Budgets get a bad wrap. Common sentiments that I hear are that they’re onerous to maintain, impossible to stick to, and facilitate a mindset of scarcity.
These sentiments are misguided. What they really mean is that how they budget or the budget itself isn’t working. A budget is a tool and there are many ways you can use a tool incorrectly or inefficiently.
I was 25 when I made my first budget. I had over $50,000 of debt. I was making about $40,000. I had a new girlfriend I was spending a lot of money on to impress. I had no concept of money management.
When my girlfriend paid off her student loans in less than two-and-a-half years (of which six months she was unemployed), I asked her how she did it. She told me she had a budget. I asked to see hers and from then on I always used one.
Because of my budget, I have accomplished some financial milestones:
- Paid off my debt in just over two and a half years
- Saved the equivalent of five months’ worth of expenses
- Invested thousands into a brokerage account
- Purchased an engagement ring
A budget has two functions: to make you mindful of your spending and to ensure you stay within defined boundaries. If we were looking at a spectrum, the far left would be “extreme deprivation” and the far right would be “reckless over-consumption.” The trick is to stay in the middle.
And so this begs the question: how does someone make a good budget? My subjective definition of “good” is that it’s simple, clarifying, and as frictionless as possible. All three attributes must exist in order to guarantee a high success rate (as measured by how long you stick to it).
I’ve experimented a lot with how to make a good budget. Here are the best three that I keep coming back to, especially when I really don’t feel like using one anymore.
(I) Use Percentages
This entire form of budgeting is predicated on the application of the following ratio to your monthly net income:
- Needs: 50%
- Wants: 30%
- Savings: 20%
If you’re a rookie budgeter and don’t know how much money to allocate to specific expense categories than let these gentle boundaries guide you.
Expenses that fall into the “needs” category include: rent, groceries, utilities, cell phone, transit pass, pet expenses, car-related expenses (gas and auto insurance).
Expenses that fall into the “wants” category include: restaurants, entertainment, fitness memberships, non-essentials subscriptions (Netflix, Apple Music, etc.). If you can’t decide whether an expense is a need or a want, a good point of reference is whether you would still pay for it in the even that you lose your job.
Under the umbrella of “savings” is the following: emergency fund, long-term investments, and short-term, big ticket items such as your wedding, a new car, or a down payment.
It’s worth noting that these are not rigid percentages and will fluctuate depending on your cost of living.
I live in Toronto, a very expensive city, so these are my actual percentages: 52% needs, 14% wants, and 34% savings. A good rule of thumb is that so long as your “savings” doesn’t fall under 20%, you’ll be okay.
(II) Budget Lite
This is a simplified version of a standard budget. In a standard budget you categorize your expenses under “fixed expenses” or “variable expenses.” Your fixed expenses are items whose amounts rarely change each month: rent, utilities, transit pass, cell phone bill, auto insurance, minimum debt payment, and so forth. Your variable expenses are largely dictated by your consumption and can increase or decrease depending on your lifestyle: groceries, pet supplies, entertainment, car share/ride share use, etc.
Budget Lite simply consolidates as many categories as possible.
- Standard Budget Categories: Groceries ($300), Dinner/Drinks Out ($200), Entertainment ($200)
- Budget Lite Categories: Discretionary ($700)
This liberates you from the arbitrary walls between each category. If you don’t have much time to cook, this method gives you permission to buy take-out to your heart’s content — so long as it’s in the “discretionary” budget. You’re given $700 to feed and entertain yourself and you can do with it what you please. The only thing to keep in mind is that this is a hard limit so pace yourself accordingly.
(III) The No-Budget Budget
I adopted this from Shannon Lee Simmons who wrote Worry-Free Money. She’s the first financial advisor I’ve come across who openly campaigns against budgeting.
This approach is predicated on a timeless piece of personal finance advice: save first, spend the rest. No categories. No expense tracking. Nothing.
When I used this method of budgeting, I simply setup a few automatic transfers that would withdraw specific amounts on the days that I got paid. One transfer would be from my chequing account to an online savings account. Another transfer would be from my chequing account to another online savings account. And the final transfer would be from my chequing account to my brokerage account. Whatever was leftover, I spent.
As far as I know, this is the most painless method of ensuring that you are covering your savings goals without tracking anything. The only concern is that you still need to be aware that you don’t run out of money before your next paycheque.
We work hard and sacrifice a lot to make money. It only seems reasonable that we develop a system that can properly manage its distribution. To squander such a powerful resource would be a shame.