What is budgeting?
Budgeting is different from accounting. Accounting is registering what happened with money. Budgeting is understanding your priorities and values and assigning your money to those before you spend it.
Figuring your values and priorities is usually a worthy exercise, but looking at what you’re actually spending towards them is highly enlightening and can help you change behavior.
We’re going to talk through two major schools of budgeting we see recommended today and how they work. We will also address how they can be fused.
Zero-based budgeting (a.k.a. envelopes)
This is a popular budgeting style made famous in particular by Dave Ramsey. You allocate every single dollar of income to specific budget categories or “envelopes” and track the remaining spend available in each envelope as you spend. You can move budget between envelopes, but only budget that is unspent.
We think zero-based budgeting is easily the best place to start. Not because it’s easier, but because it teaches you the most. It may well be the most difficult for most people. Touching each transaction for a few months or a few years really puts you in touch with your spending and enforces a lot of discipline in your spending.
The downside to this style is primarily that it is a larger commitment both upfront and on an ongoing basis that some other approaches. It’s also easy to fall behind and get discouraged.
Automation or alert based
This is popular in certain personal finance circles and it usually relies on software, but it could also be implemented by hand or in a spreadsheet. You set target budgets for spending categories and the system alerts you proactively if you exceed your spending or a threshold set a little below your target so you can adjust your spending appropriately.
This approach works better for experienced and already disciplined people and for those with minimal variable expenses or income. It can be a nice system for students with minimal income and disciplined spending (no debt spending!)
The system might be automated software, but you could also implement checkpoints on certain days of the week or month to checkpoint your transactions and “alert” yourself.
Sometimes people choose to zero-based budget their income before it comes in, but they use alerts to manage the spending for most categories. It’s not terribly important to track transactions is static categories like a mortgage if you are experienced with budgeting and comfortable with building these systems for yourself. Then you can setup your overall budget numbers for categories and use alerts and automation to watch bills and variable categories for variance or higher than anticipated spend. The more granular the alerts — e.g. each day on a monthly run rate basis — the better understanding, control, and ability to adjust you allow yourself.