Your biggest wealth-building tool is your income and the best way to harness your income is through your monthly budget. From your budget, everything else flows. If you want to invest money in stocks, bond’s or mutual funds, you make room for that amount in your monthly budget. Looking to get out of debt? List you debts in your spending plan. I’m sure you get the gist.
Often times, people don’t make a budget because they are afraid of what they will find. If you have overspent to the point that you now face a mountain of debt and little or no savings, you might be shamed into stopping right there. But doing nothing is not a solution. Don’t be paralyzed!
According to Dave Ramsey, “The point of a zero-based budget is to make the income minus the outgo equal zero. If you cover all your expenses during the month and have $500 left over, you aren’t done with the budget yet. You must tell that 500 bucks where to go. If you don’t, you lose the chance to make it work for you in the areas of getting out of debt, saving for an emergency, investing, paying off the house, or growing wealth. Tell every dollar where to go.”
What is a zero-based budget?
A zero-based budget forces you to spend every dollar you make — just not in the way you think. The basic premise of the budgeting strategy is that you must “give each dollar a job” to prevent waste and maximize your income, with the ultimate goal of reaching zero at the end of each month. However, zero-based budgeting works by using last month’s real income to pay this month’s expenses, so it is important to have a savings cushion equal to at least one month’s expenses before you get started.
Basically, zero-based budgeting forces you to allocate all of your dollars to something, whether you use the money for bills, debt repayment, or for savings. All of your dollars.Because, according to many budgeting experts, money “without a job” will likely get spent — often carelessly. Like for example if you saved some money on your car insurance through a price comparison website like Money Expert that extra income could be invested into a cash ISA.
And that’s why I believe a zero-based budget is the ideal financial plan for most hard-working families; nothing is wasted and every dollar has a purpose. When you create a comprehensive budget that accounts for everything, you theoretically shouldn’t have any cash left over to waste. This is the budget method that I use for my household. I have tried many different methods, but this is the one I settled on, because it covers every area of my financial life.
Creating a Zero-Based Budget
I know you are wondering just how to create a zero-based budget. Let me tell you how. A zero-based budget might sound like exactly what your family needs, but it can’t happen overnight. Certain steps need to take place in a certain order for a zero-based budget to work effectively and help you accomplish your goals. Here’s how I created our zero-based budget (and how you can create one too):
- Track your spending for 1-3 months: Before you get started, you need to know where your money has been disappearing to. If you use credit or debit for all of your spending, this can easily be accomplished by digging out your old credit or debit card statements. Some bank and credit card websites even offer spending tracker tools to simplify the process. (Or look into budgeting apps such as Mint and Level.) If you pay cash for everything, you need to start tracking your spending from this point on by saving receipts or writing down all your purchases in a notebook. For more information on how to track your expenses, you can read my previous post on that topic.
- List your common spending categories: Once your bank statement is right in front of you, figure out which categories the majority of your expenses fall into. These categories will be different for everyone, but might include things like groceries, restaurants, medical bills, entertainment, clothing, and transportation. You also need to list out all of your recurring monthly expenses such as your mortgage, insurance premiums, and utilities. Also make sure to create a category for miscellaneous expenses.
- Assign your spending to a category: Once you’ve written out all of your categories, go through each month (from first day to last) and assign each expense to the appropriate category. Add up each column to see your total spending in each category for each month.
- Focus on problem areas: Seeing your spending in black and white might shock you. For example, you might find that you’ve spent far more than you ever dreamed at restaurants over the past few months, or that you’re overspending on hobbies to the tune of thousands of dollars. Regardless, this might just be your defining moment. Once you see how much money you’re wasting, it may just force you to make a change.
- Assign each category a new dollar figure: Discovering that you may have been overspending in several areas can be a painful experience, but the only thing more painful is continuing on the same path. In order to make meaningful change, assign each category a new dollar figure that is reasonable, yet restrictive. For example, if you’ve been spending $1,000 on groceries each month, start by cutting that number down to $700 for the following month.
Once you’ve created a new budget with updated categories and dollar figures, you need to compare that budget to your actual earnings. In the best-case scenario, you’re spending far less than you earn and can immediately begin allocating your surplus funds to debt repayment and/or savings. In the worst-case scenario, you’re still spending more than you earn and you need to make additional cuts for your budget to work.
Since zero-based budgeting uses last month’s income to pay this month’s bills, you’ll need to get one month ahead on your finances to make this work. Getting one month ahead can be accomplished by saving one month’s expenses in your regular savings account and using those funds for the following month’s budget.
If you already have at least one month’s expenses saved, you are already a step ahead of the rest. Simply use those funds to pay the expenses you’ve outlined during the next month’s budget, and stash this month’s income away into savings for use during the following month.
If you earn the same amount of money every month, creating a zero-sum budget should be a breeze. Let’s say you and your spouse get paid the same amount of money every other Friday, and two paydays occurred during the last calendar month. When creating your budget for the upcoming month, you will simply add up the pay you received during that month and create your next month’s budget based on that figure.
Since zero-based budgets use last month’s income to pay this month’s bills, irregular incomes are also compatible with this budgeting style. Simply add up your paychecks from last month in order to figure out how much money you have to work with this month — and make cuts as needed.
One thing you’ll notice is that months with lower earnings will squeeze your budget to its breaking point. Use these months to figure out if you have any spending categories that could be whittled down even further. Months with higher earnings, like when there are 3 pay periods, on the other hand, should make the following month easy when it comes to your budget. Since you’re giving each dollar “a job,” you can easily allocate those extra funds toward your debts or savings for speedier progress.
Tips for creating a zero-based budget
Zero-based budgeting might sound complicated, but it is actually very simple to implement once you get the general concept down. But, as with most things, certain actions do help make the process run smoother. If you’re considering a zero-sum budget of your own, these tips can help:
- Budget for everything: Creating a zero-based budget will only work if you are willing to budget for everything – even things you wish you didn’t have to budget for to begin with. When writing out your monthly budget, make sure to include all categories where you spend money. Doing so is the only way to ensure success!
- Overestimate variable expenses: Variable expenses can be hard to estimate at times, especially when it comes to costs that fluctuate – things like utility bills and gas usage. With these items, I tend to err on the side of caution. If you overestimate how much you will spend, you can always transfer any “leftover money” to savings at the end of the month. Likewise, you can use it to take care of overages in any other category.
- Track your spending once per week: Your new spending plan might take some time to get used to, but it will be easier to adjust if you’re able to track your spending as the month progresses. For example, your new $600 monthly grocery allowance will be easier to swallow if you check your statements to see where you are at least once per week. Checking in frequently with each category will help you discover how much you have left to spend.
- Prepare for setbacks and adjustments: Your new zero-based budget might go off without a hitch, or it might be a total nightmare. Either way, it’s important to know that you’ll likely need to adjust and readjust your spending for categories as the months progress. For example, you might think that a $500 food budget is entirely feasible, but find out that it is completely impractical in real life. When those things happen, make a note of it and change things up for the following month. Your zero-based budget can evolve as you go: It should work as a tool to help you track your spending, but it shouldn’t be too restrictive.
Zero-based budgeting might be just what you need to get your finances under control once and for all. Why? Because it helps you identify problem areas, create limits you can live with, and make your money work for you. Even better, you don’t have to purchase anything to get started.
All you have to do is face your spending head-on and follow these simple steps to build your own zero-based budget from scratch. It might not be easy, but you are sure to learn a lot about yourself and your own spending habits along the way.
Like it or not, a look in the mirror is sometimes necessary to make meaningful changes that last. In that sense, zero-based budgeting will show you who you really are, flaws and all.