There are essentially two schools of thought when it comes to budgeting methods: Budgeting vs Forecasting.
The forecasting method is exemplified by software such as Mint, whereas budgeting, in the sense I will discuss it in this post, is exemplified by the software YNAB (You Need a Budget).
Forecasting as a Budgeting Method
When you use forecasting software such as Mint you usually add up all your existing assets and predict your future income, usually on a recurring, monthly basis. Then you do the same with all your monthly expenses. This is usually down automatically by syncing with your bank accounts.
Adding these numbers together tells you whether you are living beneath your means. For example, if your monthly income was $2,000 and your monthly expenses added up to $2,500, you would know that you need to either increase your income or decrease your spending, otherwise you’re just accumulating debt.
With budgeting as forecasting, the name of the game is trying to predict the future. If you have $10 in your checking account today and you want to spend $100 on a new jacket, if you know that in two weeks you will receive a paycheck of $1,000, you might feel comfortable floating the jacket on a credit card knowing that you will be able to pay off the balance at the end of the month since you are confident in your prediction that you will be paid $1,000 in two weeks.
Thus, with the forecasting method, the name of the game is accurate prediction of the future. The better you can estimate your future expenses and income the better you will be able to make financial decisions.
The YNAB Method: True Budgeting
The YNAB method of budgeting is completely different than the forecasting method.
Going back to our example, if you only have $10 in your account, and you want to budget for a $100 jacket knowing you will get paid in two weeks, in the YNAB system, you absolutely are not supposed to buy the jacket until you actually get the $1,000 deposited into your checking account.
If you only have $10 in your checking account, then your goal is to give each one of those ten dollars a job to do. You could put the $10 in the jacket category and when you get paid $1,000 you would only need to add $90 to the category in order to buy the jacket.
However, let’s say that you need to fill up your gas tank before you get paid the $1,000 because your tank is low and you have to drive to work. According to the YNAB system, the best decision would be to allocate the $10 to the gas because that is the most pressing thing in the moment.
Moreover, let’s say you get paid on the 15th and your $500 rent is due on the 17th. According to the YNAB system, you need to take $500 of your paycheck and allocate it towards your rent category because you absolutely need to pay for your rent – covering necessary expenses like that is the name of the game.
And if you need to spend $300 on groceries to last you until your next paycheck, then you should probably allocate the money towards food before you even think of spending $100 on a jacket.
So now you have $200 left out of the $1,000 paycheck before your next paycheck in two weeks. On the YNAB system, you have to make that $200 last until your next paycheck. If your utility and car insurance bills are due before then, you should probably also allocate the money to that before justifying spending anything on the jacket.
The goal is to take your $1,000 paycheck and give every dollar a job to do, oriented with regard to your highest priorities.
But let’s say that jacket is your highest priority, even over buying more food. If you would rather eat from your 20lb bag of rice for the next week and get the jacket instead of buying more food, then you are technically allowed to do that according to the YNAB method.
“I Never Stick to Budgeting Because It’s So Restrictive”
Nothing is “off-limits” in YNAB. Your budget is nothing more than the ordering of your highest priorities according to the money you actually have available to spend. The only hard and fast rule is that you can only “budget” with the money you actually possess, as opposed to future money you have forecasted.
Even if you know with 99% certainty that you will be paid $20,000 a week from now, if you only have $10 in your checking today then according to YNAB you should not spend money ahead of time “as if” you have already been paid the $20,000 dollars. That is the forecasting method.
So, hopefully, you get the basic idea of YNAB by now.
This system is called zero-based budgeting because the goal is to take whatever money you actually possess – real money in your account, not hypothetical future money you will likely soon possess – and allocate every dollar until you reach “zero” and every dollar has been given a job.
You repeat this process until you can eventually “age” your money and make it such that your $1,000 paycheck today goes towards paying next month’s expenses and your grocery bill tomorrow is “paid for” by the money you allocated from last month’s paycheck.
The ultimate goal is to break free from the paycheck-to-paycheck cycle that plagues so many Americans. If you look around the internet, you will read hundreds if not thousands of success stories from YNABers do exact that. And you don’t have to be a high income earner to benefit from this either. YNAB has helped people from all kinds of income ranges.
How to budget when you are broke
So, the tricky thing about YNAB when you don’t have much money in your checking account is that it’s pretty boring. If you only have $10 to your name, all you can do is plan how you’re going to spend those ten dollars. Even if you know you are about to get a $20,000 windfall three weeks from now, the YNAB method says that you shouldn’t be using the software to do elaborate financial planning trying to figure out how to spend that $20,000 until it actually lands in your account.
In reality, YNAB is only fun when you actually get paid and you get to allocate your money. Experienced YNAB users often talk about how much they love payday simply because it becomes YNAB-day and they get to go into their budget and give their dollars a job.
There is much more nuance to the YNAB system that I have glossed over, but I mostly wanted to just talk about the YNAB budgeting system at a high level and compare it to systems like Mint which rely on forecasting.
I want to end this post by saying there’s nothing inherently wrong with doing some amount of forecasting. I will admit that I do my own forecasting from time to time using pen and paper or excel sheets. It can be a useful exercise. But once you truly grasp the YNAB method, it’s hard to go back to the traditional forecasting system.
So when it comes to budgeting vs forecasting, they are not really diametrically opposed and can in fact complement each other. But once you understanding the YNAB method of budgeting, you will have a totally new approach to your personal finances.