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Brief Look at Five Budgeting Systems
Posted By Jim On 04/09/2008 @ 6:12 am In Personal Finance | 16 Comments
One of the interesting discussions that came out of the Personal Finance Blogger’s Conference in San Francisco was a discussion of how people budget and some of the budgeting styles. While we didn’t explicitly go over some of the more common budgeting systems, I felt it would be useful if I hit on a few to see where their benefits and drawbacks are.
Personally, I did the Track to the Penny system for a few months until I got a good handle on my monthly expenditures, then I essentially did the Reverse Budgeting/Nothing strategy. In between the two systems, I reviewed my expenditures to see where my spending was going and whether I could make some improvements. I saw that I was eating out far too often, a detriment to both my wallet and my health, so I took steps to start buying more groceries and preparing lunch more often.
The appeal of envelope budgeting is in its simplicity, though there are plenty of tools out there that will gladly make it more complicated for you if you’d like. The system relies on a series of envelopes, hence its name, to budget and each envelope contains a fixed amount of money for that expense. An example would be an envelope for groceries, where all grocery expenditures would come from that envelope. If an envelope is depleted, the funds must come from another envelope in the system.
Benefits: Simple to use, intuitive, and fixes your expenditures at a certain amount. In monthly reviews, you can see which envelopes are consistently non-zero and use that to adjust your budget.
Drawbacks: Cannot handle large emergencies, as a big emergency could break the bank. Limits the number of categories you can track, unless you have a million envelopes, and is less flexible in our credit-happy age.
Reverse budgeting is the idea that you save first, then spend the rest. This system is a back-ended system in which you force the savings, thus guaranteeing it, and then let the chips fall where they may on expenditures. By auto-drafting these savings out of an account, you essentially guarantee you won’t “accidentally” spend them away. An example of this would be if you set your 401(k) contributions ahead of time to draft from your paycheck and then let your spending go where it goes.
Benefits: Simplest process of them all, simply save and then you can spend from one big envelope.
Drawbacks: Lacks visibility into expense types for expenditure improvement, doesn’t force you to have the “budget discussion.”
With “Track to the Penny” budgeting, you track every single expenditure you make into a giant spreadsheet as you make it or in batches at the end of the day. You can then use this information to make future decisions about spending and this helps you identify “budget leaks,” or those small expenditures you don’t think about but end up costing you a lot each month.
Benefits: Total visibility into your spending, tremendous amount of information, a statistician’s wet dream.
Drawbacks: Most labor intensive, may give too much visibility, easiest to discard because of time requirements, relies on your ability to correctly categorize spending. This also doesn’t force a “budget discussion” but does provide good information for the budget discussion later on.
Similar to Track to the Penny, Track to the Dollar just means you can round up or down each expenditure to the nearest dollar with the belief that it will all average out.
Benefits: A little less visibility compared to “Tracking to the Penny” but still a statistician’s wet dream.
Drawbacks: Still requires a lot of labor to keep track of incremental expenses, but less so than Tracking to the Penny.
Not budgeting is a budgeting system but it requires that you have an income that comfortably exceeds your expenses and probably not a good place to start. In our discussions, SVB  mentioned a “black box,” referring to the budget, where she said that once you get a good handle on your budget you really don’t need to track it anymore. JD  then said that budgeting is most valuable when your income and expense lines are very close… it’s less valuable once your income exceeds your expenses.
Benefits: It’s the easiest “system” because you do nothing!
Drawbacks: You get no visibility into your expenditures because you’re not tracking anything!
How do you budget? Do you have a good system in place that you want to share?
(Photo by kevincortopassi)
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