Proper distribution of income and expenses is the foundation of financial literacy. Earning money is good, but managing it wisely is even better. To understand how to spend, save and invest properly, we have prepared for you several time-tested methods of budget allocation.
To make budget planning more pleasant, choose a place where it’s more convenient for you to keep your notes:
- On paper – in a notebook.
- In a table in Excel or Google Sheets – it’s especially important for large-scale and complex calculations and is suitable for organizing not only personal, but also work finances.
- In an app on your phone – that’s the most popular way, where everything is automated and always at your fingertips.
Table of Contents
Income and Expenses of the Family Budget
The easiest place to start is with income. First, they usually have fewer sources than expenses, and second, it’s the most enjoyable part of family budget planning. The main sources of income usually look like this:
- Wages, advances, bonuses.
- Scholarship, pension, alimony, social security benefits.
- Gifts, lottery or contest winnings.
- Interest on a deposit, a grant, dividends.
Unlike income, expenses are diverse, and therefore, it’s much more difficult to describe their components. For convenience, expenses can be classified by level of importance, frequency, and size.
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Level of Importance
Earned money is primarily spent on necessary expenses, and the remainder is allocated to other items, going into savings or investments. Three categories of expenditures can be distinguished according to this characteristic:
- Obligatory: food, rent and utilities, credit, clothing, medicine, communications.
- Unnecessary, but desirable. You can do without them, but they improve quality of life and mood: entertainment, shopping, going to the stores and cinemas, playing games at https://vave.com/live-casino, enjoying new hobbies, and visiting beauty salons.
- Luxury goods. Here everything is individual and depends on income. People can easily do without them, but it’s for these items or services that people save up or take money on credit: cars and modern gadgets, brand clothing, antiques and travel.
Annual spending can be divided by 12 and added to each month’s expenses, then you won’t have a financial hole from a big once-a-year spending spree. Important goals that require a lot of money can be broken down and set aside for them gradually.
- Permanent. Groceries are things we spend on weekly or even daily. It can be a planned trip to the hypermarket or an impulsive desire to eat something delicious from the store near home. If you have a car, this includes spending on gasoline; if you don’t have one, it includes spending on public transportation, carsharing and cabs.
- Monthly. This includes utilities, loan payments and payments for telecommunications and Internet services, as well as children’s clubs and sports subscriptions.
- Annual spending includes travel and vacation expenses, tax payments, and insurance.
- Variable. This category includes repairing or buying appliances, buying new clothes, medicines, household and household goods.
- Seasonal. This includes winter and summer clothes, winter tires for cars, heaters or air conditioners, and trips to a sanatorium or children’s camp.
By size, spending can be divided into:
- Small: food, household expenses, travel (public transportation or gasoline).
- Medium: entertainment, movies and theater, small appliances, household goods, clothing.
- Large: travel, car, appliances, home repairs, etc.
Ways to distribute a family budget vary, but spending on groceries is usually handled separately. Expenses depend on your lifestyle, family composition, and other factors. Here are the items that some people don’t have, but others have a significant portion of their budget:
- Children’s out-of-pocket expenses.
The Classic Envelope Method
The name of the method speaks for itself – it’s one of the oldest and most proven methods, which many people have turned to and still do. Nowadays, it has changed a bit, and people use bank cards instead of paper envelopes. The budget is allocated according to the category of expenses.
For example, food, utilities, clothing, car, and entertainment. For each group an amount of money is allocated, and you shouldn’t exceed this sum. Otherwise, you will have to limit yourself and, for example, postpone a trip or the purchase of some clothing for the next period. If you run out of money in the envelope with mandatory expenses, then you have to take from the others because this category is the main and cannot be postponed.
The expenses are analyzed, and according to the results the distribution of money in envelopes for the next period is adjusted. Thus, everyone individually forms a comfortable balance of expenses to cover the necessities and leave some amounts for entertainment. The money remaining at the end of the period can be allocated to savings.
The 4 Envelopes Method
It’s one of the basic and simplest methods of drafting, calculating and planning a personal or family budget. The amount of income for the month, which is difficult to control, is divided into four parts and put in envelopes (or other convenient places). Each envelope contains the amount of money needed to live on during the week.
To calculate the amount in the envelope, you need to divide the monthly budget into three points:
- Savings (at least 10 percent).
- Mandatory expenses (rent, utilities, loan payments, Internet and telecommunications, food and household).
- Additional expenses (gifts, meetings with friends in cafes, trips, birthdays).
The finances remaining after the top up of the first three items should be divided by 4.3 because there are not exactly 4 weeks in a month, but a little more. The resulting amount is the amount of money in each envelope. Your task is to fit your spending within the set amount.
If there isn’t enough money, you can take it from next week’s envelope. If there is money left over, it goes into the next period. The money left over at the end of the month becomes savings. This way you can control your spending. You don’t have to use real envelopes. You can keep a budget in any convenient program, for example, in a spreadsheet.
The Pitchers Method
Similar to the envelope method, but the income distribution is different. The method is considered uncomplicated, but it isn’t suitable for those who have loans in the bank or debts. The main task is to distribute all the money into 6 categories (pitchers) according to importance and priority. According to the rules, it’s forbidden to take money from other jugs, and each category has its own role.
- Pitcher #1. Put 55% of income to provide the most necessary and vital things. Food, clothes, and shoes, payment for transportation (cab, subway, bus, gasoline for cars), household goods and payment for housing and utilities.
- Pitcher #2. It’s designed for recreation. For trips to cafes, beauty salons, exhibitions, and restaurants 10% is allocated.
- Pitcher #3. This is the highlight of the method. This is where 10% of the return on investment is placed. The method assumes that money should make money, not lying around.
- Pitcher #4. This is where 10% is kept for unforeseen circumstances and force majeure situations. Anything can happen: equipment or car breakdown, illness, getting fired, theft. This Pitcher allows you not to grasp at loans like a life-saving straw.
- Pitcher #5. The 10% set aside here allows you to give friends and family gifts for birthdays, other holidays and gifts for no reason. You can also spend this money on charity.
- Pitcher #6. The last pitcher is where 5% goes for education, courses, buying themed books or sports equipment for sections. These finances go toward the physical and spiritual self-development of you or your family members, if we’re talking about a family budget.
The 60-10-10-10-10 Method
This method was invented by MSN Money consultant Richard Jenkins. The budget allocation here is similar to the pitchers method, but has different purposes. The method is not suitable for everyone, but it gives you a choice.
The entire budget of a certain period (most often a month) must be divided into 5 parts:
- 60% cover all fixed expenses: food, travel, clothing, housing and utilities, and beauty products.
- 10% goes to pension deductions.
- 10% is for large purchases (cars, apartments, expensive appliances, furniture) or payments (mortgages, loans, repayment of debts).
- 10% is irregular expenses, such as medical treatment, gifts to friends and family, small appliances, or repairs.
- 10% is entertainment and having a good time.
The main point of the method, according to the author, isn’t to follow the exact proportions set, but to meet the 60% of mandatory expenses.
Despite the name, the method is rather intuitive, but you can start with this allocation. It’s based on three categories: “need,” “want,” and savings. The formula allows you to divide your money in a 50/30/20 proportion, for example, for a month, and then see how you can change it.
Obligatory spending is 50%. This usually includes travel, medications, rent, basic necessities, and groceries. Usually the amount in this category doesn’t change much from month to month; it is also called a subsistence minimum.
Unnecessary expenditures are equal to about 30% of income. Often it’s going to cafes, movies, and events, buying books, clothes, and things related to hobbies.
That leaves savings, to which 20% of income is allocated. That’s a financial cushion – money that is saved for later larger purchases or for unexpected expenses.
This method puts money aside for savings first, and then for “must-haves.” If you manage to save less than 50 percent for obligatory expenses, then you have more left over for “want” expenses, but for many people, obligatory expenses are often half of what they are. After the first month of using this method, it will become clear what ratio you are comfortable with, which will allow you to save more money for important goals.
However, this ratio isn’t the only correct one. The author of this method – U.S. Senator Elizabeth Warren – says that everyone can change the proportions depending on their needs. The main point of this rule is to learn how to manage and plan a personal or family budget, to improve your financial literacy and to understand how much and what you spend.
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There are many ways and principles of allocating a budget. Each has its own structure, rules, and calculation formula. Some are good for families, others for personal spending, and some are ideal for people who have no credit. Everyone has different goals and results. You can try each option and choose the one you are most comfortable with. However, there are general rules for all methods that will help you manage your finances more efficiently:
- First, direct your money to mandatory expenses you can’t live without. This will make you feel secure. Money outside of this spending item can be spent further down the priority list.
- The proportions outlined in each method can vary and adjust to the specifics of your life.
- The main thing these financial management rules were invented for is not only to be able to accumulate the right amount but also to start paying attention to your income and expenses, increasing your financial literacy.
- A month is a convenient time frame in which to analyze and allocate your budget.
- Every member of the family can learn how to manage finances using any of the methods as an example. This is a useful skill that can be developed from childhood.
Take advantage of the insights of renowned financiers or make up your own way of managing a budget. Don’t be afraid to experiment within limits, and you can live comfortably without worrying about tomorrow.