Last updated August 10th, 2019.9 minute read
There are many types of budgeting. Many of us might just think of a stuffy Excel spreadsheet with a bunch of numbers.
However, there are actually many different ways to make a budget. By understanding each method of budgeting, you can find one that works for you.
Why Are Budgets Important?
Budgets are important for a number of different reasons. For example, if you are having trouble keeping your spending under control, a budget might be useful.
It may not be what you expect, but for many of us, we don’t know where our money is going until we really keep track of it. You might be shocked to find the ways in which you are wasting money.
Do I Need a Budget?
As suggested in the previous section, it is not necessarily the case that every person must have a budget. For example, if you are naturally frugal and do not have children, it’s possible that budgeting isn’t necessary.
In the FIRE community, there are many SINK (single income, no kids) people. This could mean they are single in terms of relationship, although it doesn’t have to. What is does mean is that their expenses are probably fairly simple. So, they may not have a budget.
For more on this, check out my post on why you might not need a budget.
In reality, whether you need a budget is a judgement call. Since I can’t know your exact financial situation, I cannot make a blanket suggestion.
If you just can’t decide whether you need one, you could always try it and see how it is. Or, you might want to meet with a certified financial planner (CFP). Meeting with a professional who is an expert on budgeting issues could help set you on the right path.
Types of Budgets
In this post, we’ll address some of the many different types of budgeting. Hopefully, with so many types of budgeting, you will be able to find one that works for you.
Setting up a budget is one of the first steps to getting your finances in order, especially if you are struggling.
Remember, at the end of the day, the important thing is to understand your own spending habits. Once you know where your money is going, it’s much easier to keep it under control.
One of the most common types of budgeting is monthly budgeting. The way it works is pretty simple: at the beginning of the month, write down your monthly income. Then, subtract all of your recurring expenses, such as house payments and utilities.
Then, throughout that month, track your expenses. Track every dollar spent. At the end of the month, you will know your total expenses compared to your income.
Hopefully, you have some money left over. In fact, hopefully you are saving a little bit.
But the exact amount you should budget for the next month will be up to you. What are your goals? Typically retirement advice is to save 10-15% of your income, but some FIRE people are saving 50% (and even more).
I’m not saying you need to spend 50% – I’m saying you should as much as you can, but at the end of the day, it’s up to you. Only you can decide what your financial goals are. Plus, I don’t know what your expenses are. It’s likely you can cut some things, but just how much you can cut is impossible to know as a generality.
The Challenges of Monthly Budgeting
Monthly budgeting might be one of the most common types of budgeting, but it can be a struggle sometimes.
One of the biggest challenges of budgeting for an entire month is knowing exactly how much you need. Although the approach I detailed in the previous section should give you an idea, it’s not perfect.
You may know what your expenses were last month, but expenses vary. Not just utilities, but maybe you had a lot of unexpected, yet necessary expenses pop up. So, what do we do when that happens?
The best thing you can do is to have a cash reserve. You could also call this an emergency fund; typically 6-8 months of living expenses are recommended.
If expenses are unusually high in any given month, you could pull from that fund. Then, at the end of the month, you should reevaluate your budget. Do you need to increase it?
Oh, and don’t forget to replenish what you pulled from your emergency fund!
Similar to annual budgeting, weekly budgeting involves tracking your spending on a weekly basis. Every week, you would have a certain amount you are able to spend.
If you go over that amount, you are over budget and will need to cut back. The good news is that it’s only one week, so if do go over, there’s a good chance you’re close to having more budgeted funds available.
I reviewed an app by the same name, Weekly Budgeting, that will help you with this.
A static budget is a budget that never (or rarely) changes. That means that regardless of possible circumstances or expenses, your budget remains the same.
This type of budget is usually used in the business world, but you can see how it might be used as a personal budget, too. Someone who wants to exercise exceptional financial restraint might consider a static budget.
Of course, unexpected expenses have the potential to derail such a strategy. Regardless of your goals, that might be a difficult hurdle to clear.
However, if you can structure your budget in such a way that it still works, there is definitely value in such a budgeting strategy.
A flexible budget is one that changes based on needs. While some expenses, such as utilities, might be the same every month, other may vary.
A flexible budget allows you to accommodate those fluctuations without having to stress about them. This is unlike a static budget, which requires you to have the same expenses every month.
One can imagine many scenarios in which a flexible budget would be beneficial. Those might include a month with a large, unexpected expense. Or you might take a trip that costs quite a bit. Either way, expenses fluctuate.
Incremental budgeting works by making changes to last year’s budget. You would simply add expenses, remove expenses, or increment expenses.
To increment means to add or increase. In most cases, this will happen due to inflation if nothing else. Cost naturally rise over time regardless of lifestyle inflation.
As you can probably guess, annual budgeting involves mapping out your expenses for an entire 12-month period. You would then essentially mold your costs to fit into that budget.
There are distinct advantages and disadvantages with this budgeting method. On the one hand, budgeting an entire year means you would know exactly what your expenses will be.
For an individual, 12 months is a long time to budget all at once. Over such a long period of time, unexpected expenses are almost inevitable. And when they do happen, how will you handle it?
If you have to cut spending on things that are essential, this method could create a lot of stress.
Activity Based Budgeting
Technically, activity based budgeting is a business method of budgeting. However, to a certain extent it can be applied to individual budgets as well.
One of the main features of activity-based budgeting is that it does not consider the previous year’s expenses. Thus, you would analyze all of your costs each year in order to decide create a budget.
Doing such an in-depth analysis every month, or every year, will certainly take time. Of all of the types of budgeting, this might be the most rigorous. However, it also gives you a chance to identify expenses you may have missed before.
This type of budgeting, also referred to as budget envelopes, is a simple one. You quite literally use envelopes to manage your budget.
Here’s how it works: you label several envelopes according to all of your variable expenses. Thinking gas, groceries, entertainment, etc. Each one of these is a budget category.
Every month, you determine how much you will spend on each budget category. This can be the same every month if you want. Then, as you get paid, add cash to each envelope – if you get paid twice a month, you would add half of the amount each time you get paid.
For example, say you budget $200 a month for entertainment and get paid twice per month. You would then put $100 in cash in your “entertainment” envelope two times each month.
If you wanted to spend $150 on entertainment before your second paycheck of the month, you would be out of luck. You would have to limit yourself to $100 or wait until you get paid again.
Then, when you know you are going to spend on one of those categories, you pull cash out of that envelope. If you end up using all of the cash, you can no longer spend on that category. At least not until you get paid again!
As its name suggests, this type of budgeting is specific to events. That might be a big vacation, a wedding, and so on.
This is not something would need to do on a weekly or monthly basis. Still, it’s worth mentioning because events can get very expensive. If you don’t have a budget to help with costs, they could easily get out of control.
As a general rule, with event budgeting, you should know how much you want to spend ahead of time.
But you wouldn’t just determine how much you’ll spend in total. Instead, you would actually make it granular. For example, if you’re going on a vacation, you might determine how much you spend on flights, hotels, etc. before you spend the money.
Types of Budgeting: Conclusion
With so many different types of budgeting, hopefully you have found an approach to help you. Keeping a budget will allow you to save, invest, and eventually retire.
But on a more basic level, a budget will help you avoid financial peril. Keeping a budget will help set you on the right path toward accomplishing your financial goals.
If you are constantly spending money but don’t know where it’s going, you probably need a budget. If you don’t feel budgeting is a problem for you, it may not be necessary. However, it’s always good to try it out for a while; you never know what you may find.
What is your favorite type of budgeting? Let us know in the comments.