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In this post, we will take a detailed look at how to create a zero-based budget.
A zero-based budget is a budget in which all income is allocated to a budget category with no remaining unused funds.
At this point, you should realize that you can’t afford to go another month without a budget. It could be the difference between one day reaching financial freedom and remaining in bondage to debt. It could leave you trapped working a job you hate just to pay the bills. It could diminish your happiness. If you don’t feel urgency and understand the importance of a budget, thus requiring more convincing , start here.
Methods of Budgeting
Depending on your personality and degree of tech-savviness, you may wish to create a budget the old-fashioned paper-and-pencil way. You may prefer using Excel, or even an automated program, such as Mint, YNAB, EveryDollar, or PersonalCapital.
If you are a budget rookie, I cannot understate the importance of creating a budget and crunching the numbers yourself without the benefits of an automated program, at least for your first few budgets. I highly recommend the pencil-and-paper or Excel methods for your first few budgets simply because these methods will force you to pay attention and be precise.
Before we get into the specifics of your budget, let’s review some pertinent basics.
- You need to create a new, unique budget at the beginning of the month, every month. Why? Some expenses occur on a bi-monthly or quarterly basis, and you will want to capture this within each unique budget you create. Remember, some expenses are fixed, while others vary from month to month.
- Your budget should be based upon your net income (after state and federal taxes, employer deductions, and insurance premiums). Whether you are paid bi-weekly or weekly, this figure, too, will vary from month to month.
- You should create a budget which utilizes categories. I personally use the following categories, which are recommended by Dave Ramsey. You should use the categories that represent areas of significant expense in your budget, delete those which do not, and add any pertinent categories which may be missing.
- Within each category, your expenses should fall within the following typical ranges.
Sample Expenses Within Each Category
Giving/Charity: Tithes and offerings to church/religious organization, charitable donations
Saving: Emergency fund savings, retirement savings (401k, 403b, Roth IRA, Traditional IRA), college savings (ESA, 529), vacation savings fund, sinking funds
Housing: Rent, mortgage (including property taxes and insurance in escrow), home maintenance
Utilities: Electric, Gas, Water, Trash, Home/Mobile Phone, Cable/Internet, Home Security
Food: Grocery, restaurants, fast food, coffee and drinks
Transportation: Fuel, auto insurance, auto maintenance, bus passes, train tickets, Uber fares, tolls, miscellaneous transportation costs
Clothing: Includes shoes, outerwear, work wear, accessories
Personal: Discretionary spending, disability/life/identity theft insurance premiums, miscellaneous spending
Health/Medical: Insurance co-pays, prescription co-pays, miscellaneous medicine, gym memberships
Recreation: Movie tickets, concert tickets, sporting events, local/regional travel, miscellaneous recreation
Debt: Student loans, car loans, home equity loans, credit cards
The Specifics of a Budget
Before we proceed, it is important to note that your figures may or may not fall squarely within the categorical ranges previously mentioned. For example, if your Housing costs represent 24% or 36% of your monthly budget, this is not a serious problem. Please view the percentages above as suggestions for a healthy budget. Clearly, room exists for give and take, particularly if you are a very low or very high income earner, as long as your percentages add up to 100%.
Some of the categories above cover fixed expenses, such as Housing, Debt, and Utilities. Others address what we will call variable fixed expenses; you will spend money in each of these categories during a typical month, but the amounts may vary slightly from month to month. Variable fixed categories include Food, Transportation, Clothing, and Personal. Finally, the remaining categories, including Giving, Saving, and Recreation, are what we will refer to as discretionary expenses. You may choose to allocate money within these categories, but it is not mandatory for your family’s survival.
Note: Mrs. Superhero and I strongly believe that Giving is important, and we choose to include it as a fixed expense within our budget. Your values will dictate how you choose to handle this category in your budget.
Here is a sample budget based upon a $5,000 monthly income:
|Category||Dollar Amount Allocated||Allocations as Percentage of Budget||Recommended Percentages|
As you can see above, the total of all categories combines equals $5,000. This budget adheres closely to the recommended percentages, and it even manages to stay below the recommended percentage ranges in the Health/Medical and Recreation categories.
Creating Your Detailed Monthly Budget
In the previous section, we allocated targeted spending amounts based on our categories. Now, we will explore how to reconcile our actual monthly spending with these estimated allocations.
In order to utilize accurate expense figures, it is advisable to download copies of your monthly checking, savings, and credit card statements from your financial institutions. If you are doing a paper pencil-and-pencil budget, I recommend adding expenses by category using columns.
Once you have calculated categorical totals for the entire month, the final step is to add all categorical totals and compare the final sum to your allocated final sum. Again, in order to have a zero-based budget, these figures should be identical.
Possible Problems and Trends
As you are doing your first few monthly budgets, you are likely to encounter the following problems or trends:
- Spending more than the allocated targets in one or more categories
- Spending less than the allocated targets in one or more categories
Why? A budget is a rough prediction. Think of it as a rough draft of an essay. You will return to it and refine any errors at the end of the month. The previous mistakes you made will influence and impact your thought process as you create later budgets.
Two Serious Warning Signs and Solutions
The following are two warning signs that your budget is not working:
- Warning Sign: You consistently spend more than the allocated targets in specific categories.
Solution: Increase allocated funds for the category if you are within recommended ranges. If you are exceeding recommended ranges, implement measures to reduce spending.
- Warning Sign: Your spending exceeds your income.
Solution: Forgive me for shouting, but STOP OVERSPENDING! Stay out of restaurants, learn to like your old clothes, and ride your bike to save on gas. Alternatively, seek alternative streams of income.
Now that you understand the nuances of a zero-based budget, get started on yours today. A budget only takes a few minutes to assemble, but the rewards are potentially without limit. Getting on the right path, understanding your money, and controlling your money are keys to being a Finance Superhero. A budget doesn’t require sophistication, manipulation, or secret wisdom. It requires patience, intentionality, and a desire to be in control of your money.
Readers, how do you plan your monthly budget? Do you use automated software? Excel? Paper and pencil? How much time do you spend on your budget each month? Share your thoughts and burning questions in the comments section below.