate budget that confuses even the person who created it. Successful budgets are usually simple.

The Only Investment Guide You'll Ever NeedIn The Only Investment Guide You'll Ever Need, Andrew Tobias offers the following simple yet effective budget:

  1. Destroy all your credit cards.
  2. Invest 20% of all that you earn. Never touch it.
  3. Live on the remaining 80%, no matter what.

Although Tobias is being glib, this is actually an excellent system. If you can develop the discipline to follow just these three steps, you can become rich.

That said, this budget framework is too loose for most people. (I mean, come on, it only has two categories: saving and everything else.)

The 60% Solution

A decade ago at MSN Money, editor-in-chief Richard Jenkins proposed a budget that he dubbed the 60% Solution. (That link leads to a Web Archive summary of his framework. The original is article is no longer available because MSN thinks it's smart to throw away awesome old content.)

After twenty years of budgeting, Jenkins decided that a detailed budget was too much work for too little information. He developed a simpler framework. With this framework, his goal was to keep Committed Expenses manageable. (Jenkins says that Committed Expenses are Wants or Needs that you can't or won't compromise on. You're committed to them.)

The 60% Solution

The 60% Solution suggests allocating your monthly gross (pre-tax) income like this:

  • 60% to Committed Expenses such as taxes, clothing, basic living expenses, insurance, charity (including tithing), and regular bills (including things like your cell phone).
  • 10% to Retirement.
  • 10% to Irregular Expenses such as vacations, major repair bills, new appliances, etc.
  • 10% to Long-Term Savings/Debt — money set aside for car purchases, home renovations, or to pay down substantial debt loads.
  • 10% for Fun Money to be used for dining out, hobbies, indulgences, etc.

Jenkins believes that the best way to relieve money pressure is to reduce Committed Expenses. When your Committed Expenses rise, so does your stress level. If you can keep these costs under 60% of your income, you'll have more money to spend on other things — like retirement tomorrow or fun stuff today.

The 60% Solution looks simplistic but it's powerful. In fact, I Will Teach You to Be Rich author Ramit Sethi (who famously hates budgets) uses this as the basis for his “Conscious Spending Plan” (which, sorry Ramit, is just a budget). If Ramit likes a budget, you know it's good.

The Balanced Money Formula

My favorite budget framework — the one I teach in workshops and encourage friends to use — is the Balanced Money Formula from All Your Worth: The Ultimate Lifetime Money Plan by Elizabeth Warren and Amelia Tyagi. (Yes, that Elizabeth Warren. I'm endorsing her budget framework, not her Presidential bid.)

The Balanced Money Formula (which sometimes gets billed as the “50/30/20 budget” by bloggers too lazy to do research) is meant to help people save and pay off debt while simultaneously leaving room for financial electives like going out to dinner and cable television.

The Balanced Money Formula

Warren and Tyagi argue that in order to succeed financially, you must keep three broad areas of your finances “in balance”. They divide your net (after-tax) income as follows:

  • Allocate no more than 50% to Needs (which the authors call Must-Haves). Needs include housing, transportation, groceries, insurance, and clothes you really need.
  • Set aside at least 20% for Savings, which includes both debt repayment and retirement contributions.
  • Spend the remaining (roughly) 30% on Wants. Wants include cable television, clothing beyond the basics, restaurant meals, concert tickets, comic books, knitting supplies, etc.

Warren and Tyagi insist that to maintain financial balance and to be happy, you cannot spend more than 50% of your income on Needs. (Spending less is even better.) From Warren's experience with bankruptcy law, she's seen that too many Americans dig a deep hole for themselves by taking on huge mortgages and car loans. If you want to keep a balanced budget (and eventually build a wealth snowball), it's vital that you spend less on the Big Stuff — especially housing.

Note that the Balanced Money Formula considers debt reduction to be a part of Saving. I like this. I like it so much, in fact, that it's now part of my personal “financial platform”.

Note: One shortcoming to all three of these budget frameworks is that they target twenty percent (at most) for debt reduction and saving. Twenty percent is great. It's more than financial advisers generally recommend, and far more than most people save. But I consider twenty percent a starting point, not an end point. Ultimately, I think most folks are best-served by aiming to save half of their income.

Automating Your Budget

Budget frameworks let you wrap your head around the Big Picture, but the framework by itself isn't very helpful. To build a budget that works, you need a system. You need a way to work with framework.

I have clear memories of my parents trying (and failing) to budget in the 1970s. Mom and Dad would get frustrated with how broke they were, so they'd sit down at the kitchen table to make a plan. After much heated debate, they'd draw up a budget in a spiral notebook. Over the next few weeks, Mom would track their spending and compare it to their projections.

The budgets never worked. It took too much effort. (There were other relationship reasons the budgets failed, but sheer labor involved played a major role.) After a couple of weeks of frustration, Mom and Dad would give up. No wonder they were always broke.

Nowadays, things are easier.

If other bloggers are too be believed, many folks use Personal Capital to track their spending. While expense tracking isn't the same as budgeting, it's absolutely part of the process. If you don't track how much you spend, there's no way to know if you're sticking to your budget.

From chatting with Get Rich Slowly readers, I suspect that You Need a Budget (YNAB) is a better choice than Personal Capital when it comes to automating your budget. This shouldn't be surprising, I guess. After all, YNAB is a tool specifically designed for budgeting! (Here's my review of the YNAB software.)

Apps like these do have downsides. Personal Capital is a great free tool, but it's also designed as a lead generator for a wealth-management firm. They're hoping that if you use their software, you'll eventually become a client. YNAB has no nefarious motives — in fact, the company is awesome — but the tool comes with a small monthly fee. For most folks who need to budget, however, this fee is worth it.

Still, you have other options. It's possible, for instance, to buy stand-alone desktop software that lets you both budget and track your expenses. It's no secret that I manage my money with a copy of Quicken 2007. (I'll eventually move to a new version of Quicken. For now, the old version works just fine.)

My buddy Jim at Wallet Hacks is a proponent of building personalized budget spreadsheets. In fact, he recently wrote that budgeting with spreadsheets beats automated tools every time. But Jim is a ginormous nerd who loves noodling with numbers. If you're less of a nerd, Personal Capital and/or YNAB might be a better fit.

Ultimately, it doesn't matter which tool you choose. There's no single right answer. Try several and figure out which works best for you and your budget. What matters most is that it's something you'll use, and that it's something that will help you reach your goals.

Envelope Budgeting

Automated budgeting tools are great for most people. Some, however, might need to take a different approach.

When I met with my friends Wally and Jodie recently, I got a sense that while they're making progress with their debt, they're still struggling with organization. I think part of the problem is that their budget is abstract. It's not a real, tangible thing but something that exists only on paper or in their heads.

“Have you heard of envelope budgeting?” I asked.

“No,” Wally said. “What's that?” I gave a brief explanation.

The envelope budgeting system is a simple method that you can use with any sort of budget to help you manage your spending. You can use it with the 60% Solution, with the Balanced Money Formula, or for more complex budget systems.

The basic idea is this: When you get paid, you divide cash into various envelopes designated for specific budget categories. Here's how it works:

  1. Choose budget categories. Use one envelope for each category you plan to track. Write the category's name on each envelope. Wally and Jodie, for instance, might have an envelope for their upcoming wedding, an envelope for travel, an envelope for groceries, and envelope for utilities, and so on.
  2. Set money aside. After your paycheck gets deposited, withdraw cash for each budgeted category. If Wally and Jodie have budgeted $200 for two weeks of groceries, they'd put $200 in their grocery envelope and note this amount on the back.
  3. Spend normally. Throughout the month, take cash from the appropriate envelopes as you make purchases. When you take money out of an envelope, note the amount on the back. Also note how much remains in the envelope. After you buy something, put the receipt and change back in the envelope.
  4. When an envelope is empty, you're done. If you run out of money in an envelope, you have two options. Hardcore budgeters argue that if your “Dining Out” envelope is empty, you need to suck it up until your next paycheck. Once you've spent your restaurant budget, that's it. Others say that it's okay to take from one envelope to fund another. Which route is right for you is a personal call. But please, don't resort to credit to compensate for an empty envelope.
  5. Decide what to do with surplus cash. At the end of the pay period, you're likely to have money left in certain envelopes. You should have a system to handle this. Maybe you want to leave the surplus there, effectively giving you a larger budget in the next pay period. (If you have $87 left in your grocery envelope and add $200 more, then you have $287 for the next pay period!) A smarter move might be to take the surplus cash at the end of a pay period and put it toward a long-term goal. (Wally and Jodie could take extra grocery money, for example, and put it in their wedding envelope.)
  6. Do it again. Repeat this process each pay period. If you discover that you consistently have a deficit (or surplus) in certain categories, make adjustments.

Here's a terrific step-by-step envelope budget tutorial from YouTube:

The beauty of envelope budgeting is that it's system agnostic. It doesn't care what kind of budget you use. You can use it for all of your budget categories or just a few. (I think most people would use it for variable expenses, not fixed expenses like mortgages and phone bills.) Plus, it's physical. The money is real and you're forced to actually handle it and experience the “pain of paying”.

I should note that some people want to use the envelope system but don't want to hassle with actual envelopes. For these folks, a budget spreadsheet is a good way to simulate the system. (Or, you might try to replicate it with the You Need a Budget software.)

In 2013 here at Get Rich Slowly, Kristin Wong shared her adventures in returning to the envelope system.

How to Build a Better Budget

That's a lot of information about budgeting, I know. It might be overwhelming. But before we wrap things up, I'd like to offer a few final tips. Let's start with what I consider the four cardinal rules of budgeting.

  • The first rule of budgeting: Don’t worry about perfection. A budget is a target. Your spending won’t be perfect the first month. Or the second. Or the third. If you can’t get your money into perfect balance, get as close as you can. Learn to make adjustments, and don’t give up.
  • The second rule of budgeting: The big stuff makes more difference than the small stuff. Yes, you should clip coupons and shop at thrift stores. But you can save thousands of dollars at once by being smart when you buy a house or a car. Decrease your major expenses — like housing and transportation — and you’ll have a lot more room in your budget for the fun stuff.
  • The third rule of budgeting: Make plans based on your real life, not how you wish life would be. Don’t budget for possible salary increases and ideal spending habits. If you spend money on coffee every day, make that part of your budget. If you haven’t received a raise at work, don’t count that in your income. Budget for reality, not wishful thinking.
  • The fourth rule of budgeting: Keep it simple. If using your budget is a chore, you’ll never follow through. Include only as much detail as you need. Find a way to track your spending that works the way you do.

Lastly, if you struggle with keeping a budget, it may be because you're trying to predict your spending in time chunks that are just too small. A 2008 study published in the Journal of Consumer Research found that people who made annual budgets were better able to predict their spending than those who made monthly budgets.

From the original press release:

[Researchers] found that, contrary to popular advice, people were more accurate when constructing an annual rather than a monthly budget, even when they were logging their expenses weekly.

“Consumers' default tendency is to underestimate their budgets, for both next month and next year frames,” write the authors. “However budgets for the next year are closer to recorded expenses because consumers feel less confident when estimating these budgets, and therefore, adjust them upward.”

One reason yearly budgets are more accurate is that consumers consider a greater number of expense categories when they construct them. If you construct your monthly budget in April, will you remember to include a category for Christmas gifts?

If you've followed my own spending adventures this year, you know I've encountered some of this. “Oops! I forgot I'd have a huge tax liability in April. Oh wow, I forgot that we booked a September 2019 vacation in April 2018. Now the balance is due.” And so on.

Yearly budgets aren't very useful, however, for planning your day-to-day spending. The obvious solution is to take the best of both worlds:

  • Since people generally do a better job of estimating yearly expenses rather than monthly expenses, create an annual budget.
  • Once you've arrived at your annual budget, divide your estimated expenses in each category by twelve. This will give you a monthly number to work with.

The results of this study reiterate that over-confidence is an enormous drag on the average person's finances. We believe we're immune to advertising, that we can handle credit responsibly, that we can pick winning stocks. Yet study after study demonstrates that this just is not the case. In fact, those who lack confidence often make the best financial decisions.

This is also true with budgeting. In this study, subjects who were told that budgeting was difficult made more accurate estimates regarding their expenses than those who were told that budgeting was easy.

Budgeting Sets You Free

For many folks, “budget” is a four-letter word. Not for money bosses. A money boss views a budget as a useful tool with which she can help build the life she wants. At the same time, she knows that a budget isn't fixed in stone. It's always a work in progress.

When you use a budget, even one as simple as the Balanced Money Formula, you need to make constant adjustments. But once you get the most important expenses figured out (your Committed Expenses or Needs), you usually don’t have to worry about them much. Your housing payment doesn't fluctuate from month to month, for instance. Your insurance premiums stay pretty constant. The same is true for your Savings. Once you get used to saving a certain amount, that becomes a habit.

Your goal, then, is to trim your Needs and boost your Savings until they're both at respectable, sustainable levels. If you can keep these two broad categories where they should be, you can spend everything else on Wants.

Spending on fun stuff is less stressful when you know you can afford it. Budgeting isn't a straitjacket. Budgeting sets you free.

Want more help building a budget? Try these tools:

Remember: If one budget doesn’t work, try another. Don’t just blindly use a budget from somebody else — even Dave Ramsey or Suze Orman. Use their ideas as a starting point, but tailor them so that your budget fits your life.

That's what I did, and it worked.

Note: This is a substantial re-write of an article originally published 02 May 2011. In fact, I'd go so far as to call it a new article. I've moved forward many of the comments on the old article and, as usual, have placed a marker so you can tell where old comments end and new comments begin.

More about...Budgeting

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LifeAndMyFinances
LifeAndMyFinances
9 years ago

J.D.’s right. Many budgets fail for various reasons. It can be tough to keep a budget with another individual, but just remember, while the budget it important, don’t make it your life goal to match your budget every month.

If you’re over by $50, just make a mental note and get on with your life. It’s probably a heck of a lot better than the way you used to budget….or not budget. 🙂

Ash
Ash
9 years ago

I will say that I do better with a month-to-month budget. I just calculate at the start of the month how much I will need, throw 10% into a fun money account, and save the rest.

That budgeting doesn’t factor in the odd expenses like car insurance, but since I don’t go crazy with the saved money, I pull the irregular expenses out of that. If I did a yearly budget the money would go into savings anyway, but I think I’d be more stressed about filling the individual pots instead of the overarching goal–save the money!

Sam
Sam
9 years ago

I’m a spending plan gal, I create an annual and monthly spending plan that accounts for fixed and recurring expenses as well as savings goals. We manage our day to day spending via an allowance system so I don’t have to budget for day to day expenses it comes out of allowance money and is limited to allowance money. I could be more precise in budgeting if we did away with allowance and came up with actual categories, but this seems to work for us and I think my husband would be annoyed if he was limited in his spending… Read more »

Debt Payer
Debt Payer
9 years ago

I have been thinking a lot about budgets lately. Mostly have dumb I am for not budgeting all year. You see, my wife just finished her first year working for the school district. Her school pays only during the school year. It does not budget for you. We didn’t put money aside like we should have because for most of the year we were living off of just my salary and saving hers. But we just bought our first house, so now we have way more expenses going into a summer with no savings and only 1 salary, which is… Read more »

Dee
Dee
9 years ago
Reply to  Debt Payer

Does your wife have the option of receiving 12 months of (smaller) paychecks, as opposed to just 10 months of the school year?

PB
PB
9 years ago
Reply to  Debt Payer

Can she teach summer school? Or tutor?

El Nerdo
El Nerdo
9 years ago

There’s an interesting alternative to the 50/30/20 formula, which is the “retire in 5 years” formula– save 75% of your income (75%!!) and invest it into income-producing bonds and stocks.

I’m not set up where my needs and wants are meet with just 25% of my income, but I am definitely intrigued by the idea. Then again the guy recommends one spends just $50/month in food. I think I’d have to include “free” cockroaches in the menu if I were to do that… 🙁

Maria
Maria
9 years ago
Reply to  El Nerdo

this may be the way to retiring in five years but these will be very long years; if one survives this is.

Maria

Nancy L.
Nancy L.
9 years ago
Reply to  El Nerdo

But will your “retirement” involve continuing to subsist at the 25% level?

I mean, if I’m going to subsist on 25% of my current income, I might as well not work at all and try to live off public assistance. Why bother with the five years of drudgery in the first place? LOL!

Nancy L.
Nancy L.
9 years ago
Reply to  Nancy L.

(Not trying to imply that everyone who uses public assistance is lazy–rather that at 25% of my current salary, I’d do better on assistance than having retired)

El Nerdo
El Nerdo
9 years ago
Reply to  Nancy L.

I have no idea, I’m not that guy, but I was wondering if anybody here had tried it. I think that blog’s author posts here occasionally (apparently, he lives).

I can’t think of how to eat for under $2 a day unless it’s gruel for breakfast, gruel for lunch, and gruel at night. That’s like asking for beriberi, pellagra, scurvy, ricketts, anemia, and a serious protein deficiency all at once.

Dan
Dan
9 years ago
Reply to  El Nerdo

Yeah, my wife and I eat well. We spend about $400/mo on groceries for the two of us. We do try to balance out the base food — ie chicken, ground beef, tilapia, and salmon. We buy from the grocer, not a specialty market or Whole Foods. When I think about how we could cut back on our food spending, there’s no easy “fat” to skim off the top. We already buy cost effectively, so cutting back would probably mean cutting back the quality of the foods and possibly switching to more unhealthier options.

Kevin M
Kevin M
9 years ago
Reply to  El Nerdo

There are several like-minded folks that post in his forum (link should be on the front page of his site) that have retired extremely early.

Before dismissing it completely or assuming the worst (eating gruel), I urge you to check out the site or the forum. I haven’t followed it to the letter, but I am convinced there are ideas over there that anyone can use. A lot of the ideas Jacob presents have the nice side-effect of being environmentally friendly as well.

El Nerdo
El Nerdo
9 years ago
Reply to  El Nerdo

@Kevin M – Yes, I’m checking the website, and I’m intrigued by his ideas, which is why I posted this as an alternative to the money balance formula. I’m just wondering how Jacob can spend $50 a month in food without getting into dangerous territory. Dan posted he spent $200 per person last month, my family spent $300 per person and I’m sure we could cut back, but there’s a point in “cutting back” where one would be lacking nutrients. I read on Cockeyed that the maximum one-person allotment for food stamps is $141: http://www.cockeyed.com/science/eating_in/feb28.html (see at the bottom of… Read more »

Early Retirement Extreme
Early Retirement Extreme
9 years ago
Reply to  El Nerdo

@El Nerdo – Okay, here’s how to think 😉 Buy 50lb bags of rice and beans at restaurant outlets or ethnic stores. Don’t buy anything preprocessed. Avoid most dairy (it’s bad for you anyway) and think of meat as a side dish (like the Chinese). Learn to cook focusing on Chinese and Indian (Mexican is fine too but downprioritize the meat and cheese). Don’t get your food from big stores. Find the cheapest grocer in town (something like Aldi) and get only the vegetables currently on sale and cook with those. Sales change weekly. I am a 170lbs person with… Read more »

El Nerdo
El Nerdo
9 years ago
Reply to  El Nerdo

Okay, I see how you do it, and it makes sense from a financial point of view, but I really can’t see myself eating that way unless it’s a life-threatening emergency (e.g., there’s been a nuclear war and I’m in an underground shelter). I don’t say this to make fun of your choices, by the way. It’s just that too much carbohydrate is bad for mel I gain weight like mad eating grains and I actually do better on a diet of meat, fruits, vegetables and healthy oils (fish, olive, coconut), with little salt, no sugar, no processed foods of… Read more »

Patrick Sievert
Patrick Sievert
9 years ago
Reply to  El Nerdo

$300/month per person! Holy smokes! I live in the middle of nowhere, where food is expensive, and we only spend $280/month between my wife, 9 month old daughter and me. And we eat well, too. We buy very, very few processed foods. What we do, however, is make a lot of dishes that make a lot of meals. For instance, I can make a pot of red beans and rice for about $10 that will last all week long. Same thing for a pot of chili.

Dan
Dan
9 years ago
Reply to  Nancy L.

El Nerdo, Thanks for the link. I followed it through to the actual government website, and cockeyed reports the numbers wrong. For a one-person household, the maximum monthly benefit is $200. For two people it is $367. As your household progresses in size, the additional benefit is $150 per person. I’m actually shocked to learn that my wife and I spend only $33 dollars per month more than what foodstamps would provide if we were in poverty. ETA: After thinking for just a moment. I need to add this qualification: I budget my work lunches separately. That’s $60-$100 depending on… Read more »

El Nerdo
El Nerdo
9 years ago
Reply to  Dan

Oh, yeah, the $100 makes a difference. I work and eat at home, otherwise it’s a business expense (meeting, etc). It’s nice to know that people in a tough spot can get some decent help though– thanks for checking the source on that info. I shop mostly at Costco and Walrats, with some visits to Trader Joes and the hippie store (co-op) for a few choice things– we buy organic in a strategic manner, avoiding the most pesticide-heavy crops per this guide: http://www.foodnews.org/walletguide.php So we get organic apples and blueberries, but stick to conventional mangos and grapefruits, for example. With… Read more »

Lulu
Lulu
9 years ago

I completely agree about keeping your budget simple as you can but also tailoring it to meet YOUR specific needs and wants. I think one of the most important things is to treat your savings like a bill and include that under your expenses and fix a certain amount that you save. Treating it like a bill will make you more likely to save instead of waiting to see what is left over and then save that. Your savings does not have to be a large number….when I first started I was literally saving $1 a month in my savings… Read more »

Mary Kate
Mary Kate
9 years ago

I love the post and the PDFs. It’s all so well written. We don’t budget because we’re not big spenders. However, I saved all the PDFs to share them with my teenager. As her income and expenses increase I’d love for her to benefit from budgeting.

Kevin @ Thousandaire.com
Kevin @ Thousandaire.com
9 years ago

I love my budget because it tells me where I’m allowed to spend money. If I didn’t have the budget, I’d probably never spend money on things I want because I’m too cheap. However, knowing I can afford a few things gives me that ability.

Tara
Tara
9 years ago

That is *exactly* why I have a budget too! Except I call it a spending plan. Otherwise I miser my money far too much and I make plenty of money. Even though I think my monthly budget is high, I am still on track to save 57% of my net income for the year.

Luke
Luke
9 years ago

Kevin – I’m exactly the same – a budget allows me to stop self-flagellating and actually enjoy some of my wages 😉

Weston
Weston
9 years ago

I’m a big fan of Professor Warren’s. However, while I believe the example you reproduced of 20% for savings (including retirement) is perfectly reasonable for people (like Prof Warren and I) who are at an age where it reasonably certain that Soc Sec will still be around during our retirement years, I believe 20% is extremely inadequate for those who are in their 20s and 30s.

BareheadedWoman
BareheadedWoman
9 years ago
Reply to  Weston

that amount needed for retirement is predicated on amount expected still to be around “for us” as opposed to how much will be around “for our children”…

…kinda just says how screwed we all are regardless of how we are budgeting our money. I’ll be glad when our parasitic societal behavior starts being paid attention to as much as our individual budgets, and our collective spending agencies held to as strict scrutiny. I know this isn’t a political site but our finite behavior is telling of the collective.

Megan
Megan
9 years ago
Reply to  Weston

I agree, thank you for pointing that out. 15-20% should be exclusively retirement for those of us under (I’d venture to say) 35 right now.

My budget looks more like 50% Needs, 20% Wants, 30% savings – with about half that going to retirement (we’re still in grad school).

Even in her book, Warren points out that the percentage is more of a minimum and reducing Wants should lead to more retirement savings. She suggests 15% of the “savings” at least to retirement after debt is paid off and you have a decent amount in savings.

Laura
Laura
1 year ago
Reply to  Weston

I also love the 20%. It is a great line in the sand. I find it too easy to get caught up in the exact number which isn’t the point. I save at least 20% now which doesn’t include my mortgage or short-term savings and feel good about it!

Frugal Living
Frugal Living
9 years ago

I use tools like Mint.com, Google docs and calenders to help me keep up with my budget and spending.

Tyler Karaszewski
Tyler Karaszewski
9 years ago

Based on the four rules of budgeting, the ideal budget seems to be no budget. Consider: Don’t worry about perfection. Easy to do with no budget! The second rule of budgeting: The big stuff makes more difference than the small stuff. Ok, this one doesn’t make much of a difference whether you have a budget or not, it’s true regardless. The third rule of budgeting: Make plans based on your real life, not how you wish life would be. When your budget is “whatever I happen to spend money on”, it always reflects real life perfectly! The fourth rule of… Read more »

JakeIL7
JakeIL7
9 years ago

Tyler,

Anything you are contracted to pay (mortgage/rent, car payment, student loans, etc.) is a NEED. The objective of the balanced money formula is to determine how much of these contracted items you can afford to spend your money on hopefully before you setup the contract. Yes, before you sign the papers, you should consider that $4,000/mo and how it fits in this. But after the paper is signed, you HAVE to pay it.

Obviously, this rule is pretty general and does not apply to everyone. As with all things in personal finance, YMMV.

Tyler Karaszewski
Tyler Karaszewski
9 years ago
Reply to  JakeIL7

So taxes are a “need” then? Well, it’s going to be tough to stay under that 50% limit then. I’m actually expecting someone to say “but taxes don’t count!” in response to that. All I can say then is, “what, why not?” Does paying off a credit card count as a “need” or as savings? Based on how you want to count it, it could be both. Say you owe $1000 on a credit card, but the minimum payment is $50/month. If you spend $200/month to pay it off faster, is that all “need” or is it $50 “need” and… Read more »

Milly
Milly
9 years ago

The 50% is based on your take-home pay.

Tyler Karaszewski
Tyler Karaszewski
9 years ago

So how do I count my 401k contributions? They’re not savings? What about my property taxes? They’re a need, but my income taxes aren’t counted at all?

The formula has more holes in it than swiss cheese.

Patti
Patti
9 years ago

Yes, property taxes are a “need” or maybe think of it as a “must pay.” With food, groceries are a need, you know, sustenance and all. But a nice dinner out… that is a want. With clothes, these are usually wants in my case, but you do need fabric to cover your torso. So when it is really a need, a must-buy, you can log it accordingly. Your mortgage is always a need, even if you are confident in your home value and consider it a type of forced saving. Your 401K is pre-tax savings. Once you track your spending… Read more »

shallowwater
shallowwater
9 years ago

PROTIP: You are a troll.

If you don’t want to budget then don’t. Stop trying to derail the subject for those of us who are interested in taking a more active role in managing our finances. We get it. You think budgeting is dumb.

Tyler Karaszewski
Tyler Karaszewski
9 years ago

Protip: if you want to skip over certain comments that you don’t like, there is a scrollbar at the right edge of your screen.

Protip 2: no one will ever be “pro” at this if they don’t think about how and why these recommendations do (or don’t) work.

I think the only reason J.D. likes this formula is because it gives some validation that spending 1/3 of his income on wants is ok, and he doesn’t have to deprive himself of everything for the sake of frugality. Not because the categories are clear cut or the allocations are well-thought-out.

J.D. Roth
J.D. Roth
9 years ago

Ha. Tyler’s not a troll. He’s a curmudgeon. 🙂 Actually, Tyler often has constructive criticism. I don’t mind. Well, not usually anyhow. In this case, I knew he’d have complaints. He doesn’t like the Balanced Money Formula, and has said so many times before. In fact, as I was writing this post yesterday, I thought, “I should write Tyler’s comment for him and e-mail it to him.” I didn’t, though. Tyler, you’re right that part of the reason I like the BMF is that it gave me permission to spend. It freed me from the mental shackles I’d given myself.… Read more »

Tyler Karaszewski
Tyler Karaszewski
9 years ago

I should write my own alternative budgeting post. One that doesn’t allocate broad categories based on percentages of your income (the BMF says Steve Jobs should spend something like $75 million/year on “needs”), and which has the primary goal is to make sure your cash flow is net positive at the end of the month, rather than spending a lot of time categorizing things.

In fact, it’s not exactly a budget, but it is a “money management/spending strategy” or something.

Nancy L.
Nancy L.
9 years ago

Tyler, it sounds like there’s a certain sweet spot in terms of income for the BMF. If you earn too little, it’s impossible to meet basic needs without being out of balance, and if you earn a higher salary, there’s a good chance that you can meet your needs, wants etc with a much lower overall percentage. I would venture that for the lower income person, the ultimate goal is to get your income to the point where you can execute the BMF. If you have an income high enough that your basic categories are becoming excessively funded, then I… Read more »

El Nerdo
El Nerdo
9 years ago

Hmmm, yes, Elizabeth Warren wrote her book specifically for Steve Jobs. How could I have missed that! He bought all the copies.

Des
Des
9 years ago

Doesn’t it kind of defeat the purpose of having a money formula if you have to be in the “sweet spot” in terms of income for it to apply? I mean, at that point isn’t the formula really just describing the reality of how most people in that bracket spend their money, rather than being an ideal to strive for?

Lincoln
Lincoln
9 years ago

I think it makes more sense to track cash flow than it does to use the “Balanced Money Formula.” Cash flow is lot easier to figure out. If you are meeting your goals/needs/wants and have positive cash flow, then you are probably doing fine. If you have negative cash flow, then you may want to drop or pare down some of your goals/needs/wants.

Also, I think it’s worth asking what really counts as “savings?” Some people view “savings” as untouchable, whereas others treat it as money they haven’t had a chance to spend quite yet.

J.D. Roth
J.D. Roth
9 years ago

Tyler, you’re either not reading carefully, or you’re being willfully obtuse! 🙂

The BMF says less than 50% on Needs. It doesn’t say “exactly 50%”. If Steve Jobs makes $75 million a year, it’s easy for him to spend less than 50% on Needs. Similarly, it says more than 20% on Savings. Anything that’s left over can be spent on Wants.

The whole point of the BMF is you don’t have to spend a lot of time micro-managing your budget.

Tyler Karaszewski
Tyler Karaszewski
9 years ago

You’re right J.D., I’m not reading carefully! Maybe it’s because the graphic, which is much more obvious than the text under it, just says “50% needs”. But I still have to agree with Des that a formula that only works in a “sweet spot” that is right around the average income is not a very good formula. Maybe that’s why I don’t like it, because my income is higher than average, and my cost-of-living is higher than average. If it’s only really intended to work for people that make $50-60k/year and buy houses for $175-250k, then that’s fine but those… Read more »

Bella
Bella
9 years ago

+1 to Tyler and Nicole. Right now we don’t budget. If I couldn’t pay my bills, or wasn’t making good enough traction on our financial goals – I probably would – to figure out what’s wrong and how to change it.

MacroCheese
MacroCheese
9 years ago

Great summary; I’m a Mint user myself.

I agree you should budget for your real life, not how you wish you would be, isn’t budgeting for how somehow actually lives (not how they should be) the entire reason they end up needing a budget in the first place?

John K
John K
9 years ago

The 50/30/20 plan is a good guideline but I would say that it is specific to different individuals as well. I just looked through our family’s budget and our ‘Needs’ are closer to 65% than 50%. Granted we’re at a different stage in our lives, just starting out in new jobs (and with a toddler, so child care and diapers are a lot of that). But depending on your income bracket, I imagine these numbers will change. For example, it’s hard for me to imagine someone making a million dollars a year having 10 times the needs that we do.… Read more »

retirebyforty
retirebyforty
9 years ago

Budget fails because it’s too much work to keep track of every expenditures. Mint helps a bit, but that information is already in your bank and credit card statement.
I’m tracking every pennies for 3 months to figure out my cash flow, but after that I’m probably not going to track it 100%.

Maria
Maria
9 years ago
Reply to  retirebyforty

This is a good strategy and in my experience it does work. We wrote everything we spent for several months. But this only gives you the information you need to set up a budget and develop some habits (like, in my case, noticing how much things cost). Keeping track of expenditure is the first step to setting up a budget; one is about how much you spend and the other about how much you would be spending. Many people don’t realise this and confuse record of expenditure with a budget. Now our budget is a very simple spreadsheet – this… Read more »

Rosa
Rosa
9 years ago
Reply to  retirebyforty

The vast majority of my “need” items are fixed – mortgage, utilities (budget billing plan), taxes, insurance. I try to find ways to reduce them about once a year, but I don’t have to worry every month. It’s basically only groceries and clothes that I have to watch.

Wants are less likely to be fixed (though I consider the cell phone & car costs wants, and they’re pretty fixed) so that’s where the daily and monthly decisionmaking happens.

Melanie
Melanie
9 years ago

My husband and I tracked our expenses for a year before we settled on the budget that we use now. We needed to get an idea of how much we would spend on gifts at Christmas, how much car insurance would cost for our two vehicles, etc. We also took stock of our lifestyle under the first draft of the budget. Budget 2.0 is very well suited to our needs and goals, but is continually under scrutiny for any changes that need to be made. We haven’t fought about money since we got married – the budget eliminates the need… Read more »

Maria
Maria
9 years ago

J.D., I have become a regular reader of your blog; it is fun and it is informative. In this post I would agree with the need for budgets to be simple, flexible and personal – I never managed to have a complex one and other people commenting on my ‘wants’ really annoyed me. My wants are mine and only I know what these are and which ones are important to me. I also happen to believe that some wants should be ‘protected’ never mind what – if we allow ourselves to have these things we also find that it is… Read more »

Amanda
Amanda
9 years ago

My husband and I do 40% savings, 20% long term (retirement) and 20% short term (everything else). That short term includes a down payment, vacations, a new computer, but it is all planned spending and it is all stuff that can wait. That way if something happens like one of us loses a job or if I go on maternity leave. It turns out we are only ‘living’ on 60% of our income and we can adjust to 50% pretty easily. I find this very reassuring. Last time I went on maternity leave we actually ended up ahead.

Dan
Dan
9 years ago

I don’t think debt repayment of any sort should be considered “savings.” 18% of my net pay goes towards my car payment and student loan payments. If this is really the proper way to classify it, then I can just buy a really nice brand new car every few years and tell myself I’m “saving” 20% of my income.

Marsha
Marsha
9 years ago
Reply to  Dan

I think your car payment should go under “needs,” because it is a fixed expense for transportation. Similarly, your mortgage payment goes in the needs category, and not the savings.

The debt repayment category is probably more for credit card and other unsecured debt. People with cc debt that are just starting to budget need a way to classify that debt, and until they pay it off, they should probably not put as much in savings–maybe just a small emergency account. Once the unsecured debt is paid, the whole category should go to savings.

Cam
Cam
9 years ago
Reply to  Marsha

I think JD is also referring to extra debt payments beyond what’s required. So if you are paying ahead on your car loan or mortgage (as well as CCs like Marsha said), that extra amount would be included in the “Savings” category.

Dan
Dan
9 years ago

JD, I go both ways on “don’t sweat the small stuff.” I budget every dime I make. I don’t go out of my way to track every penny, but I don’t use much cash, and I use mint, so I more or less track every penny without trying. In the end, if I go over budget in one area, it has to come out of something else. For us, it’s likely to be savings. If we go far enough over budget long enough, it *will* affect our bank accounts. So, what counts as “the small stuff”? If we’re over budget… Read more »

Rosa
Rosa
9 years ago
Reply to  Dan

If we were over by $100 every month, i’d look at the big stuff first – refinancing the mortgage, renegotiating insurance, cutting transportation costs, getting a cheaper cell plan.

Some people might have enough of a casual spending problem to be over $100/mo on small stuff, but they’re not going to turn that around on a dime the way giving up a parking pass or getting your loan payment down will.

20 and Engaged
20 and Engaged
9 years ago

The balanced money formula works extremely well, but unfortunately I had to put it on hold while I’m unemployed. It definitely was a great way to balance my budget.

Becca
Becca
9 years ago

So what are you supposed to do when your rent is more than 50% of your income? I have a good deal on rent for my area, $850 a month, and I take home roughly $1150 after taxes.

The formula sounds great, and I’d love to be able to switch from a mindset of “spend as little as possible” to planned spending. I’m just not sure how to get there.

J.D. Roth
J.D. Roth
9 years ago
Reply to  Becca

Becca, I think Warren and Tyagi would argue — and I would too — that if your housing is eating up 75% of your budget (as yours is), your money is out of balance. That’s not sustainable. There may be reasons for that in the short-term, but long-term, you can’t continue to live that way. You either have to find a way to cut your rent or boost your income. Or both. Until you do, you’ll always feel pinched.

Dan
Dan
9 years ago
Reply to  Becca

Becca,

I think the short answer is “get a roommate.” Either that or a second job. (I don’t intend to be trite here, but those are really only your two options.) When I graduated college, I was making only slightly more than you, and the only way I could survive was with a roommate. For 2.5 years. I rented a room from a guy for $410/mo.

El Nerdo
El Nerdo
9 years ago
Reply to  Becca

Wow, you’re cutting it really close; with only $300 month left for clothes, food, transportation, health, phone, etc, you’re one bad case of flu away from disaster.

Having been where you’ve been (oh yes, I’ve been there, trust me), you’re probably getting into debt for unplanned expenses– then the interest starts to eat into your budget and you have less and you have to use more credit and… you get the idea.

You gotta move or find a roommate or make more money for sure.

Nicole
Nicole
9 years ago

Here’s our “Do you budget?” post http://nicoleandmaggie.wordpress.com/2010/08/31/do-you-budget/ . We’re at the “Liz Pulliam Weston says it’s ok not to budget” stage in life right now. http://articles.moneycentral.msn.com/SavingandDebt/LearnToBudget/weston-is-it-time-to-dump-your-budget.aspx That may change some day. We are balanced according to the balanced money formula, but we didn’t intentionally set out to do that. Back in graduate school we weren’t balanced according to the formula but we didn’t have much choice because our income was so low and housing was so incredibly expensive. A good portion of our “want” spending went towards housing, because living in a relatively safe neighborhood was more important than any… Read more »

Eileen
Eileen
9 years ago

Thanks for this post. I’m a sorta-new GRS reader (and love it) and budgeting is still my area to improve. I will bookmark this to re-read for sure. As an aside (as long as I’m commenting), I should mention that despite not really budgeting, we have put together an emergency fund. Most of it is is from our bonuses or refunds and such (but in the past those have been used for ‘other things’). With our 2011 IRS refund, it hit $20,000. Two days later we found out our A/C compressor is dead (we live in the south). Our HVAC… Read more »

Alex
Alex
9 years ago

Wow, thank you for this post. All this information looks great. I am a current college student starting a personal finance blog and I recently posted about why students should be budgeting. A lot of my friends don’t budget because they think they don’t need to but also because it can often be frustrating. There are a lot of good tips here and I like your Balanced Money formula.

Rick Barton
Rick Barton
9 years ago

I’m loving this site. It’s chocked full of information. I’m trying to get a better grasp on my finances and the articles in this site are helping out a lot.

Rob F.
Rob F.
9 years ago

Ooof. I just tried applying the Balanced Money Formula to my income and expenses, and even after tightening the belt as far as we can my wife and I (one wage, one pension) are at 86-7-7 instead of 50-30-20.

Looks like I need to start investigating my income options…

amber M
amber M
9 years ago

I found this article interesting. Especially about doing a yearly budget. I have been doing monthly, but really like the idea of the yearly too. I thought it was funny how you listed out what we need vs. what we want. For example Dog food…not a luxury expense when you have a pet. Believe me, animals need to be fed!

Andrea Travillian
Andrea Travillian
9 years ago

I love that you approach budgeting from the point that you do what works for you. Everyone operates and thinks differently and if you don’t follow what works for you then why bother? I actually do a budget for a month, so I can see what the big picture may be but then use a cash flow budget to manage the ins and outs of the month.

S.G.
S.G.
1 year ago

I literally can’t picture life without a budget. I don’t know how one functions. Even your frameworks would probably give me hives. There just isn’t enough detail.

It would probably work if my fixed costs were so low compared to my income/wealth that it just doesn’t really matter. The more margin I get in between my income and lifestyle I track things less closely, but that’s not what you’re describing here.

T'Pol
T'Pol
1 year ago

I have been budgeting since 1998 and it has always been a yearly one. I use Excel and over time, my simple budget evolved into a file with several sheets dedicated to details and analysis of my financial life. I have prepared two blog posts on this which I will be sharing very soon on my blog.

Daniel
Daniel
1 year ago

Have you tried using Simple? My wife and I quite like it over Mint and Personal Capital. Happy to give you a tour sometime.

Sarah
Sarah
1 year ago

I’m a long time user of https://mvelopes.com which is a digital envelope system. You can link it to your accounts (credit cards, mortgage, savings, money market, checking, etc.) as well as manually track cash and gift cards. It helped me pay off my debt and makes budgeting with my spouse super easy. We know if there is money for x if we check the app and there is money in the x envelope. We’ve gotten to the point where we’ve used it long enough and have stabilized a lot of our expenses so we can put aside a little bit… Read more »

Kate
Kate
1 year ago

I also like an envelopes app (and website), Good Budget. I wanted something super simple to track spending in the categories we are most likely to go over our budget on, and which we also actually had control over – groceries, restaurants, and alcohol, but to not need to carry a bunch of cash (we put everything on credit cards and pay them off every month). Its a simple system where you can assign a certain budget to a category and input expenses, and it tracks how much is left in that category (as well as if you are behind… Read more »

Joe @ Retire by 40
Joe @ Retire by 40
1 year ago

I think it’s more important to track your expense. Once you know how much you spend, you can make a better budget.
For example, our budget is $4,000/month. It’s just overall spending. If we overspent one month, we usually try to be more careful next month. It works out.

El Nerdo
El Nerdo
1 year ago

Haaahaaahaa, it’s fun to read the old comments.

These days I do a hybrid of BMF and the envelope system, using YNAB (YNAB does virtual envelopes).

One thing to add is that a lot of people confuse tracking with budgeting.

Tracking tells you where you’ve been. Budgeting tells you where you’re going.

Not the same thing.

When I was broke I used to track my failure to budget to the last penny, haaa haaa haaa.

Now that I budget with YNAB, the future allocations take priority, and the tracking happens automatically as transactions get matched.

Angelica
Angelica
1 year ago

YNAB v.4 was pivotal in figuring out how to go from tracking spending to actual budgeting and planning for the future. I’ve been using it about 4 years now and my budget is pretty automatic. I don’t use the program “perfectly” but my workarounds work for me and my family. Sometimes my family thinks I’m crazy when we’ve spent the bulk of our entertainment money – even though we have $$$ in our overall account – and we don’t go to the movies but instead rent a $3 movie from Amazon and make popcorn. Sorry kids – but you’ll survive.… Read more »

sequentialkady
sequentialkady
1 year ago

I do a variation on Jordan Page’s 1 envelope budget method. It’s amazing how much my impulse buys got curbed when I gave myself an “allowance” for food and groceries and had to track it. While I’ve never gone underwater, I’ve actually been able to harvest more surplus for investing.

https://www.youtube.com/watch?v=VCr-54OH7IY

nicoleandmaggie
nicoleandmaggie
1 year ago

We still don’t budget, though it’s sad that Liz Pulliam Weston article is no longer available.

El Nerdo
El Nerdo
1 year ago

Hey! Great to see you back. Been ages.

So, what’s the gist of this no-budget idea? Curious…

Coopersmith
Coopersmith
1 year ago

Budgets are important to see where you money goes. THAT IS THE KEY. To say you need to live off 60% of your income is a suggestion. I have heard 70% in another blog. But as you age things get better. Things get paid off( mortgage) , thing don’t matter as much and you have all your stuff you want. (I hope) My wife is retired from 32 years of full time teaching and we can live on her pension minus our house taxes and all our vehicle insurances. So about 40% of our income. I am looking to retire… Read more »

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