Budgeting is an incredibly popular topic among the financially savvy. And yet some of the most financially-savvy people I know don’t actually budget. With zero based budgeting, there’s no longer any excuse to avoid a budget.
When you think about a budget, what do you think of? You might think of having umpteen different categories to divide all of your expenses among. Each time you make a transaction, you have to decide which category to put that expense into. And then what happens if you over-spend in one category? You have to decide which other category that expense comes from.
This can get really complicated really quickly. In fact, you could wind up spending hours and hours each month just managing your budget. I, for one, don’t have time for that!
Instead, I use a practice I call reverse budgeting. It can also be called zero-based budgeting.
Here, we’ll talk about how this works for me, how it might work for you, and some tools you can use to make it work.
How Zero-Based Budgeting Works
You may have heard about this type of budgeting from financial guru Dave Ramsey. Except he uses it to describe this incredibly detailed, category-oriented budgeting system we talked about above. That’s one way to do zero-based budgeting, but it’s not the only option.
At its core, zero-based budgeting is actually about subtracting all your expenses, savings, and goals from your total monthly income and coming up with a difference of zero. There are actually several different ways to make this process work for you. Let’s talk about the options, and then figure out what might work best for your particular needs.
Option 1: Percentage-Based Budgeting
This is the option my family uses. Frankly, we have too much on our plates to spend loads of time examining every purchase. Instead, we devote a certain percentage of our income to savings goals each month, and then spend the rest. We can basically spend up to what we devote to spending, and no more, since we don’t do debt.
For instance, you could decide to devote 20 to 30 percent of your total monthly income to savings. You might split this between long-term goals, like saving for retirement, and shorter-term but necessary goals, like saving up to replace your vehicle. Then, maybe you’ll save 10 percent of your income to pay for one-off expenses, like getting your tires replaced or dealing with home repairs. Then you can spend the remaining 60 to 70 percent of your income on your daily needs and wants.
This is a very loose way to go about budgeting, but it works for a few reasons:
- It’s easy to maintain. When you’re just shifting money around to savings accounts on payday and then keeping track of your balance, you don’t spend hours maintaining your budget. You can spend more or less in certain categories, as long as you don’t wind up going into debt.
- You pay yourself first. One of the first principles of personal finance is to pay yourself first. This means you need to save before you start spending. This type of budget has aggressive savings goals, and you start saving right away.
- You can use it to get out of debt. If you’re still working your way out of debt, this type of budget can still be helpful. You can, for instance, set aside a certain percentage of your income for savings, but then another percentage for extra debt payments. Outside of those categories, you can spend what you need to spend.
- We’re still frugal. We could maybe save a few extra bucks a month if we more carefully tracked our budget down to the penny. But we’re still pretty frugal, especially since we have high savings goals. By putting a bunch of money into savings each month, we force ourselves to live on less. And as we’ve gotten pay increases over the years, we’ve been able to devote more and more to savings rather than falling prey to lifestyle inflation.
- It’s easier for a variable income. If your base income varies or you have a side gig that brings in varying amounts of money each month, this is an easier option. Category-based budgeting can be tough when you don’t know exactly what your income will look like from month to month. With this option, you know that no matter what your income is, you save a certain percentage. And then you spend the rest. If your income is really variable, set up a system where you save extra in flush months to cover additional expenses in lean months. And consider lowering your savings percentage when your income for a particular month is really low.
With that said, this option isn’t for everyone. Some people need or want a much clearer picture of where their money goes every month. So here’s the other way to work a zero-based budget.
Option 2: Giving Every Dollar a Name
This is the budgeting option espoused by Dave Ramsey and his followers. And it’s not a bad way to budget. Basically, you start out the same way–with your total monthly income. But instead of just assigning a percentage to savings and the rest for spending, you detail your entire spending plan.
This means budgeting by category for things like your house payment, utilities, grocery spending, dining out spending, money for clothing, savings for holidays and birthdays, and more. You can get as broad or detailed as you want, though Ramsey’s budgeting templates are pretty detailed by category.
The goal here is to give every dollar a job before the month even starts. When you’re first starting out, you may find you need to move money from one category to another frequently. Over time, you’ll get more familiar with what you actually need to spend in each category on a monthly basis. But if you’re restricting your spending in this way, you shouldn’t ever need to spend more than you make.
Here’s what’s good about this more complicated budgeting option:
- It lets you know exactly what you’re spending. A zero-based budget tries to be prescriptive. That is, it tries to tell you what you should be spending in each category. But at first, you might be off base. As you track your expenses carefully, you’ll know better what you’re already spending and where you need to make adjustments to live frugally.
- It’s great for becoming debt free. If you’re dealing with a lot of debt–especially if that debt is due to your own over-spending–this may be the budgeting framework you need. Yes, it takes more time. But it also keeps you more closely in touch with your spending so that you can find ways to become debt free more quickly.
- It helps with projections. A very detailed budget can help you know not only what you are spending now but what you’re likely to spend in the future. When you’re careful to plan for expenses that are a few months out, you’re less likely to be stuck without enough cash in hand to cover those expenses when the time comes.
Option 3: A Hybrid Approach
What if you know you over-spend in some areas but don’t want to spend an hour every week controlling your super-detailed budget? In this case, a hybrid approach may make sense for you.
In this approach, you’ll still devote a certain percentage of your monthly income towards savings and short-term goals. Then, you’ll set a couple of categories to track your spending money.
For instance, maybe you have a problem over-spending on your kids’ clothes because you just can’t resist a good sale at Old Navy or Children’s Place. You might seem frugal because you’re only shopping sales. But at the end of the day, the kids have too many clothes, and you’ve spent way too much on them. In this case, track spending on your kids’ clothes for a few months, and see when and where you need to cut back. Just the act of holding yourself accountable for that spending can help you cut back!
Or what if your problem area is spending on food? Track all of your food spending for three months. Then decide if it’s too much or if you can cut back. If you dine out a lot, just seeing how much you’re spending on those trips to the restaurant can help you decide to cut back.
This budget approach is great because:
- It doesn’t take as much time as a detailed zero-based budget. You can spend just a few minutes a week totaling up spending in those chosen categories, and otherwise just spend what’s available to spend.
- It can help you become more frugal. If you’re struggling with over-spending in just a few areas, this option can quickly help you get that spending in check. You may find that you suddenly have more money for things that are actually more important to you, or that you can pay down debt or save more quickly.
Tools to Get it Done
No matter which of these zero-based options you choose, there are some great tools to help you deal with your budget. Here are a few that work really well:
Free Bank Accounts
Yes, this counts as a tool! This is especially true if your spending plan involves moving money around on pay day. Say you’re trying to save 20 percent of your income. On payday, you should be transferring that much straight out of your checking account. When your accounts are free, it’s much easier to maintain this option.
The best online savings accounts can also help if you want to divvy up your short-term savings goals. Maybe some of the money is for an emergency fund, while the rest goes towards vacation savings. Having a different account for each can let you keep track, at a glance, of where you are on your savings goals.
And this can also work for the hybrid budgeting idea. Say you want to restrict your spending on the two categories we mentioned above: clothing and dining out. Set up a checking out for these expenses, specifically. On payday, transfer the percentage or dollar amount you want to spend on these categories to their own checking accounts. Then, you’ll be restricted in the amount you are able to spend unless you dip into your primary checking account.
Online Budgeting Programs
Online budgeting programs have come a long way since we originally published this article in 2008. Now, you can easily import transactions in programs like Mint.com and YNAB. Sure, you have to spend a bit of time categorizing your transactions. But this is helpful if you’re doing a detailed budget or just tracking spending in a few categories.
Resource: Our list of the best budgeting tools
Want to go old-school? Use a spreadsheet to track your percentage of savings and spending over time. You can even create a chart to show you how your savings is growing, and how much money you’re spending month to month so that you can figure out if you need to cut back.
The point here is that zero-based budgeting is a great option for most budgeters. Whether you opt for a super detailed plan or a very loose one, this type of budgeting can help you make the most of every dollar and reach your financial goals.