Compare budgeting strategies: 50/30/20 vs envelope method vs zero based budgeting

Introduction

Instead of staring at a blank spreadsheet wondering where to begin, it can be useful to follow a framework for setting up your budget. All budgets have the same aim, which is to bring control into your spending habits, and leave you with money left over for saving or debts. Control over your money is one of the defining features of being financially secure.

When creating a budget, simplicity is key. If things become too complicated, then we have a tendency to switch off and not stick to it for the long term. In this article we will dig into three of the most popular budgeting strategies, and how they differ.

50/30/20 budget

What is the 50/30/20 budget

This simple budget was popularised by Elizabeth Warren (the US politician) in one of her books. The principles are to divide your net income into three categories, and split the sum in each category into percentages.

First you need to figure out your net income. This means, the amount that is paid into your bank account on pay day after tax, pensions etc is taken out. If you get paid weekly (assuming it is the same amount each week), take the amount you get paid after tax for the week and multiply by 52 to get your year's earnings, and divide by 12 to get your monthly net income.

Next you need to divide this income into three categories:

Spend 50% of your money on needs

50% of the money you earn after tax goes into the 'needs' pot. It is no surprise that this is the biggest chunk as it encompasses so much of our earnings including mortgages/rent, council taxes and all the other lovely stuff you need to pay to be alive in the UK.

Spend 30% of your money on wants

It is reasonable that you have a decent 'wants' category of spending, as it does encompass things like replacing clothing or your children's toys / hobbies. It makes sense that it isn't as big as your needs pot but also not the smallest. Living and enjoying your life is important for long-term change.

Stash 20% of your money for savings

And finally 20% is funnelled into a debt / savings pot. This should be distributed to your debts first. Once the debts are cleared you can move on to building a nice "Emergency Savings" or "Rainy Day" fund. You could even start investing in the stock markets for your retirement. Ultimately it is up to you, but this is a pot dedicated solely to paying future you.

It's that simple!

Pros

• Really simple to get your head around
• Limited mental gymnastics
• No need for a fancy spreadsheet

Cons

• Isn't very flexible
• The % ratios might not make sense with your income
• Assumes everyones priorities are the same
  

We covered the 50/30/20 budget in detail in another article. If you want a deep dive, then take a look.

Envelope method

What is the envelope method?

This method is a little old school in it's execution, in that it uses cash. It involves having a physical envelope for each line in a budget. Then you withdraw cash when you get paid and place the relevant amount for each budget line into the correct envelope. When you spend all the cash in that envelope, you can't spend anymore money for that purpose until next month.

How to do the envelope method

1.Create a budget

To know how much cash to place in each envelope, you need to create a budget with your main categories of spending. Start with your total net pay, and then divide it into different categories.

Here are popular categories that most people will use and find useful:

• Housing
• Energy bills
• Internet
• Groceries
• Entertainment
• Hobbies
• Clothing
• Car
• Gifts
• Restaurants

2.Create and fill envelopes for each category

Let's say you get paid £1,500 for the month and decide that you want to spend £400 on grocery shopping. Take an envelope and write groceries on it, then place £400 in cash from your bank into the envelope. Every time you go to the supermarket to do your shopping you take this envelope with you. Rule number one is to NEVER take cash from this envelope to spend on another purpose that isn't groceries.

Do this for each of your chosen categories.

Why does this work?

This works for a lot of people because it provides a visual representation of how much money you have left to spend, and stops people guessing. There have been many studies that show that people spend less when they pay with cash vs paying with a bank card. There is something inherently more painful about handing over the cash vs tapping your card. Tapping your card barely even feels like you are spending money.

What if I pay some of my expenses online?

The envelope method works best for the areas of spending where you physically walk into a store and can pay in cash. Think groceries or restaurants. The envelope method works very well in these scenarios

There are ways of working around this. Detail all your online expenses at the beginning of the month and the total you want to spend in this category and write it down in a notepad or on another envelope. Each time you spend online deduct off this total. When you are down to zero you can't spend anymore money online.

Pros

• Using cash limits card or debt payments
• People who spend in cash spend less
• Quick visual sense check on how much money you have left

Cons

• Regular trips to the cash machine
• Not everywhere accepts cash
• Not great for people who shop mostly online

Zero based budgeting

What is Zero based budgeting?

The clue is in the name with this one. When planning your income vs your outgoings the number needs to finish at £0 at the end of the month. This doesn't mean you have £0 left, it just means that you have accounted for all the money.

Say you make £2,500 in a given month. You account for the entire £2,500 across savings, investments and spending. There isn't any money left that doesn't have a purpose.

How to make a zero based budget
You can either use the old fashioned method, which involves spreadsheets and downloaded statements from your bank or you can make use of apps that use the zero based budgeting method. We recommend 'You Need a Budget' for this. The benefit of using an app is that it links to your bank and makes categorisation of transactions and income much much easier.

1. List monthly income  

Calculate your entire net monthly income including any side hustles that may bring in additional cash. It is important to be as accurate as possible here as opposed to doing a rough estimate. The zero based budget needs to be based on real, accurate numbers to work.

2. List expenses (including savings, debt payoff and charity giving)

Create a list of categories that covers all your spending, similar to what we outlined within the envelope method. Also factor in how much you want to save every month or give to charity. If you need to pay off debts, include these in the expenses also.

3. Make it get to zero

Subtract your expenses from the income and see what number is left. This rarely ends up at £0 the first time around. Normally people overspend and have a negative budget or underspend and have money left. Having money left isn't a bad thing, but it is important that is has a purpose, otherwise it just sloshes around month to month.

4. Track it during the month

You need to track how you are spending vs what you put into your zero based budget. I would suggest that if you are doing your budget manually in a spreadsheet you set pre-defined times that you will do this work. Once a week is a good idea. The idea is to input your spending to see how it compares to your originally planned zero budget. This is where an app can be handy that does a lot of the work for you in real time.

5. Adjust the budget when needed

Things change in life and your budget will need to adjust. Moving house, having a baby or some other lifestyle adjustment will change the numbers. Make sure to sense check your budget every month to make sure that it is fit for purpose before starting a new month.

Pros

• Very detailed
• Accounts for every penny in your budget
• Conquering this method gives a strong sense of financial control
• Flexible and can be adjusted based on lifestyle priorities

Cons

• Some people can find it complicated
• Big upfront time investment
• Can feel a lot like dieting (restrictive)
• Not everyone is comfortable with an app or spreadsheet

Conclusion

There is no right or wrong budget, it all depends on what works best for you. Those who prefer working with cash should consider the envelope method, whereas those that prefer a budget with a little more detail might want to consider the Zero Budget. Some people need to try all of them before they find one that fits. A lot of people struggle with budgeting in general. Budgeting is a very restrictive practice, and similar to dieting, can be difficult to stick to long term.