I’m not going to beat around the bush today.
I don’t really care about trying to draw you in with some exciting introduction or illustration to get you to scroll down the page and read the rest of this post.
Because today we’re talking about budgeting.
And budgeting is not fun.
“Budgeting is boring.” “Budgeting sucks.” “Budgeting is for nerds.”
I’ve heard it all.
But guess what?
Budgeting is what you need to be doing to actually save money, get rich, and retire comfortably.
Budgeting is what will help you become debt free, buy a house, save for college, build up your nest egg, and give to the causes and people you care most about.
Making a budget is the key to becoming successful financially.
If those things sound good to you, then budgeting is what you’ve got to do. And I don’t want to sugarcoat it because unless your name is J.Money (from BudgetsareSexy), budgeting is boring.
SO if you’re ready to learn how to budget, then this guide is for you.
Read it. Put it into practice. Take action.
And you’ll start saving money.
You’ll start reaching your goals.
You’ll start to chip away at your debt, save for that vacation, and be less stressed about your retirement.
If those things sound good to you, then do the hard work and make a freaking budget.
Now, if you want budgeting to be slightly more fun, I have 3 recommendations:
- Dark Beer… because IPAs are never worth the money.
The one thing most personal finance experts can agree on is that the best way to budget is the one you are most likely to stick to. The most perfectly crafted budget is worthless unless you actually follow it.
But there are *better* ways to budget than others. There are strategies that are proven to work well, be more effective, and help people save more money.
My personal favorite way to budget is the zero sum / zero based budget.
What is Zero Based Budgeting?
A zero based budget is pretty simple. The goal is to allocate every bit of your income until you have zero dollars left to assign.
You start with your income, subtract out your expenses, and then decide where your monthly surplus is going to go.
The premise behind zero based budgeting is that every dollar is put to work. At the end of the month, there shouldn’t be any money left in the budget.
That does NOT mean you should spend every dollar you bring in, but it means that any surplus is going towards a specific goal (savings, retirement, debt payoff, downpayment, vacation, kids college, etc).
The magic of this kind of budget is that every single dollar is given a job. Either it is being used to pay for something you need or it is going directly towards your goals! No dollar is left behind or wondering what to do.
Let me give you an illustration.
I’m a middle school youth pastor and whenever we take the kids on a mission trip, I have one serious piece of advice to all of our leaders.
The key is to make sure every kid is assigned a job. The second they aren’t working or kept busy, they’ll find a way to break something, wander off, or get into trouble.
Your money is the same way.
When we have money in our budget that is not assigned anywhere, either to expenses or to savings, then it tends to end up slipping through our fingers. It gets spent on small things like coffee and work lunches. The money not assigned ends up wandering away from our bank accounts.
When every dollar is assigned a job, your budget will be as effective as possible
But the zero based budget isn’t for everyone…
Who is the zero based budget good for?
If you have a steady income, then the zero based budget is probably the best option for you! The more steady your income is, the less changes you’ll have to your monthly budget. The less changes, the more consistent you can be and the less work you have to do to make adjustments.
When your income and spending are consistent, you have the ability to automate more of your budgeting.
Willing to work hard to get max results
There’s no way around it. The zero based budget takes a bit more work. When you have budget plans that don’t involve making sure every dollar is used the right way, you don’t have to track every dollar.
That usually means that more of your money is NOT being used effectively.
If you’re willing to put in an extra hour a month, you can achieve max results.
Personally, I think if you’re disciplined and want your money to be used most effectively, the zero based budget is for you.
If you’d rather budget by feel, gut, or what you “think you are spending,” then go for it.
But if you don’t actually know where your money is being spent each month, then you really aren’t budgeting. You’re just trying to be mindful about your spending.
Being mindful about your money is not the same as having a written out plan of attack.
Think about it in terms of an hourly rate.
If spending an hour each month tracking your spending and sticking to your budget saves you an extra $100-200 a month, wouldn’t that absolutely be worth it?
If it’s not, then you are probably making enough money to not worry about a budget.
How to start a zero based budget?
If you’re still reading, take a sip of whatever you’re drinking, open up an excel tab, and let’s get ready to make a budget.
That’s right. Excel.
Or a google spreadsheet if you’re feeling fancy.
Not Mint. Not YNAB. Not Every Dollar. Not Level.
For now I want you to be hands-on and changing the #’s in excel is honestly the fastest way to put the pieces together. Once you’ve done that then you can pick any budgeting software you want and run with it. That being said though, You Need A Budget (YNAB) is definitely my favorite. A friend of mine recently published a big YNAB Review that you should check out!
Let’s walk through my simple 5 step system to start a zero based budget. Follow these steps as closely as makes sense for your own financial situation.
Step 1: Figure out your after tax income
The first piece of your budget is the income you bring home each month. The easiest way to figure this out is to jump over to your checking account to see how much your employer direct deposits into your account each month.
If you are “regularly employed” then your employer withholds taxes for you. If you are self-employed or a contract employee, then things get a bit trickier.
Personally, I like to input my pre-tax and after-tax income in my spreadsheet so I know how much is being taken out to go to Uncle Sam. Lastly, if you are already setting aside money pre-tax for a 403B, 401K, or anything else, then go ahead and add that back into your after-tax salary.
Don’t worry, you’ll get to retirement savings in step 4.
Step 2: List out all monthly Expenses
Once you’ve got your income figured out, the next step is to identify all of your monthly expenses. I like to break this down into two subcategories: fixed and variable expenses. Anything that you pay on a yearly basis, hold off on those for now! You’ll do them in step 3.
Fixed expenses are all of the line-items in your budget that don’t change month to month. Things like rent, your mortgage, insurance, or any kind of memberships/subscriptions.
- Rent / mortgage
- Insurance (car, home, health, life) if paid monthly
- Gym membership
- Cellphone / Wifi
- Subscriptions of any kind: DollarShaveClub, Netflix, etc.
- Prescriptions for medicine
- Tithe / Fixed giving
- Minimum payments on all forms of debt: car payment, credit card, student loans, etc.
Now what I’m about to say is super important!
“Fixed” does NOT mean that these things can’t ever change!
You could downsize to a smaller place, cancel a membership, negotiate a lower rate, increase your charitable giving, and if you pay off a loan, then that payment is gone for good!
Variable expenses are exactly what they sound like. They can change month to month depending on your spending and consumption habits. Some months you may spend zero in a category and other months you may go way overboard.
- Eating out
- Travel set-aside
- Utilities (water, gas, electric)
- Personal allowances: clothes, luxury coffee,
- School expenses: books, books, and more books.
Personally, we like to create fewer categories that are more encompassing because it’s less work for us to actually track.
We could separate out a category for things like alcohol, house supplies, makeup, etc but we buy all those things from the grocery store, so we lump it all together.
Step 3: Identify all non-monthly expenses
The third step in making a budget is figuring out how to plan and budget for your non-monthly expenses. We’re talking about all things you pay on an annual basis like home insurance, yearly memberships, etc.
In this step I like to kick it up a notch and include any upcoming expenses that you can plan for. Think about it this way… Christmas comes around every single year, yet most people fail to plan and save for it throughout the year. Christmas comes and their only option is to put it all on the credit card.
Let’s say that your tires are starting to lose their tread. You know you only have a few more months until you have to replace them. Most people would ignore the problem and when the time comes, find the cheapest set and put it on the card.
This is the area that trips up most people.
But you’re better than most people.
You’re in the middle of putting together an air-tight, rock-solid budget. Silly things like annual subscriptions and Christmas gifts aren’t going to stop you from hitting your goals.
Here’s a quick list of things that might fall into this category:
- Home insurance / taxes
- Yearly memberships: costco, amazon prime, etc.
- Annual pet
- New tires
- Home repairs
- Pet vaccinations
The best way to budget for non-regular expenses is to create what’s called a sinking fund.
If you want to really get granular, you can check out my Ultimate Guide to Sinking Funds.
But I’ll give you a quick primer here… Take another sip of your scotch or coffee. Eat a cracker. This is boring but helpful.
A sinking fund is an account created to set aside money for the upcoming payment on an expense. Often used for annual recurring payments or large future expenses such as home or vehicle repair.
So basically, you’re going to figure out what all of your annual or expected expenses are and then divide them by however many months you have to save for them.
- If you pay $1,000 in car insurance every 6 months, you’ll need to set aside $166 each month.
- If you plan to spend $600 on Christmas this year, then set aside $50 a month.
- If your contacts cost $500 a year, then set aside $42 each month.
So add them all up, get a monthly total, and you’re going to set up your checking account to automatically transfer that money to your savings account.
Now, whenever those things come up, you’ve already got the money sitting there, ready and waiting for you to spend!
That’s smart budgeting.
Step 4: Make some goals
At this point, you have the biggest pieces in place. You know your income and expenses, and now you can figure out your monthly surplus (or deficit!).
We know we have a surplus of around $2,250 each month to work with.
If you have a deficit, then before you move on you gotta find some ways to spend less.
But if you have a monthly surplus, GREAT!
Let’s figure out what to do with it.
Essentially these goals are going to be seen as line-items in your budget.
If you already know what your financial goals are, great! Create an “expense” for each one and add them on.
But if you aren’t sure where to go from here, let me give you some suggestions. I’ve also got a full article on how to balance chasing multiple financial goals.
Here are 8 possible financial goals you might have
- Emergency fund
- Debt payoff
- House downpayment
- Travel / vacation
- Home improvement
- Wedding / honeymoon
- Kids college funds
- Start your own business
Now, it’s your turn! Do you have an emergency fund? Do you have debt to pay off? Are you trying to buy a house in a few years?
Make a quick mental or written list of your financial goals. Put these into your spreadsheet so that you can remember them!
Any time I meet up with people in real life to coach them on their finances, I walk them through my quick 3 step plan for prioritizing their finances early on.
- Emergency fund of 2 months expense (link to further reading)
- Contribute to retirement accounts to meet your employer match
- Pay off all high interest debt (4.5% +)
The key is to get yourself in a secure place with your finances so that you can start building wealth from a position of strength rather than weakness. Starting an emergency fund and paying off your high interest debt is KEY to being strong in your finances.
Plus, when you have all of your debt paid off, that’s an extra chunk of money that can go towards your goals each month.
The goal in this step is to funnel all of extra cash each month towards your goals. This does NOT happen by accident.
My wife and I have 5 main goals right now:
- Re-fill our emergency fund ($5k)
- Pay off our car loan ($4k)
- Contribute the max for my 2018 Roth ($2k)
- Contribute the max for my 2019 Roth ($6k)
- Max out her 403B ($19k)
Step 5: Reach zero
The last step is simple! You want your income – expenses – goals to equal zero! That’s why this whole thing is called a zero based budget.
We want every single dollar allocated towards a goal.
If you have a surplus, you should increase one of your “goals” so that you can balance it out.
If you have a deficit, then ideally you can find a way to decrease your spending, but if you have to cut one of your goals line-items, then do what you gotta do.
My wife and I cheat a little bit and have a “miscellaneous” line-item in our expenses that covers all of the small things that can come up any given month.
The 1-2 Punch: Income & Frugality
The goal over time is to find ways to decrease your monthly spending and push all that money towards your savings goals.
The more you can cut from your budget, the more dollars you have being put to work for you.
Every dollar you spend is gone forever, but every dollar you save can be used to buy back time, freedom, and security.
Keeping your expenses constant over time or even lowering them is crucial to saving money and building wealth.
Just as important though is increasing your income.
As you earn more money through your full-time job or side-gigs, the best thing you can do is put that towards your savings goals.
With the 1-2 punch of frugality & increasing your income, you’ll be on the fast track to reaching all of your financial goals.
3 Strengths of the Zero Based Budget
The zero based budget is my #1 recommendation to people who are trying to take control of their finances so that they can save more.
1. Extremely effective
The zero based budget is an extremely effective budgeting method because every single dollar is given a job. If you’re able to stick to your budget, then you’ll be so successful at saving money that you might even surprise yourself.
2. Saving more money
The key to really being effective with the zero based budget is to continually optimize and funnel more money towards your “goals” section. If you do this right, this is one of the biggest strengths of the zero sum budget.
You can design it to help you put more and more money towards your goals.
As you cut expenses and increase your income, the amount allocated towards your goals should be the only place you increase.
Over time, you’ll be saving more money each month than you’re spending!
3. Knowing what you spend
The majority of people have no clue what they actually spend their money on each month. They don’t know how much they spend on food, entertainment, gas, or what their average utilities cost. Many don’t even know their phone bill or how much their car loan is.
When you know exactly how much you’re spending each month, you can make informed decisions about your finances.
For a while, I’ve neglected the habit of tracking my spending, but it is by far one of the most important steps you can take if you want to save more money.
3 Weaknesses of the Zero Based Budget
Even though I am a HUGE fan of the zero based budget, I know it isn’t perfect. The reality is that no form of budgeting is.
1. Takes more time to track
This is by far the biggest challenge for most people.
When you track where ALL of your money is going–every single dollar–it takes more work to track. It’s much easier to just go with the flow and budget “by feel.”
The reality though is that if you want any form of budgeting to work, you will have to track your spending. If you aren’t willing to do the hard work of tracking where your money is going, then no budget on earth will work for you.
This is a weakness of any form of budgeting.
You can either choose to do the hard work & get results–or say no and continue to spin your wheels.
2. Hard to predict all expenses
The hardest part of a zero based budget is predicting all of your expenses.
No matter how thorough you are, there are going to be things come up that you didn’t expect. At times, that can throw a wrench in your budget, but if you create a catch-all line item like “miscellaneous” or “random,” then you’ll be fine.
The goal of a zero sum budget is to get as close as possible.
3. Not good for variable income
If you have a variable income, then you have unique challenges when it comes to managing your money. The whole idea of a zero based budget is knowing what your income is and budgeting every bit of it as effectively as possible to reach your goals.
When your income changes each month, then your zero sum budget would have to also change each month.
The truth though is that anyone with a variable income will have a harder time sticking to any kind of monthly budget.
However, that doesn’t mean it can’t work.
I’ve actually been working on a guide on budgeting with a variable income, but until I write my own, here are two great articles: Slaying the Variable Income Dragon and How to Budget on an Irregular Income.
10 Budgeting tips for a zero based budget
If you like the idea of starting a zero based budget, then GOOD FOR YOU!
I’m seriously so glad that you are taking control of your finances. I’m pumped to hear that you are wanting to improve your financial future.
Here are 10 tips for zero sum budgeting
- Overestimate variable expenses. A little wiggle room helps.
- Negotiating your fixed costs gives you a high return over time with no ongoing effort. Try to negotiate your bills, memberships, cell phone plan, wifi, etc.
- Look for 1% improvements to your finances. Every small improvement can add up big time.
- Focus on reducing your “Big 3” expenses: Housing, transportation, and food.
- Use cash-back apps to lower your everyday spending… Check out my super detailed Ibotta review.
- Budget in money for car repair, home repairs, etc.
- Automate your “goals” section by setting up transfers to increasing your retirement contribution.
- Set-up autopay for your credit cards
- Set up your checking account to automatically transfer to your sinking fund or IRA accounts
- If married, for the love of all things good in the world, walk through this whole process with your spouse.
Big Takeaway: Make a Budget Today!
Once you’ve got your budget in place, the key is to make sure to track your spending! Check our our most recent post on why we’re getting back to tracking our spending! Zero based budgeting is just one way to budget. If it doesn’t work for you, check out these other 7 Best Budgeting Methods.