Have you tried budgeting but felt like it wasn’t hitting all of your goals? Traditional methods are intended to help you realize where all your money is going and to get your spending under control. But what if you have bigger aspirations like paying off your debt or saving for retirement?
Perhaps what you need is to try a different system called zero-based budgeting. In this post, we’ll explore the benefits of using a zero-based budget and how it can help you to better manage your household finances.
What Is a Zero-Based Budget?
A zero-based budget is one where your income minus your expenses and savings goals equal zero. At first, this may sound like exactly the same thing as a regular budget. However, there is a difference.
With a zero-based budget, you’re assigning any extra money at the end of the month towards specialized savings goals that you pick out. The goal is to make sure that every dollar has an intended job or purpose.
Essentially, this makes your savings goals just as important as your other bills. You have to pay them just the same as you would your rent or credit card. By the time all is said and done, there will be no money wasted under this budgeting plan.
Zero-based budgeting was originally developed by Peter Pyhrr, an account manager for Texas Instruments who wanted to pioneer a new approach to corporate budgeting. In recent years, zero-based budgeting has been retooled by personal finance gurus as a strategy to ensure that all household needs and goals are addressed.
What are My Savings Goals?
Your savings goals can be anything you want them to be. Ideally, they should be endeavors that will help you to build long-term wealth or bring happiness to you and your family.
Some typical examples might include:
- Paying off high-interest debt
- Building up an emergency fund (3 to 6 months’ worth of expenses)
- Increasing your 401k or Roth IRA contributions
- Saving for your children’s college 529 plan
- Extra principal payments on your mortgage
- Family vacation
The best way to determine your savings goals is to grab a paper and pen and start writing down every idea that comes to mind. Do this exercise with your spouse or significant other so that both of your wishes are equally considered.
Example of a Zero-Based Budget
Here’s how a typical zero-based budget plan might look:
- Let’s say your average monthly income is $4,000 after taxes.
- Your average monthly expenses are $3,500.
- This leaves you with a difference of $500 extra per month. Assign that $500 to one or more of your savings goals. For instance, you might apply $200 towards paying off your debts and add $300 to your retirement contributions.
Once all is said and done, your income and expenses will both equal $4,000. With each of the equation balanced, the net sum will be zero – exactly as intended.
How to Start a Zero-Based Budget
If working with a zero-based budget sound like a system that you’d like to adopt, then here’s how you can get started.
1. Start Tracking Your Purchases
The first step is to get to know your purchases. What do you regularly spend your money on and how much? It’s important to fully understand this because, in order for your budget to work, it must be realistic. (This is true no matter what style of budget you decide to adopt.)
To track your purchases, if you’d prefer not to go through the painstaking process of recording every transaction, you could instead use a helpful app like Buxfer. Buxfer connects to over 20,000 different financial institutions and condenses all of your purchases into one report that constantly gets updated in real-time.
Pay particular attention to your fixed and variable expenses. Fixed expenses will be those things that don’t change (like your rent or auto loan payment) whereas variable expenses will be things that do (like how often you might eat out at restaurants).
2. Determine Your Income
Next, take note of how much you earn from your employer. If you get paid the same amount every two weeks, then take your paycheck and multiply it by “2” to get your monthly income.
Note that people who are paid biweekly will actually have two months each year where they receive three paychecks (52 weeks divided by 2 = 26 paychecks). Don’t forget to include these two “extra” paychecks in your calculation.
If your income is variable, then it may be best to look at it from a yearly perspective. Take this amount and divide it by 12 to get a monthly average.
3. Plan Out Your Purchases
Using a spreadsheet or paper, put your income at the top and your expenses at the bottom. Subtract your expenses from your income and determine how much money you’ve got left over each month.
Although the easiest way to do this is just to look at one “average” month, a more comprehensive way would be to repeat this step every month throughout the year. This way you’ll catch one-off expenses that only happen at certain times throughout the year (such as buying Christmas presents).
If at any point your balance is negative, then stop right there – we’ve got some work to do. Your main priority should be to get your spending under control so that your expenses don’t exceed your income. Find out which expenses are causing you to exceed your income and start trimming away those purchases that you can live without.
4. Add In Your Savings Goals
With any money you’ve got left over, it’s time to start allocating them to a specific purpose. Again, this could be for things like building your emergency fund or raising your 401k contributions.
Before making your assignments, it will be helpful to think about what goals you have in mind. Make a list of everything you’d like to accomplish and assign it a priority. Depending on how much money you’ve got to work with at the end of every month, you might wish to assign your leftover balance to two or three different purposes.
This method will take a little while to get used to. But be patient and stay disciplined. Once you see that no money is going to waste and your goals are being funded, you’ll know you’re on the right track.
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