With the cost of living crisis continuing to bite, many Australians are watching their spending.
But there’s more than one way to budget.
We looked at the pros and cons of three popular budgeting methods and spoke to two financial advisors for their take.
What is a budget?
A budget is a plan for every dollar you have.
It estimates how much money you’ll earn and spend over a certain period of time.
Glen James, creator and host of a podcast called This Is Money, says it’s a way to ensure your income and expenses are in sync.
“A spending plan forms a part of your financial foundations and I encourage everyone to be using one, otherwise you’re guessing with your money,” Mr James tells the ABC.
What’s the best way to budget?
That depends on who you ask.
Mr James says a spending plan is beneficial, but financial educator and author Melissa Browne is against rigid budgeting.
“A budget will tell you if you have enough money for what you need, and essentially whether you can afford what you’re spending on,” Mr James says.
“It also helps you set aside money for saving and investing for your future.”
Essentially, it encourages you to put your money to work in the best way possible to achieve short, mid, or long-term goals.
Ms Browne prefers a different approach, saying budgets can be too restrictive.
“Research has shown that budgets don’t work in the same way that diets don’t work,” she tells the ABC.
“At the end of the budget, people tend to bust out and spend that money on something other than what they had originally intended.”
Work out what works best for you
“The truth is that finance is personal,” Ms Browne says.
“There’s no one size fits all approach that works for most of us.
“The messier and more sustainable approach is figuring out the method and habits that are right for you.”
A looser budgeting option
Ms Browne’s anti-budget approach aims to make people feel less boxed-in.
She says to consider setting up your finances in such a way that you have a choice.
Steps to do this might include:
- 1.Understand what money goes in and goes out for your main household bills. This might include rent/mortgage, electricity, subscriptions, insurances, school fees, groceries and more
- 2.Understand what you have and what you owe
- 3.Create financial goals you’re excited about achieving and figure out what that means for the next 12 months
- 4.Set up bank accounts for your everyday expenses, bills, buffer, savings and investing, and set up automations to those accounts in line with your bills and your financial goals
- 5.Reassess every month to make sure you’re on track
“What does work is having shared goals, understanding your money, and setting up your finances in such a way that you’re prioritising your goals while at the same time, being able to enjoy today,” Ms Browne says.
Going back to basics
Mr James’s method also starts with outlining your household income and all your expenses.
He says your expenses will typically fall into two categories:
- Core needs: housing, groceries, transportation, utilities, etc.
- Everything else: lifestyle costs, subscriptions, holidays, clothing, etc.
This should give you an overview of where your money is going and some areas where you can cut back.
After that, he recommends setting up a banking structure that has accounts for all your needs.
“Think of accounts like weekly spending, essential bills, gifts/Christmas/holidays, and savings.
“Automating money into these accounts each time you get paid is the simplest way to ensure you build up surplus funds for all your needs.
“Plus, automating it removes the temptation to spend money unnecessarily.”
If you think a budget may be useful for your own circumstance, Mr James says it can “give you the reality check you may need”.
What are some other budgeting methods?
The two we talked about above are just two of many different ways to approach budgeting.
When you venture into the realm of budgeting advice on Google and social media, you’ll come across a bunch of different hacks and strategies.
We had a look at three mainstream methods you might have heard about.
50/30/20 rule
The 50/30/20 rule is a budgeting technique that divides your take-home income into three buckets.
In Australia, you might have heard a similar method created by The Barefoot Investor, Scott Pape — although his breakdown is a little different.
Think of each category like this:
- Needs: Rent or mortgage, car payment, utilities and groceries etc.
- Wants: Shopping, vacations, meals out and streaming service subscriptions etc.
- Savings or debt: Emergency fund, credit card payments, child’s education, retirement etc.
Separating wants from needs can be difficult. In general though, needs are essential for you to live and work while wants are something you desire, but can live without.
Here’s an example to consider:
John’s monthly gross pay after tax is $3,000.
The $3,000 of after-tax wages are what he will use when dividing his income according to the 50/30/20 rule.
That means John would have $1,500 (50 per cent) designated for needs.
He would have $900 (30 per cent) to spend on wants throughout the month.
And that leaves $600 (20 per cent) to pay down debt or save for the future.
Pros
- It’s a big picture budget and you’ve only got three categories to think about
- It recognises that your wants aren’t unimportant as you’re devoting nearly a third of your income to optional indulgences
- The percentages are a suggestion and can be altered to fit your needs
Cons
- You could still overspend — you might borrow from your needs to satisfy your wants
- Multiple bank accounts might mean you’re not offsetting any debt
- Doesn’t leave a lot for saving
Zero-based system
The zero-based method is when every dollar you earn has a function.
The goal is that your income minus your expenses equals zero by the end of the week/fortnight/month.
The difference between zero-based budgeting and living pay cheque to pay cheque is that all of your financial goals are met.
Here’s an example using a $3,000 monthly income:
| Expense | Amount |
|---|---|
| Rent (share house) | $1,050 |
| Groceries | $375 |
| Bills | $250 |
| Eating out | $150 |
| Insurance | $100 |
| Transport | $250 |
| Clothing | $100 |
| Entertainment | $120 |
| Streaming subscriptions | $25 |
| Medical | $100 |
| Emergency fund | $150 |
| Credit card payments | $125 |
| Travel fund | $100 |
| Gifts | $50 |
| Buffer | $55 |
| Amount left | $0 |
When creating a zero-based budget, you need to know your income, write down your fixed and variable expenses (you might need to track this for a few months), and then categorise them (with dollar allocations).
Pros
- Every dollar you spend is accounted for
- The system is customisable — you determine what money (and how much) goes where
Cons
- Can be a more involved budgeting system as you have to allocate every dollar somewhere
- Could pose a problem if you have an irregular or unpredictable income
Envelope system
Or otherwise known on social media as, cash stuffing.
Popularised by Dave Ramsey, this method uses cash in envelopes to control spending.
You withdraw your weekly/fortnightly/monthly pay in cash and then “stuff” it into categorised envelopes.
The point is that once the money is gone, you stop spending in that category. You then refill your envelopes after you get your pay cheque.
But because most of us pay our big bills like electricity and rent electronically, you can use the envelope method for all other expenses.
So, after you’ve accounted for all your online bills, then you can split the cash into other categories like fuel, eating out, groceries, next holiday, coffee, etc.
Pros
- More visual and tactile than adding and subtracting numbers
- You can physically see how much money you have left to spend on each category
Cons
- For digital consumers, it can be inconvenient to convert their pay cheques into cash
- You could be tempted to steal money from one envelope for another
- You could be at higher risk as you’re carrying large amounts of cash
- You’re not gaining interest as your money isn’t in an online account
Cost of living is making it harder to budget
Don’t beat yourself up if you’re overspending — especially on essentials.
“The cost of living crisis is making budgeting a challenge at the moment,” Mr James says.
“If possible, try to get your costs as low as you can in your current context, and know that you’ve done the best you can.”
He says that realistically, there’s only four things you can do to cut back:
- Increase your income (not always possible)
- Decrease your savings (not ideal but sometimes needed if you want to keep the status quo)
- Get a better deal on an expense item (e.g. insurance or electricity)
- Cut an expense completely (a sacrifice will need to be made)
“When things are tight, try and get micro — use fuel apps, grocery apps, and look for deals,” Mr James says.
“Basically, try and control what you can control.”
Disclaimer: This article contains general information only. You should consider obtaining independent professional advice in relation to your particular circumstances.
Are you a household budget whiz? We want to hear from you. Let us know in the form below what budgeting methods you’ve implemented to manage your household cashflow. We may be in contact for future finance coverage.
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