Budgeting lies at the foundation of any financial plan, but that doesn't mean that budgets should be one-size-fits-all. In fact, people use all kinds of budgeting strategies with varying degrees of success, including cash envelope systems, elaborate spreadsheets and everything in between.
One type of budget that has remained popular and effective over the years is the zero-sum budget. This brand of budgeting works because it gives each dollar "a job," forces you to live within spending parameters you set, and uses your actual income instead of projections. Here's how it works.
How zero-sum budgeting works
Zero-sum budgeting becomes effortless once you get started, but there are certain principles that must be followed to make it work. The first thing to know is that your zero-sum budget will be based on last month's income. Generally, that means that you'll need to save enough money to go an entire month without touching your regular income. Once you've figured out how to accomplish that crucial step, you simply need to get started. The following outline shows you exactly how to do just that:
- Start by tracking your spending from previous months. Figure out how much you spend monthly in all significant categories such as fixed expenses, food, entertainment and transportation. Add additional categories that make sense with your specific situation.
- Write how much you've spent in previous months down on paper. Figure out which categories are ripe for cuts. For example, if you're spending far more than you'd like on groceries or entertainment, consider whittling those totals down by 20 to 40 percent.
- Create a written plan for the upcoming month. Create categories for next month's spending based on the modified spending you've decided on from previous months. Write it down.
- Make your plan inclusive. When coming up with next month's plan, set yourself up for success by budgeting for any expense that is likely to come up. In order words, don't forget to budget for things like gifts, doctor visits, miscellaneous expenses and debt repayment.
- Compare your planned spending against last month's income. If you plan on spending less than you earned, allocate the difference (last month's earnings minus your total planned spending) to savings and add it as a line item on your budget.
- Look for more places to cut. If the amount you think you can save is not nearly enough, look for additional ways to save. For example, consider cutting planned spending for the "extras" such as cable television, hair care or entertainment as low as they can go.
- Follow your zero-sum budget exactly as planned. As the month progresses, check in to see how your spending is panning out in each category. Check bills off as you pay them and keep an eye on your totals to make sure you stay on track.
If you fail at zero-sum budgeting when you first start out, it is important to keep trying until you get it right. Most zero-sum budgets require a certain amount of tinkering, and it's not out of the ordinary for some ongoing work to be required.
Also, it is equally important to remember to pay yourself in savings as if it were a regular bill. That could mean making a bank transfer to your online savings account at the beginning of the month. If your current account isn't paying very well, you might also look into finding a savings account with a higher interest rate.
A zero-sum budget in action
Let's explore zero-sum budgeting further by taking a look at a real-life example:
Suppose you earned $4,000 last month and spent every penny on fixed bills and living expenses, including $700 for rent, $500 for transportation, $500 for insurance, and $300 for utilities. However, combing over last month's bank statements, you notice that you spend $1,000 on groceries and eating out, $500 on movies and entertainment, and $500 at the mall. No wonder you didn't save anything, right?
Using a zero-sum budget, you might be able to allocate your funds in a way that makes more sense:
- Rent: $700
- Car: $500
- Insurance: $500
- Utilities: $300
- Food: $500
- Entertainment: $200
- Shopping: $150
- Savings: $1,150
In this example, $1,150 in monthly savings were realized by cutting the budget for food, entertainment, and shopping significantly and funneling that money into savings instead. Further savings may also be found by looking for ways to cut insurance, utility and transportation costs.
The benefits of zero-sum budgeting
Tracking your spending can be an eye-opening experience in itself, but putting limits on your spending -- especially if it's the first time -- can be downright painful. After all, telling yourself "no" isn't necessarily a pleasant experience, and neither is going without.
On the other hand, zero-sum budgeting can be extremely lucrative and rewarding. Imagine going from a paycheck-to-paycheck existence to saving hundreds of dollars in a matter of months. Those savings could then be used for the things that matter most: retirement savings, college, a down payment on a house and more.
All of that aside, the biggest benefit to using a zero-sum budget is that it forces you to come face-to-face with the reality of your situation. It forces you to take a look in the mirror and evaluate where you've been, as well as create a plan for where you want to go.