Tuesday, October 19, 2010

Setting A Monthly Budget: What’s The Most Efficient Method?

8:05 AM |

Since the beginning of setting up our monthly budget, we’ve struggled between two methods for providing cash flow every month. While both methods work and are reliable, the question remains: what’s the most efficient method? Which budgeting tactic truly saves us the most money every month? Before we get to the two methods I’m discussing, let’s start out with one principle that has kept us on the straight and narrow:

Spend This Month’s Income Next Month

This one has saved us time and time again. The whole idea behind this principle is that this month, you only spend the exact amount of money you earned last month. This can help your budget in a number of ways:
  1. It ensures you have a buffer for spending during the month. You most likely won’t have to worry about what days you get paid, when your bills are due in relation to your checking balance, or if you’ll ever overdraw your accounts. This is an awesome way to cut down on your stress.
  2. It ensures that you spend based on what you actually earn, not what you think you will earn. At the end of the month, you’ll be able to count up your paychecks and total them to use that figure to spend for the next month. No more will you have to guess what your income will be for the next month. Instead, you can just spend what you’ve already made!
  3. It provides a visual of the results of your work. As you go throughout a month, your paychecks are counted up and you can clearly see how much money you’ll get to spend next month. This provides motivation for doing well and earning as much money as you can.
Note for the wealthy: as you move through your financial plan, you might want to put a cap on how much money you save for the next month if it exceeds your monthly expenses. The rest of the money can be used immediately for investments, further savings, etc.

Two Methods In Question

Once you get to the end of a month, you’ll likely have some money left in a few categories. The question becomes whether that money should be left in those categories or if the categories should simply be funded up to a cap. Allow me to explain:
Let’s say you have a “utilities” budgeting category. This category is funded at $250/month. You spend $230 within a given month for utilities. Now, when you’re budgeting for the next month, do you simply refund this category with $230 dollars to bring it back to $250 or do you fund it with another $250 to bring it to $270? I suppose this depends on your average expenses throughout the month. If you’re averaging $250 in expenses, you’ll probably want to fund the full $250 again when you reach the next month. If you’re averaging $230/month, you might be safe with funding the category with what you spent from last month.
This question gets more complicated when you start talking about discretionary categories versus mandatory categories. Our rule of thumb? If it’s an envelope, roll it over (to encourage savings of discretionary categories). If it’s a debit category, put a cap on it to push extra funded into our area of focus (like our emergency fund). However, every few months, it seems as if we should change whether or not certain categories have caps.
I’m asking you! How do you budget your money? Perhaps you keep very little in your checking account and dip into savings when the going gets rough. What do you think about the two methods in question? To recap:
  • Method 1: Fund budgeting categories up to a cap.
  • Method 2: Fund budgeting categories with a fixed amount of money every month, even if some money rolls over from last month.

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