This article was published in the New Haven Register on July 21, 2019.
Creating a household budget can help free you from debt and achieve your goals. Yes, it’s a little bit like calorie counting, but having a budget can liberate you from uncertainty and outsized credit card bills at the end of the month.
There are two basic types of household budgets: zero-sum and proportional.
With a traditional, zero-based budget, you write down your financial priorities first, then you track income and expenses in detail every month and make sure income minus expenses equals zero. If you are over or under, you need to identify the discrepancy to determine areas where you need to take better control of spending.
Over time you will understand where your money goes, and you can use that knowledge to find places to save money or ways to increase income, guided by your highly specific priorities. For example, if a priority is to set aside $500 per month to build an emergency fund and you have not been able to do so, you can delve into your expenses and find ways to save that money.
Proportional budgets are simpler and provide a framework for determining how much to spend without setting out detailed priorities or tracking every dollar. For instance, the 50/30/20 budget, popularized by Sen. Elizabeth Warren when she was a law professor, recommends that you spend about 50 percent of your after-tax income on necessities (needs), spend 30 percent or less on things that you desire (wants), and set aside 20 percent or more to invest in your future (savings, investments and payment of high-interest debt).
Needs include housing, utilities, groceries, insurance, transportation, child care, clothing and more. Wants include travel, eating out, gifts, video games and a coffee at Starbucks on the way to work in the morning.
Proportional budgets can work well for middle-income folks with moderate debt but tend to break down for people in deep debt or people with high incomes. Some critics say 30 percent is too much for a spending allowance, for instance. Also, it’s not as easy to identify areas to save money if you follow the proportional model rather than a zero-based budget.
Another challenge with the proportional model is the difficulty of deciding what is a need and a want: Do you need to go to the high-end gym or do you want to? Do you need numerous shrubs and flowers in the house and yard or do you want them? In addition, needs can transform into wants overnight: Clothing for work is a need, but designer jeans are a want. A car is a need, but a Mercedes is a want. These are clear examples, but sometimes the line is not so clear.
Whatever type of budget you decide to use, the biggest favor you can do for yourself is to automate the process by having your bank whisk money out of your paycheck and into your savings or investment accounts before you get your hands on it.
To stay motivated, write down your top two or three motives for following a budget and place them where you will see them every day. If you keep in mind the reasons you are making sacrifices, you will be more likely to stay the course.