The Personal Finance Podcast - How to Choose The Right Budget for You (Why budgets Create Freedom!)

Episode Date: February 3, 2021

Episode 39: How to Choose a Budget System (Why budgets create freedom)  The Reverse Budget  The Zero-Based Budgets  The 50/30/20 Budget  The Envelope system  Why budgets are freeing!  Savings Chart Stuff I Recommend!  M1 Finance Best Place to Invest  Personal Capital Free Wealth Management and Budget App  CIT BANK (Best Savings Account) ** Some links may be affiliate links and we earn a small commission at no extra cost to you. We only recommend products we truly believe in.  Make sure to check out the episode sponsor Turbo Debt: www.turbodebt.com/FINANCE Learn more about your ad choices. Visit megaphone.fm/adchoices

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Find your advisor at IG Private Wealth.com. On this episode of the personal finance podcast, we're going to talk about how you can choose the right budget system. Welcome to the personal finance podcast. I'm your host, Andrew, founder of dollar after dollar.com. And today on the personal finance podcast, we're going to talk about how to choose the right budget system. And if you don't have a budget, if you don't have a budget system in place, this episode is for you. Because I'm going to show you. the various options of budgets that are out there, and a couple of these that I have talked about in past episodes, but I'm also going to present to you some new budget systems that may work for you. And the reason why I want to show you a multitude of different budget systems

is because personal finance is extremely personal. And some budget systems may not work for you and your family and your personality, but they may work really well for other people. And those same systems that work for other people may not work for you. And one of the biggest things to do, before you get into thinking about which budget system you want to choose is you have to think about your own personal personality. Are you the type of person that needs to have everything strictly set up in order? Everything has to be tracked perfectly. Otherwise, it drives you crazy. If you're type

A, everything probably has to be tracked perfectly down to the penny. Or are you the type of person that can never keep up with a budget that's down to the penny? But feel like maybe if something was a little easier, if there was other easier options that would take you less time when working on your personal finance because you just don't want to spend a lot of time doing it, then that may be the better option for you. It all depends on your personal preferences. But what I'm going to do is I'm going to show you each of these systems, the pros, the cons of each of these budget systems. I'm going to tell you exactly what I do with my budget systems, and I actually use two of these. And I know that sounds weird, and I'll explain that later on, but I actually use two of these systems.

And before we jump into these systems, I just want to explain a few things about budgets, because what a lot of people think budgets are is extremely constricting. And that's not the case whatsoever. What a budget is actually there for is to create freedom for yourself. Most people see budgets as something that is going to take money away from the things where they want to buy. And it's exact opposite. It's actually allocating your dollars towards the things that you want those dollars

to do. It's putting your dollars to work towards your priorities. And that's the number one way to manage your money is, putting your dollars towards your priorities. Because if you're not doing that, you're just floating in the wind. Your money has no plan and you're absolutely going nowhere. But if you're putting your money towards your priorities, you're creating freedom for yourself.

And this is where money creates freedom. Because every dollar you put towards your priorities, towards things that bring you value, that dollar is doing exactly what you want it to do. And there's no other way to do this unless you have some sort of, of budget system in place. And maybe you hate the word budget because you've had a hard time budgeting in the past. You can call it money management.

You can call it cash flow management. I don't care what you call it. But at the end of the day, you have to have some way to move your money towards what you wanted to do. It's the only way to get ahead financially. It's truly the only way to get ahead financially. I don't care if you have a million dollar a year salary. You still have to have a budget.

There's a reason why there's so many doctors and lawyers out there who have huge salaries who are completely broke because they have no way to manage their money. There's a reason why athletes go completely broke because they have no way to manage their money. People who have made well over a hundred million dollars over the course of their career go completely broke because they blow it over and over and over again. And there's only one way to reel that in. And that's managing your money properly. So what I'm going to do is I'm going to show you four systems. And of each of these systems, some may work for you, some may not work for you. And if one just seems like it's way better than the other is give it a shot. If it doesn't work for you, then try a different one.

But understand this. No one ever has a perfect month budgeting. So if your budget isn't perfect the first month, I've never had a perfect month in my entire life. So if your budget isn't perfect, just roll with the punches, move money around, and go to the next month. That's what you have to do with the budget. You can't just quit because you messed it up one time, because you blew it up one time. You got to start over again, pick yourself up, and move on to the next month. So let's get into how to choose the right budget system. So the first budget system is called the 50, 30, 20 budget system. Now, where did that name come? The 50, 30, 20 budget system. What that means is you're going to set up a budget where 50% of your income goes towards your needs, 30% of your income goes towards

your wants, and 20% of the income goes towards savings or paying down debt. So what do those categories actually mean? What qualifies each piece of those categories? Well, let's look at the needs categories first. So needs would be anything like groceries, your rent, utilities, electricity, water, those types of things all fall under your needs category. It's things that you can't operate and live without. If you drive a car, this could be gas money. It could be home maintenance bills. It could be repair bills. All of these things fall under the needs category. And then you have the once category.

So 30% would go towards your wants. So your hobbies, your vacations, your dining out, your Netflix subscription, your jujitsu lessons, your two tickets to the synchronized swimming invitational. All of those would fall under the once category. It's anything that you want, all your things that bring you value, that bring you joy that you add on top, all those wants that you have, those would fall under the 30% want category. And then finally, the last thing would be 20% towards your financial goals. So this is your savings goals.

This is paying down debt. This is putting money towards your kids college fund. All of those would fall into the 20% category. And it's pretty simple to set this budget up because what you have to do is you set it up by calculating how much money you make each month. What's your monthly income? And there's a couple of ways that you can do that. You can look at your old bank statements, just add up how much you make each month.

And if it's consistent, then you have a consistent way. to measure what your income is. If it's inconsistent, then you're going to have to do a yearly average of some sort. And then once you have your income calculated, then what you're going to do is figure out how much fits into each category. So there's a few calculators out there online that you can do this really, really quickly with. But let's say, for example, that you make $5,000 a month in household income.

So the way that would work is if you made $5,000 in income every single month, $2,500 would go towards your necessities, your needs, $1,500 would go towards your wants, and $1,000 would go towards your savings or paying off debt. It's a very simple budget to understand, and it's very simple to set up. Now, a lot of people like to recommend this budget. I, for one, am not one of those people. Now, this is a great budget for someone who loves their job and wants to work for a long period of time, because if you want to work for a long period of time, then a 20% savings rate is great.

But what I don't like about this 20% savings rate is it's not all going towards investing. So 20% going to investing is a good starting point. But you're going to be working a long time if you're only saving 20% of your income. But if 20% is going towards paying down debt and saving, now you're really decreasing your savings rate significantly. And what I prefer to do is save more money towards my financial future than to be spending more money on needs and wants. Now, some people may feel different.

And that's why this may work for you. I'm not a yolo guy. I'm not a you only live once guy. But if that's you and you want to spend more time on things that bring you joy now, then you do you. This may be an option for you. But for me, the savings rate isn't high enough. And let me explain why.

So if you go to www. dollar after dollar.com slash savings rate chart, what this is going to show you, and I'll leave a link to this in the show notes, but what this is going to show you is based on your savings rate and how much you're saving each month, How long will it take you to retire? Now, if you love your job, 20% savings rate is great. But if you don't love your job and you want to retire early, a 20% savings rate means you're going to be working your entire life. So understanding this now, as soon as possible, can totally change your life.

Because if you understand this, which most people don't understand this, but if you understand this, it's going to completely change your life. And I challenge you to go look at this chart because a 20% savings rate means that you would have to work for 37 years. 37 years before you can retire. Bump that up to a 30% savings rate. Now you're at 28 years. Bump that up to a 50-50% savings rate. Now you only have to work for 17 years. So see the power of adjusting that number.

All of a sudden, you're buying time. And that's why we talk about how money buys freedom, because you're buying time back. If you only save 20%, you're going to be working an additional 20 years longer than you would if you save 50% of your income. And so the measly, 20% savings rate is my biggest problem with this budget. Now, if you love your job, let's say

you're a professor and you want to work for a long, long time, then this is a great budget for you because it allows you the flexibility to have options, it allows you to spend more money on your wants, and allows you to continuously work and have a savings rate that will still give you a great nest egg when you retire. But if you're someone who has a bunch of people around you that you do not want to work for a long period of time and you want to get out of there as fast as possible, then you need to increase that savings rate. And if you want to know how fast you need to increase that savings rate, look at this chart. And that's not to say, but this savings rate, if it's a 20% going to savings and paying down debt, if you're paying down debt with half of that,

then you're only at a 10% savings rate. And a measly 10% savings rate means you're going to be working for 51 years. And that's a major problem. That is a major problem. It's why I have the biggest problem with people saying save 10% of your income or save 15% of your income. Yeah, you can do that at the beginning and that would be great, but you need to increase that every single month, month over month. So see if the 50, 30, 20% rule would work for you. It definitely didn't work for me. I remember when I needed to hire someone fast, but finding the right person quickly felt impossible. And if you've ever been there, you know how stressful this can be. That's where Indeed comes in. When it comes to hiring, Indeed is all you need. Instead of struggling

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For Jeff, trying any salsa is like playing Russian roulette with a flamethrower. Luckily, Jeff saved with Amazon and stocked up on antacids, ginger tea, and milk. Habaniero? More like habanier, yes. Save the everyday with Amazon. The second budget option. And this option is probably what your grandma did way back in the day. And you've probably heard about this option in the past because it was a popularized option for a long period of time.

And that is the envelope system. Now, if you're not familiar with the envelope system, it's an archaic way to kind of go backwards and start spending all your money in cash. Now, this is great for people who, A, have credit card problems because it forces them to have to only spend their money in cash. so they only spend what they have. So if you're prone to going into debt, especially if you're prone to going into significant debt, this is a fantastic system to have into place because you're only spending what you have in each envelope. So here's how it works. You're going to set up budget categories and envelopes. So let's say, for example, you need to spend $500 a month in groceries. That may sound like a lot to some people. It may sound like a little to some people. If you have

kids, you may need a lot more. If you don't, if you're a single person, you may lead less. I don't know what your situation is. But let's just say for an example that you have to spend $500 a month on groceries. So what you do at the beginning of each month is you put $500 cash into that envelope. And that's all the money you can spend on groceries every single month. So you're going to take your $500 envelope to the grocery store every time you go and you're not going to bring anything else. And that is what you're going to spend on groceries. And if you spend less that month, it can roll over or if you spend more that month, it's impossible because it's in cash in the envelope. So this is a way to limit your spending if you're an overspender. Now there's a few

reasons why I think this is fantastic. If you're starting off, this is a good system to see how budgeting works. But if you're prone to giving up on your budget a lot, this takes a lot of extra work. You have to go to the bank, get the cash out. You don't get the extra perks and benefits of credit card reward points. And it's just all around a more arduous task to have to do. And what I like to do with money is make it as simple as possible. So if you have some of those qualities and traits, then this may not be the best option for you, but it has worked for millions and millions and millions of people. Now, there is an app out there. I think it's called the good budget app that works with the envelope system.

So it's basically the envelope system, but you don't have to deal with the actual envelopes and that digitizes this system for you. And that may be an app that you want to look at to digitize this system and make it a little bit easier if you think this is something that sounds good to you. If you're an overspender or someone who just wants their categories to be exactly set up before each month. Now you may say, well, I don't have $500 before the month. How do I actually implement this system if I can't put $500 cash?

each month in there. Well, in those types of cases, you'd put $125 a week in there, and then all you can spend is $125 a week. Because truly your budget is broken down into weekly spending anyway, especially for weekly occurrences like the grocery store. So if you can break it down that way, or if you go buy weekly, then $250, it just depends on how you go, then you can break it down that way as well. Now let's get into the two budget systems that I use. So the third budget system that I'm going to talk about here is one that I think is the simplest budget system of all. It takes the least amount of time. It's the easiest budget system to implement. And truthfully, I think is one of the best for most people. Because a lot of people quit.

A lot of people don't care about the granular breakdown of every single category. And a lot of people just want whatever is the fastest, easiest way to budget without having to worry about the budget all the time. And this is what I call the reverse budget. Some people call it the pay yourself, first budget, there's all different names for it. And this budget originally came up a while back when I was reading a quote by Warren Buffett. And one of his biggest financial pillars that he talks about is paying yourself first. So every time you get paid, you save money towards your financial future first and then you spend what is left over. Because paying yourself first guarantees that you will actually use that money towards what you wanted to do, which is investing or paying down debt.

And that idea, which is a long-term idea, Warren Buffett didn't come up with that idea. It's hundreds of years people have been doing it that way. But taking that idea and implementing it into a budget becomes an extremely simple process. Because all you do is you take your savings off the top. So let's say you want to save $2,000 a month. You take your savings off the top, you save that $2,000, put it aside into another account. And then the rest of the money that you have left over, that's the money you spend on your needs and your wants. And it's an extremely simple process because as you can see, you're just automatically saving money every single month.

And what I would do is I would automate this, and this is how I do it, is you automate that money every single month. So you're going to save X amount of dollars every single month. It automatically transfers into another bank account every time you get paid. And the rest of the money that's in your checking account, you can spend. And it's so incredibly simple. It's so stinking easy that anybody can do this. And you don't have to spend a lot of time because if you set it up automated, you don't even, have to spend 10 minutes on this every single month.

Because once it's automated, it's going to automatically work for you and whatever you have in your bank account you can spend. Now, the downside to this is I don't think it's the most efficient way to budget, but I think it's the best way to budget. Now, what do I mean by that? I think people can stick with this more consistently than any other budget out there. And consistency in finance is what matters. Consistency, if you want to get ahead with your money, you have to be consistent.

Because if you're not consistent, you're going to get ahead. then fall backwards. You're going to take two steps forward and three step backwards over and over and again. You'll literally never get ahead. But if you stay consistent with your budget and say consistent with your cash flow management and consistent with your investing, you're going to get way farther ahead than anybody else who doesn't. And that's why this is so massive because I think people can consistently stick to the reverse budget. I think people can consistently do this and do it with persistence because it's so easy to do that literally a little kid can understand this. So most of you out there who haven't been able to stick to a budget for a long period of time,

this is a great system to use. Now, how would I automate this? I would set up automatic transfers into your savings account from your checking account and your brokerage account every single paycheck. So if you want to save $2,000 a month, I would save $1,000 every paycheck if you get paid biweekly into either your brokerage account

or your savings account. And then I would use personal capital to track your net worth and make sure that your net worth is going up every single month. I'll leave a link for personal capital in the show notes. That is an affiliate link. But personal capital is free. So it doesn't matter for you at all. But I would use that to track your net worth.

That way you can just see if you're on track. And it's a coolest app. It's really, really slick. You're going to absolutely love it if you've never used it before. Now, the fourth budget system. And this is the one I use the most frequently, is called the zero-based budget. And the zero-based budget is you're literally allocating every dollar towards a category.

So you give every single dollar a job. I'll go through all my budget categories with you guys, because I want you guys to see how I do it. But it's extremely important. Rule number one is to give every dollar a job. That means every time you make money, every dollar that comes in, you have to give it a job. So $10 goes to lawn care.

$1,500 goes to your mortgage or rent. Every dollar gets a job. Every dollar has somewhere to go. Because what that does is it allocates your money towards your priorities. And the reason why I think this is the most efficient, budget system is you can take advantage when you either overspend or underspend in certain categories. Because the second rule of a zero-based budget is to embrace your true expenses. So what that means is, let's say you have to pay your car insurance every six months.

And every six months, your car insurance is $600. Well, instead of getting surprised by your car insurance bill every six months, what you do in a zero-based budget is you save $100 every single month towards your car insurance. insurance. That way, at the end of every six months, you already have the money right there to give to your auto policy. And it's extremely simple way it reduces stress significantly because there's zero surprises. You have everything planned out already. It allows you to take control of your money because you're never going to get in surprising, sticky situations because you're planning for every situation. What happens to a lot of people is their emergency funds get so big that they actually have to

start moving money around so they can save more of their emergency funds. because this allows you to plan for certain things. I have a category for car repairs. I have a category for home repairs. I have certain emergency fund categories that will tackle certain situations. And then the third rule is, and this is what I always talk about with budgets, is you need to be able to roll with the punches. Because if you can roll with the punches,

you can make significant adjustments when you have a bad month. You blow up your budget, which is every single month. Everybody blows up their budget every single month. Nobody has a perfect month. And if you understand that, then you can understand, oh, shoot, I overspent $100 on groceries. Let me move $100 over from my auto repair category to cover the overspending I did on the groceries.

That's how you do it. You don't give up. You don't quit. You just make adjustments as you go. Adjustments are part of this game. And then the last thing with the zero base budget is you want to age your money. So you want to be aging your money for a long period of time.

Now, what do I mean by that? What I mean by that is when you get paid in June, you won't be spending that money until December of that year after a long period. period of time because aging your money gets you months ahead and allows you to take the stress out of your money so to start off your first goal should be hey i want to spend last month's money on this month's bills so the money you got paid last month will pay for the next month's bills that gets you one month ahead and there's an unbelievable power of being just one month ahead with your bills

because now your your money's running like a system and when surprises come up you already have the money there because everything is working in synchrony. And so that's why I love this system. This is the system I used the most. And it's the way I truly got ahead with my finances in the beginning. And I still use it to this day because of the amazing things it did for me. So consider this budgeting system because it's one of the best systems I think that are out there. Now, if you want to hear the episode where we talk about the reverse budget and the zero base budget, I dedicate an entire episode to that early on in this podcast. And if you go back to episode five, I believe is what it is.

It's called why budgets aren't boring. And we go through exactly why that is. So if you haven't heard that episode, go check that out if you're interested in those two budgets, the zero base budget and the reverse budget. Now, before we wrap this episode up, I just wanted to remind you that all budgets are there to do is to spend your money on your priorities. And only you can decide which budget's going to work for your personality and for your family's financial needs.

But understanding all the options that you have out there and trying them out if one really didn't work for you is the best way to reach consistency because consistency equals true wealth and true wealth equals freedom. And that's all it's there to do is create freedom for you and your money. That's what budgets do. Understanding where your money is going is the most powerful thing you can do with your money. So look into these systems, see which one works best for you and take action right away. Thank you guys so much for listening. And if this is your first time listening, Consider subscribing so you never miss an episode. And share this episode with a friend.

And don't forget to leave a rating and review on iTunes as well, because our goal is to bring as much value to you as possible. And we're trying to spread this message that money can buy freedom. That's what money is there to do, is to buy more freedom. So thank you again so much for listening, and I hope you have a great day. Rosen lasagna, medium power, 15 minutes. Sounds like Ojo time. Let's play.

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