Definition of Zero-Based Budgeting
Zero-based budgeting is the process of creating a financial game plan that assigns a purpose to every dollar you make. The purpose or expenses then get subtracted from your monthly income. The desired result is a perfectly balanced budget with zero dollars left over. Hence, zero-based budgeting!
Advantages of Zero-based Budgeting
- Zero based budgeting forces the user to get extremely familiar with their monthly expenses. You will personally be responsible for assigning what each dollar will go toward. This close relationship with your spending allows for early and easy detection of potential trim backs or adjustments.
- This budgeting method gives flexibility for unexpected changes to your predetermined allotments. If something pops up, zero based budgeting allows you to shuffle around funds to reach that magic number; zero! And let’s be real, something always pops up.
Disadvantages of Zero-based Budgeting
- Zero Based Budgeting may be difficult for a beginner with no budgeting experience. You pick the categories, you determine the allotment, you decide if changes need to be made. Although this allows for a great amount of personalization, you may be looking for more guidance. In this case, 50/30/20 Budgeting may be better suited for you.
- Zero based budgeting is time consuming. Some budgets are near-identical from month to month. Others have variable incomes and numerous changing expenses where the constant updating can get overwhelming.
Creating Goals Before Creating a Budget
Goal creation is probably the biggest missed step in the budgeting process. Budgets can be perfectly balanced for years, but if you’re not achieving any of your goals what good are they. Before making your budget, try to write out the following:
- My short-term financial goal is…
- My long-term financial goal is…
- My short-term personal goal is…
- My long-term personal goal is…
For more guidance on goal setting or budgeting, read How to Budget. Spelling out your goals can give a blueprint on where you need to assign your dollars to each month to achieve your goals.
Steps for Zero-Based Budgeting
- Figure out your monthly income. Your monthly income is the amount you take home after taxes. (Those with automatic deductions for retirement/healthcare accounts may want to add those back to your take home amount to achieve a better understanding of where “every dollar” is going.
- List Monthly Expenses. Look through your last few months of bills and create an expense list. Checking credit card transactions and auto-payments from your checking account can be helpful in the process.
- Categorize Expenses. Create categories for the above expenses. Be as specific or as generic with your categories, customize to your particular style. The only rule is that all expenses must be listed!
- Get to Zero. Start subtracting your expenses from your monthly income. A good place to start would be your necessities of life. Food, housing, transportation. Next prior is assigning dollars for debt repayment, Emergency Funds, retirement accounts, etc. Finish by allowing room for discretionary spending.
- Adjust to Zero. Life is always changes and expenses will pop up that weren’t planned for. Adjust as necessary to get back to zero.
Example of a Zero-Based Budgeting
In the above example of a Zero Based Budget we have come in $75 over budget. In order to get back to zero we must trim $75 from other allocated expenses. The most logical choice would be to cut down on the “Dining Out” category. Saving $75 on Dining Out has brought the budget back and we have reached our monthly goal of zero. Easy, right!
You may be in the “Red” after your first attempt and thats OK. Figure out where you need to trim to get back to zero. If you have a surplus, good for you! You then need to determine what the best use is for your extra dollars .
Tips for Zero-Based Budgeting
Budgeting is definitely an art form which improves with practice. Zero-based budgeting keeps you in touch with your expenses so that you never really have the chance to drift that far off track.
- Set up Sinking Funds: A sinking fund is saving money for a particular goal in mind. It could be Christmas gifts, a vacation, or any other large purchase. With Zero-Based budgeting there is little room for you to make large purchases on a whim. Sinking funds allow you to put aside small amounts so come time for the large purchase the budget isn’t busted.
- A continual analysis on your spending needs to be performed in order to search for ways to improve. Groceries may cost $500 each month, but it doesn’t mean you can’t find sales or discounts and get that number down to $425. Maybe it takes some planning to buy things when they are on sale or an extra effort not wasting as much food. It is easy to be content with a balanced budget, but looking for ways to improve your success is always a good thing.
- High-interest debt should be a priority. Credit cards, payday loans, etc. should move to the front of the line. Clearing high-interest debt is one of the best ways to free up money in your budget! It may be difficult to do so follow a Debt Repayment Plan.
- Do not allow money to sit unassigned in your checking account. Give it a purpose! Even if that purpose is an emergency fund, by moving it to a high-yield savings account takes away temptation to spend it.