If you’re reading this, you’re ready to take the next step in shaping your financial future. The baby step of all baby steps would appear to be creating a budget, right? Well, there are a few ways of monitoring your spending which many financial experts disagree on. Gurus like Dave Ramsey advocate for strict zero-sum budgeting, which is when all of your income has an allocated place in your budget. Other experts support the spending plan method.
What is the difference and which is right for you? Read on to find out more.
What is the difference between a budget and a spending plan?
When researching budgets and spending plans, it can get incredibly confusing to tell them apart. They are very similar but the intentions behind them are quite different.
Budget – a budget is a document that helps you to plan your finances by detailing your income and expenses. You allocate your income into strict expense categories to control your spending.
Spending plan – a type of budget that combines with your financial goals to plan out your spending. Your spending allocations are more like a financial roadmap than a restricted, non-negotiable path.
The key differences mostly boil down to the mindset around them.
Think of budgeting like dieting. In dieting, you have a calorie count that you have allocated to each food group and then track your calories. In budgeting, you have a set amount of income to allocate to each expense category and then track your expenses.
To continue the analogy, a spending plan would be closer to intuitive eating. You know you want to have five pieces of fruit in your diet but how much you eat per category is not nearly as strict as dieting. With a spending plan, you still make sure that your baseline expenses are accounted for, but after that, you spend where you want to! You could allocate 5% of your income to a fund for your next vacation. You could spend less on dining out and more on your grocery bills this month. You are not bound to any strict guidelines of where your money should go.
Though it may sound like a spending plan is the cool, younger sister of the grumpy, joyless budget, both methods are incredibly effective at getting your finances in check. Let’s go through the pros and cons of both.
The pros and cons of budgeting
PRO: Hard limits on your spending is great for reforming bad spending habits
If you have a Louboutin closet that could rival Carrie Bradshaw but live a paycheck to paycheck lifestyle, then you need to go to spending rehab. There is no better spending rehab than a by-the-book budget. Those tough parameters over your expenses will keep your spending habits under control (if you follow them!).
PRO: If you are in financial troubles, a strict budget can guide you to financial stability
We are living through one of the toughest financial eras in human history. Times are hard. It is important now more than ever to account for every dollar, especially if you don’t know where the next dollar is coming from. The clarity you get from a fully detailed, restrictive budget can put you in the driver’s seat of your finances again.
CON: Budgets can feel joyless and restrictive
We compared budgets to dieting… and who likes dieting?!
It seems to be the bane of those who practice it so why put yourself through something so restrictive. Unfortunately, budgets can feel joyless when you overspend on your grocery budget and therefore can’t go to the cinema with your friends. Or you can’t splurge on a chai latte from Starbucks every morning, because you ruled it out of your budget. What makes budgets impressively effective, is also what makes them a bit of a pain.
CON: Budgets don’t take your big financial goals into account
This isn’t strictly true in all cases. Broadly speaking, however, budgets just account for your expense allocations and perhaps some debt repayment. If you are saving to buy a house or want a more flexible fun-fund, then you’ll be better off with a spending plan.
The pros and cons of spending plans
PRO: Spending plans feel flexible and free
The antidote to the financial diet, spending plans allow you to be flexible with your categories. Your spending buckets can be as broad as you like. After your expenses are taken care of, you can allocate your income to the things that matter to you. A fun-fund thrives here as you can move money freely. Maybe you spend less on fun this month and put more towards your dream house. Perhaps next month you move money towards a vacation in Vienna and put less towards debt repayment. Without the harsh restrictions, the spending plan reframes your mind to “what I get to do” rather than “what I must do”.
PRO: Spending plans allow you to integrate your larger financial goals
We touched on this in the previous point but spending plans look at the broader picture of your finances. While budgets are great for the minute day to day, spending plans excel in helping you roadmap your goals for financial success in the future. You can have an investment pot, a vacation savings goal, and a fun fund. Whatever matters to you, you can integrate into your spending plan easily.
CON: Spending plans can create distractions
Because of the straight forward, get-your-stuff-together nature of budgeting, it is pretty easy to follow. Everything is allocated, you just follow the path you have set yourself. With spending plans, you have the freedom to move money towards goals and other things without feeling guilty. That can be distracting. Saving for your dream house while paying down debt and trying to organize your finances, is a lot to tackle at once.
If you are just getting started in the world of tracking expenses and financial planning, a spending plan could be quite complex. A financial coach can help you set one up so that you aren’t overwhelmed when starting.
CON: Spending plans are harder to track than budgets
Another part of the complexity of spending plans is that they can be harder to track than budgets. A budget is tracked line by line. You put x amount aside for groceries this month. You write in what you actually spent on groceries for the month and compare. Simple!
For spending plans, their flexibility can make them harder to keep records of if you don’t set up a good system. You will have to be diligent with tracking the general direction that your spending is going in.
Which financial tracking method is right for you?
Personal finances are just that; personal. I know, cliche. The financial tracking method for you is the one that you can continue long term and fits with your psychology.
If you are the type to thrive with strict rules and flourish with disciplined accountability, a budget is for you. The mindset of “I must not let myself down” will kick in. You’ll get your finances under control in no time.
If you prefer looser parameters and trust yourself to invest in what is most important to you, a spending plan will be perfect. The freedom to spend on what matters to you will make your brain much happier!
Whatever you choose, try it out for at least one month to see if it is creating the results you want.