A guide to budgeting

Budgeting is an essential element to managing your money. Without establishing a budget, you may not know how much you have spent or what you can afford to buy. People often shy away from budgeting as they think it will be too difficult or even boring having to make cutbacks.

However, there are a variety of different ways you can budget. Most people assume that budgeting involves setting up a spreadsheet, working out your incomings and outgoings and then making cutbacks. And while it is true, that any form of budgeting involves knowing what you have coming in and going out, there are many different methods of budgeting depending on you, your finances and lifestyle.

This blog will list different types of budgets or budgeting methods:

The Cash-only budget method (or the “Envelope method”)

The basic idea behind this type of budgeting method is that you use cash for buying goods instead of using a credit/debit card.

A cash-only budget is often linked with the envelope budgeting system – where you have an envelope for each of the categories in your budget e.g. Food, transport, kids, activities. You can only spend the money you have in those envelopes for the month. Once the money in an envelope has been spent, you can’t spend any more for that category. Unless of course it is an emergency

If you don’t spend all the money in a particular expense envelope, then you can repurpose the money towards something else like savings or debt.

The Zero-based budget method

This budget method has one simple rule: your incomings minus outgoings equals zero at the end of every month.

For example, if you earn £1,500 (after tax) each month, then all your spending, including the money you put towards your savings, should equal £1500 each month, giving  you a zero balance.

This method is useful as it helps teach you to stop spending more than you earn. If you are spending more than you earn each month, you will have to start looking at ways to save money for example, instead of eating out at restaurants, try eating in more including making a packed lunch for work.

This method does not come without its disadvantages. One of the main disadvantages is that it does not allow for unforeseen spending – e.g. your car breaking down and needing repaired. This is why it is always suggested that you have an emergency fund to cover unexpected costs.

The Goals-Driven budget method

This method of budgeting is for those who need a goal and rewards to be motivated to save.

For this method choose one goal. It could be a holiday you want to go on, or a new car you want to buy. This goal will influence everything you spend money on. Work out how much it costs and from your incomings and outgoings how much you can contribute to your goal each month. This could mean you have to cut back on non-essential items – gyms, coffees, eating out – and redirect the extra money to paying off your goal.

Open up a savings account specifically for your goal. You can then set up a standing order for the amount you can contribute each month, so that it directly comes off your current account.

The remainder of this blog will now discuss alternative ways that you can save money and pay off your debts.

Debt Snowball vs Debt Avalanche

There are two popular ways to pay off debt – the debt avalanche and debt snowball methods. Both are payoff methods which require you to continue to make the minimum payment on all your debts but either pay off the largest interest debt first or pay off your smallest value debts first.

Firstly it is important to create a budget and stick to it, this will allow you to free up money to start paying off your debts whatever method you decide to use. Have a look at this handy budget calculator to get started.

Debt avalanche

The first method is the debt avalanche method is where you make the minimum payments on each of your debts and dedicate any extra money to the debt with the highest interest rate and once that debt is paid off, you move onto the next highest interest loan and so forth until all your debts are paid off.

Is the debt avalanche for you?

There are various advantages of this method. The avalanche minimises the interest amount which you pay – as long as you stick to the plan! It also allows you to pay off your debts in a shorter time period as less interest will accumulate.

The disadvantage however is that it takes commitment and discipline, it may be a while before you feel like are making any headway and if you feel you aren’t making progress quick enough you might give up. If you need small victories to keep you motivated then the debt snowball method may be better for you.

Debt snowball

The debt snowball method is when you list your debts from smallest to largest and devote any extra money you have to pay off the debts from smallest balance to largest – regardless of the interest rate. Once the smallest debt is paid off you move onto the next smallest debt and so forth. You continue to make the minimum payments on your other debts.

Is the debt snowball for you?

The advantage of this method is it motivates you as one debt is paid off completely before you move on to the next. So by the time you get onto the debts which are larger you will be into the swing of paying them off and it won’t seem as intimidating.

On the other hand, you may end up paying more back in interest rates as you are focusing on balances and the debt accumulating the most interest may be paid off last.

Most importantly whatever method you chose you should ensure that you pay your debts in way that keeps you motivated until the very end!

If you are struggling with budgeting there is no better time to receive informed debt advice.

Contact us at talk about debt on 0808 156 7730 for unbiased advice from one of our expert advisers.

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