Budgets don’t pay dividends or interest and they don’t appreciate in value. Who needs them? Well, as it turns out, just about everyone. More than three-quarters of U.S. workers live paycheck to paycheck. That’s a pretty bleak static. Equally as grim, 28% of Americans have no emergency savings at all. When it comes to consumer debt, we likewise find similarly concerning data. The average household debt in the United States today sits at $137,063 compared to a median household income of $61,372 in 2017. It’s no surprise then why so many articles and books have been written to focus precisely how to budget to live within your means. In this post I’d like to take a moment to not just explain the process of my favorite budgeting method, zero-based budgeting, but also focus on why we should budget in the first place.
Budgeting forces us to be intentional with our money. We all have different financial goals. They might be to retire early, pay for college expenses, donate to a favorite charity, or travel the world. Whatever your goals may be, you have to be intentional with your wealth to achieve them.
This is exactly why I push back against the notion that budgeting is “limiting” or “restrictive”. Not having money left over at the end of the month is restrictive. Not having enough money to enjoy retirement on your terms is restricting. Having a budget in place to guarantee your expenses are aligned with your financial goals? That’s liberating. I encourage you to use the steps below to put together your own zero-based budget. You might find your spending habits don’t align with your values. You may realize you aren’t saving enough to build the retirement nest egg you need. Whatever your experience may be, with a written budget in hand you’ll know exactly where your dollars and cents go each month.
Which budgeting method is right for me?
“Okay John I get it, budgeting is important. But how should I budget?” There are a number of popular budgeting methods and I’ll briefly cover a few here with my own thoughts.
The 50/30/20 System
This system is straightforward. You set aside 50% of your income towards necessities, 30% towards wants, and 20% towards savings. The problem with this method is rarely do we find our financial situation allows us to keep such a rigid breakdown of necessities, wants, and savings in place. For a budget to work month after month is needs to be flexible.
The “pay yourself first” method
This budgeting method, sometimes referred to as “Reverse Budgeting”, has you set aside money to meet your savings goals first and then move on to budgeting expenses. While this might be a great way to prioritize savings, it can also lead to paying down debt taking much longer than necessary.
The envelope system
The envelope system is ideal for those of us prone to overspending. You set a monthly budget limit for your categories, like entertainment or groceries. Then, you label and fill an envelope with the allotted amount of cash. Throughout the month you use that envelope as needed. When the envelope runs out, that’s it. In the 21st century with the widespread adoption of cashless payment processors and peer-to-peer payment systems like Venmo the envelope system can be cumbersome. However, the inconvenience of only using cash might very well be made up by the measurable difference in restrained spending habits compared to using plastic.
The “zero-based” budget
The zero-based budget is my preferred method of budgeting. The concept is simple, you take your monthly income and give every dollar a job, whether it’s spent or saved. Overspenders and savers alike can create a budget that meets their individual needs. Furthermore, like the envelope system, hard boundaries can be set to help fine tune your spending and saving goals.
How to create a zero-based budget in 5 easy steps
Let’s dive into the zero-based budget further.
Zero-based budgeting is such a powerful tool because it’s so simple. And when it comes to budgeting simple is good. We want a method we can stick with month after month. It’s also quick. You’ll find it takes no more than 15-20 minutes per month to create your fully fleshed out budget. Let’s walk through the steps below so you can begin your journey of aligning your values and goals to your expenses. If you have a partner you should do this exercise together.
Step 1 – Add up all your income
Start by adding together all your sources of income for the month. This might include your salary, Social Security, pensions, dividends or interest received, tips, commissions, alimony, etc. Write this number at the top of the page.
Step 2 – Make a list of expenses
List out all your monthly expenses underneath your monthly income. Start with the necessities like food, clothing, utilities, and rent or mortgage payments. Then continue listing any other expenses which come to mind. Remember to include savings goals as well. If you set aside $250 into your retirement account each month, that amount is coming out of your monthly income.
Expenses can vary month-to-month, especially when it comes to seasonal expenses like Christmas or irregular expenses like property taxes and insurance premiums. The easiest way to deal with these types of expenses in your budget is to plan ahead with sinking funds.
For example, let’s say you’d like to spend $240 on Christmas gifts this year. Instead of having to scramble to find the money in December, put aside $20 each month towards your Christmas fund. When December rolls around you’ll have $240 set aside and can gift shop guilt free! These types of savings goals are called “sinking funds” because you’ll contribute a certain amount to them each month to make a future purchase. Other popular sinking fund categories include expenses like emergency funds, home maintenance, auto purchases, health insurance deductibles, and vacations. Remember, a budget will only be useful if it aligns with your individual goals. Tailor these sinking funds to your individual needs.
Step 3 – Income minus expenses equals $0
Now it’s time to balance your budget. Remember, the goal of the zero-based budget is for income minus expenses to equal zero. If after listing all your expenses you have a negative amount of money remaining, you can trim your budget as needed. If you find you have money left over, consider paying down debt or adding to your savings goals. Budgeting is a skill and like any skill over time you’ll get better and better at crafting a more accurate budget.
Step 4 – Monitor and make adjustments as needed
You’ve crafted your budget, now put it to work. Monitor your spending throughout the month and make adjustments as needed. If you find you overspend in one category don’t panic! You can pull money from a different category to make up the difference. For example, let’s say I budget $200 for groceries but find I’ve spent $213. Meanwhile, I have $50 budgeted for entertainment but have only spent $20 this month. I could subtract $13 from my entertaining category to make up the difference.
Step 5 – Close out your budget and create your next budget
Consistency is the key to creating a budget you can stick to. At the end of each month review your budget. How did it hold up? Make note of where you over or underspent. Use that information to help create a more accurate budget for the next month. After just a few months you’ll find this entire process runs like clockwork. No more wondering where your money went or stress you may not be saving to reach your goals. Just complete peace of mind knowing exactly where you stand with your finances.
There you have it. In just a few simple steps you can have a flexible, personalized budget. Repeat the steps at the beginning of each month. Now you’re being intentional with your money. You’re in control of your financial situation. You can enjoy the freedom and peace of mind that comes from knowing your money is being spent on what matters most to you.