What is Budgeting?
This is the complete guide on using a budget to manage your money.
Budgeting isn’t about restrictive spending or living on rice and beans.
It is, however, about making an intentional plan for your money that provides clarity and direction in your financial decisions.
This guide covers budgeting basics, types of budgeting, and how to get started.
It will change everything about your relationship with money.
So, if you’re looking for a way to gain total control of your money, pay off debt, and build wealth, keep on reading.
What Is Budgeting?
Let’s just start with this right out of the gate: budgeting gets a bad rap.
Say the word budget to someone, and they’ll immediately assume the worst. Living on ramen noodles. Restriction. Deprivation. No more spending on fun things. In fact, a lot of people consider it a form of punishment for previous financial decisions. Budgeting means you are submitting to a sad and dreary life where money is this awful thing that just happens to you.
“I screwed up. Therefore, I must go on a…(gulp) budget.”
None of this is true. Not one bit. If you think that budgeting is this awful, demoralizing thing, I’ve got news for you: you’ve been budgeting the wrong way.
A budget is simply a plan for how to spend money.
The good news? Budgeting the right way is really powerful and can finally put you in control of your finances once and for all.
Types of Budgets
There are four common types of budgets:
- A static list of expenses
- Expense tracking
- Zero-based budgeting
Only one of these strategies—zero-based budgeting—uses a proactive approach to money management. That’s the route we recommend. Let’s first take a look at these other common budgeting approaches and why they don’t often result in long-term change or momentum.
A Static List of Expenses
When you imagine budgeting, it conjures thoughts of a list of expenses with a target amount next to each category:
- Rent: $1,200
- Electricity: $150
- Phone: $120
- Gas: $200
- Groceries: $150
(Is it actually $150 for groceries? Well, no. But you think it should be low like that. You’re on a budget, right?! No. We’ll explain the difference soon.)
That’s not budgeting. That’s just a list of expenses. Often, it’s just an optimistic, unhelpful look at expenses, like when groceries last month were three times as much as what you “thought” you should budget.
Everyone needs to take the time to sit down and make a list of their monthly and non-monthly expenses. This is part of budgeting, but it’s only the first step.
If you’ve ever saved receipts, used a spreadsheet, or used a free budgeting app like Mint, you’re well familiar with this type of budget.
Tracking expenses is extremely important. It gives you a crystal-clear picture of where all of your money goes. It is not really budgeting, though.
Picture you’re driving a car. You glance up in the rearview mirror and see a view of where you’ve been. That’s expense tracking. There’s nothing about the rearview mirror view that helps you take your next turn or keeps you from missing your exit.
Expense tracking is passive, rather than proactive. It creates a record of what happened without ever creating a plan for what should happen.
Tracking your expenses comprises a vital element of a successful budget but only makes up a part of the entire budgeting process.
Forecasting might be the most common budgeting trap. It’s almost our natural inclination to justify buying something today. “After all, I get paid this Friday.”
You probably have a list of your expenses created and an estimate of how much you’ll bring in that month. That’s called forecasting, and it will eventually get you into trouble, guaranteed. This mindset doesn’t consider how much money you have on hand right now, along with your other competing non-monthly goals and priorities.
At the end of the day, when you’re forecasting, you’re just guessing.
It’s like saying, “I’m planning to have barbeque chicken pizza for dinner,” without checking to see if you have the necessary ingredients in the house. Maybe you had chicken but used it to make soup two nights ago. You may have planned both of them, but there was only enough chicken for one dish.
Have you ever spent money you thought was safe to spend, only to wish you could get it back two days later? “Man, if I’d realized I need this money for the phone bill, I wouldn’t have bought new jeans.” You were probably forecasting.
This is where real budgeting comes in.
Zero-Based Budgeting or The Envelope Method
Zero-based budgeting requires you to earmark all of your money on hand to expenses, savings goals, and debt payments. Each month, your income minus your expenditures equals zero. Every dollar becomes allocated. With this approach, you cannot spend more than you make.
If one area of the budget becomes overspent, you have to pull from a different category to keep the overall total at zero. Anytime the budget goes from zero to negative, this is a stop sign for the budgeter to pause and correct.
If you’ve ever heard of the Envelope Method—this is a zero-based budget in action. A person gets their paycheck in cash and then has a pile of envelopes: one for rent, one for groceries, etc. They dole out cash to these envelopes until there’s no cash left on the table.
Sometimes, you may have to pull from other envelopes to cover overages. For example, if your utility bill is $20 more than what you have in the envelope, you need to pull money from another envelope (maybe Vacation) to make up the difference.
When you get paid next, you immediately put each of your new dollar bills into envelopes. This method makes it easy to ensure that you aren’t budgeting or spending more money than you actually have. Once you run out of dollar bills, you’re done budgeting/spending.
It’s also important to note that you are only budgeting/spending the money that you currently have. You can’t budget your next paycheck because you don’t have the cash to put into envelopes.
Rather than carrying all of your money around in cash (which some people do choose to do), you can use YNAB as a digital envelope system.
How to Set Up a Zero-Based Budget
1. List your monthly expenses.
Remember that “list of expenses” we talked about up top and how we said it was the first step? Create a list of all the things you spend money on: debt payments, mortgage/rent, utility bills, groceries, etc.
2. Add in non-monthly expenses.
These are expenses that don’t come up every month. The twice-annual car insurance payment? Holiday spending? Oh, and you’re pretty sure the car will need new tires soon. Don’t forget to add those to your list.
3. Add in goals.
You might want to save for your next car, a down payment, or a vacation. The sky’s the limit. You want your budget to represent your aspirations, and adding goals to your budget is an essential part of making them happen.
4. Add up your current money on hand.
Tally up money in your checking account, savings account (you can set this aside in a savings category if you want to keep it intact), and cash. This is the amount you can budget.
5. Assign the money.
This is where the cash would go in the envelopes. Dole out all the money until it’s assigned to a specific expense, savings goal, or debt payment.
Four Rules for a Successful Budget
Here at YNAB, we’ve found there are four simple rules for a successful budget and less money stress. Whether you use them with the YNAB app or not, they remain successful concepts for any zero-based budgeting system.
Rule One: Give Every Dollar a Job
Budgeting is assigning the money you have to your spending plan. This is the magic of a zero-based budgeting system. Here at YNAB, we call this Rule One: Give Every Dollar a Job, and it’s the foundation of YNAB’s method. Tell every one of your dollars what you want it to do for you before you spend it. Boss them around, even.
Rule Two: Embrace Your True Expenses
With Rule Two: Embracing Your True Expenses, there’s no more getting walloped on the side of the head with the twice-a-year car insurance, the three-times-a-year water bill, or the yearly holiday gift-a-thon. Rule Two teaches you how to bake these non-monthly expenses into neat-and-tidy monthly costs. You save for them equally all year, turning your monthly expenses from unexpected crunchy surprises to spoonfuls of smooth monthly consistency.
Rule Three: Roll with the Punches
Rigid budgets break. They break on paper, break your heart, and break your budgeting willpower. So with Rule Three, we future-proof the ol’ budget by Rolling With The Punches.
When (not if) you overspend on groceries, just move money from a less-important category. Our community calls this WAMing the money, which stands for Whack-a-Mole(ing).
Picture the classic arcade game: a mole pops up one place, then disappears below the surface and pops up in another. That’s your money, just reappearing in a different spot where it’s needed more. It’s robbing Peter to pay Paul. Only in this situation, you’re both Peter and Paul. Go to town and WAM away.
Rule Four: Age Your Money
If you’re here to break the paycheck-to-paycheck cycle, this rule is massive. Like life-changing, stress-busting, happy-dancing huge. Think of it like this: with Rule Four, you Age Your Money by using last month’s cash to pay this month’s expenses.
As you budget, you will naturally assign your dollars to the most important things, like quickly approaching bills. Then, you’ll move on and start budgeting for non-monthly expenses. So far, so good. You will reach a point where you’ve budgeted for the entire month, and you still have some money left. Every dollar needs a job, remember?
When you get to this point, you can start assigning dollars to next month’s job. Yeah, they’re mostly the same jobs as this month, but instead of waiting for next month to start covering them, get ahead of it by starting now.
Eventually, you’ll find yourself looking at your budget on the first of the month, and the entire month will be covered. You will feel amazing. Go grocery shopping any day of the week. Pay bills as soon as they arrive.
Side effects of following Rule Four include forgetting that it’s payday, feeling confident about paying the bills in the mailbox, and telling all your friends about this zero-budgeting magic.
Benefits of Budgeting
At this point, you’re hopefully feeling a lot better about budgeting. You’re now in control of your money and prepared for whatever expenses may come your way. Budgeting can even give you a few more superpowers to level up your financial game.
Here are four benefits of budgeting:
You’ll hit your goals.
Pay off debt, save more, or retire early. A budget lines up your money to set your financial goals and then achieve them.
You’ll build wealth.
Zero-based budgeting allows individuals to pay off their debt, break the paycheck-to-paycheck cycle, and then build wealth. As you learn to give direction to your money and line it up with your priorities, the snowball of building wealth tends to happen as a natural byproduct.
You’ll free up mental space.
An average person might make half a dozen financial-related decisions every day. If you don’t use a budget, all of this complicated information is taking up valuable space in your brain. A budget takes that mental load out of your brain and places it into an organized system, freeing up your thoughts and keeping you from worrying about money so much.
You’ll make decisions more confidently.
Budgeting gives you a clear decision-making framework for all your financial needs, big and small. And just wait until you have a big ol’ financial decision to make: do you buy the car for $10K or $20K? Can you afford that house? Can you afford to reduce your income? The budget will give you a clear view for effortlessly making that decision, with all the data you could want at your fingertips.
If you want more control of your finances, freedom to spend without guilt, and a tool to build your wealth, you need a budget. In fact, we all need a budget.
What are you waiting for?