How many categories should you have for your budget or expense spreadsheet?

My friend is getting serious about his finances, and at my suggestion he has agreed to work through a couple months of my free budget and expense tracker spreadsheet.

The first thing that struck him was the list of budget categories. Many mainstream budget worksheets have about 20-30 categories. Even Bundle, a money site I write for, displays spending into 22 subcategories.

By contrast, the simple expense tracker has 12 categories, 10 for spending and 2 for savings. The compactness is possible because some subcategories are grouped together. For example, the subcategories phone, cable, and internet are combined into a single “utilities” category. Or the subcategories for 401(k), IRA, and emergency fund savings are grouped into “planned savings” category.

Which method is better: having more atomized categories or general categories? I will share my take and then I certainly want to hear your opinion.

The 5 percent guideline

I started out tracking expenses using a canned budget worksheet that had about 30 categories. After one year of doing this, I realized this level of detail was overkill. The attention to detail obscured the larger picture–it was cumbersome and trivial to track how much I spent on a gym memberships or on stamps as separate categories.

I solved the problem with a new rule: I would only track categories that reached 5 percent or more in spending. The threshold was arbitrary, to be sure, but I had some justification. Spending 5 percent translates to about $200 a month on a gross income of $50,000. This felt like a decent chunk of money and such a category was definitely worth tracking.

I applied the 5 percent rule of thumb to combine smaller subcategories. Expenses like phone, cable, and internet–under $100 individually–were lumped them into a single category utility. And that is how I ended up with the current categories in the expense tracking spreadsheet.

I still monitor my progress and combine categories if they start falling below the 5 percent minimum. And conversely, I introduce a new category whenever I start spending more than $200 a month on something.

How many categories does the 5 percent guideline imply?

10 to 15 categories is about right

If you agree with the 5 percent rule of thumb, then you can follow the logic to see why 15 categories is sufficient.

Here is the reason. Let’s say a normal person pays about 30 percent in income tax–that’s one category. The remaining net income is 70 percent and gets divided into spending categories. Hence, there can be at most 14 categories that would break the 5 percent threshold meriting a separate category (70/5 = 14). Adding the one category for tax, and you can see that 15 categories is an safe upper limit.

Practically speaking, 15 categories is probably too many. The reason is that housing or rent often constitutes 20 percent of spending. This would leave a remaining 55 percent to be divided into spending categories. The result is 12 budgeting categories are realistic–and surprise, surprise, this is the same number as the categories listed in my budget and simple expense tracker.

But of course, it’s useful to make exceptions if you wish to track special expenses like how much you spend on a girlfriend or significant other.

How many categories do you use?

Budgeting and expense tracking is an individual exercise so I am sure you have reasons for whatever you do.

How many categories do you have? What categories do you find useful? If you use an online tracking tool, how many categories does it have? Are any of these categories useful in tax preparation? What is your advice for coming up with good budget categories?